A golden investment

by December 6, 2019 0 comments

Putting money in gold has its pros and cons. However, including it in the portfolio is vital to hedge against volatility and inflation

Indians have a major love for gold and hold it in high regard as a safe investment option and a nest egg for future generations, especially women. It is estimated that a large chunk of the 700-800 tonnes of gold that India imports goes into making jewellery as women and families traditionally like to think of it as a substitute for money. Even now, gold has not lost its glitter among the host of investment options available like stocks, bonds, mutual funds and real estate, to name a few, as historically, it offers a perfect hedge and stability when the markets do not. This is because it has an inverse relationship to equity investments.

For instance, if the equity markets start performing poorly, gold would have performed well. Adding the yellow metal to an investment portfolio forms a buffer against overall volatility. Additionally, putting money in gold is worthwhile because it is an inflation-beating investment. Over a period of time, the return on gold investment is in line with the rate of inflation.

Increasing political and economic uncertainty in the country and globally is a harsh reality of the times we are living in and it affects the economic environment everywhere. Hence, gold is considered a safe haven in ambiguous circumstances. In fact, history is full of falling empires, political coups and the collapse of currencies. During such times, investors who held gold were able to successfully protect their wealth and in some cases, even use the commodity to escape from the turmoil. Consequently, whenever there is news that events might lead to global economic uncertainty, investors often buy gold as a safe haven.

Any rational investor should include the yellow metal in his portfolio to provide stability and diversify against sharp movement in equity and bond prices.

People can invest in Gold Exchange Traded Funds (ETFs). These are simple products that combine the flexibility of stocks and the simplicity of gold as an investment. ETFs trade on the cash market of the stock exchanges, like any other company stock. They can be bought and sold continuously at market prices. ETFs are excellent passive instruments that are based on gold prices and invest in bullion. Because they are backed by gold, ETFs have complete transparency. Due to their unique structure and creation mechanism, ETFs have much lower expenses as compared to physical gold holding. Gold ETFs are ideal for those who would like to invest in the yellow metal but do not want to suffer the hassles and bear the costs of storing and safeguarding it.

Gold equity funds invest in the shares of firms that are involved in gold mining. These are pure equity funds and are often international in nature since there are not many listed gold mining firms in India. Like any other stock fund, they can deliver much higher returns than pure gold. But when gold prices are low, mining companies shut mines as the cost of production is higher than realisation costs. Stocks of such mining companies were battered for many years. Investors have to deal with three risks in these funds. First, returns from these funds are dependent on gold price movement. Second, these gold funds invest in stocks, which means they carry the risk associated with shares. Third, there is also currency exchange risk. This means if the rupee appreciates, returns can get affected. Gold equity funds are best suited for sophisticated investors and are not ideal for a retail investor.

With the advent of the Sovereign Gold Bond (SGB) scheme investing in the yellow metal has become much easier and convenient now. With the Union Government’s SGB scheme, an investor can earn an assured interest rate, eliminating risk and cost of storage. The SGB 2018-19 Series-I has a subscription price of Rs 3,114 per gram and an individual can buy a maximum of 4 kg. SGBs provide attractive interest rates with an asset appreciation opportunity. The annual interest rate offered is 2.5 per cent and the interest is tax free. The redemption is linked to gold prices. There is 100 per cent elimination of risk and cost of storage. Also, SGBs are exempt from capital gains tax, if held till maturity. The bonds carry a tenure of eight years with an option to exit from the fifth year onwards. SGBs are the most efficient way of putting money in gold from an investment point of view if you can stay put for five years or more. Importantly, indexation benefit is available if the bond is transferred before maturity. Gold bonds score high on liquidity as they are tradable on the exchanges. Also, they can be collateral against a loan, an aspect that is missing in ETFs.

Like every investment, putting money in gold also has its pros and cons. However, including it in the portfolio is vital to hedge against volatility and inflation. Depending upon the economic, financial and political situation, the level of diversification should range anywhere between five per cent to 30 per cent.

(Writer: Hima Bindu Kota; Courtesy: The Pioneer)

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