Should investments in gold be a part of your portfolio?

Madhusudhanan Raghunathan

All of us have seen or heard advertisements related to investments in gold. Hedge against the market fall is a strong pitch for any gold or gold-related products. But the basic query of the layman on whether gold should form part of his strategic portfolio still remains unanswered. In this article, we will assess if investments in gold should be a part of your portfolio?

  • Safe haven – Gold is traditionally viewed as one of the safest investment instrument. It is an instrument that has the potential to appreciate during times of geopolitical crisis or political instability. A wise investor normally looks at gold as an insurance for the portfolio against any financial market crisis.  Any domestic or global events that have a potential to make the financial market participants nervous like Brexit, Geopolitical tensions in the Middle East, a nuclear threat from North Korea, Tightening of monetary policies by central banks, makes buying gold-related instruments as a lucrative proposition
  • Hedge against inflation – Gold is a classic product that provides hedging against inflation given price of gold generally tends to rise during an inflationary period. With an increase in the cost of living, the value of gold holdings also increases thereby protecting an investors’ purchasing power. We, at ORO, found that while inflation increased by around 8-9% over the past 15 years, gold has offered around 12-14% returns during the same period thus protecting an investor from inflation.
  • Liquidity – Gold is an acceptable instrument to provide easy liquidity either a security for gold loans or can be sold to any jeweler.
  • Source of diversification – We have been always taught in school that one should never keep all eggs in one basket. The proverb applies very well to the financial market and this is nothing but diversification. Diversification in simpler language is nothing but spreading investments across different asset classes. In order to safeguard investments across different investment instruments, an investor should ideally invest in instruments which are negatively correlated or have a low correlation which means that rise or gain in one asset category is typically accompanied by nearly equal and opposite movement in another asset category. Gold as an asset class has a negative correlation to equities and has a low correlation to fixed income asset classes. Thus, investment in gold helps in reducing the volatility of a portfolio without necessarily sacrificing expected returns.

How to look at gold allocation in the portfolio?

Gold because of its negative correlation with equity markets, lower correlation with debt instruments, ability to leverage, safe haven status and protection against any financial crisis,  thus, gold should always form a part of an investor’s portfolio. However, what is more, relevant and important at this point is how much of the portfolio should be allocated to gold. We believe for an investor ideal approach would be to diversify investments across all three key asset class namely – equity, debt, and gold. This approach, to our belief, provides added advantage of an improved risk-return profile of the overall portfolio. Given the return and risk profile of gold, it should not account for more than 15% of the total portfolio.

How to invest in gold?

Now when the question of should an investor invest in gold is amply clear, let us look at the ways of investing in gold.

  • Physical Gold – Physical gold can be bought in different forms such as gold bar and gold coin. These forms can be in different sizes such as 1 gram, 2 gram, 5 gram,10 gram, 20 gram, and 50 gram and the likes. However, holding physical gold also brings in certain disadvantages such as no utility value, the risk of being stolen, require an adequate arrangement for storing, trust issues with the purity of the gold.
  • Jewelry – one of the other ways of creating utility for physical gold is to convert gold into jewelry. It goes on without saying that in India demand for gold jewelry is always soaring. However, this brings in conversion charges from raw gold to jewelry in form of making charges and/or wastage taken by jewelers.
  • Gold Funds and Gold ETFs – This mode is becoming increasingly acceptable from an investment perspective. Gold fund and/or ETF are nothing but passive investment in gold. In gold funds, while an Asset Management Company invests in gold on an investors behalf and provides units in the fund in return for an investment. Thus, a gold fund provides an opportunity for small investors to invest in gold without having a concern in relation to the quality of gold, storage etc. Gold ETFs are gold funds that are traded in an exchange. Gold ETF allows an investor to trade and invest in gold in real time through exchanges by way of Gold ETFs
  • E-Gold –E-gold is an instrument that can be bought on a commodity exchange through a broker who is a member of the exchange. Typically, each unit of e-gold is equivalent to 1 gram of physical gold. This e-gold is held in a demat account. E-gold has ad advantage of getting converted into physical gold at any time by way of re-materialization.
  • Shares of companies dealing in gold – An investor may also look at investing in companies that are engaged in gold mining and/or gold trading. However, by way of investing in shares of these companies, an investor not only thinks positively about the future prospects of gold prices but also have enough faith in the management of the company.
  • Sovereign Gold Bonds – The government, with an aim to reduce to parking of physical gold in Indian households, have launched the sovereign gold bond scheme. These bonds offer the investors a return that is equivalent to holding physical gold along with a nominal interest in the investment. Given the money is lent to the government in this case the safety is completely assured. Further, for investment in such bonds, there is no requirement of opening a demat account. Liquidity in these bonds are offered by trading in stock exchanges and the government also provides a tax exemption on these bonds if held until maturity.

To conclude we can say that gold should be a part of every investors’ portfolio but its allocation should not be more than 15% of the overall portfolio with gold funds and sovereign gold bonds appearing to be the best way of holding Gold through the choice really boils down to what is convenient for an investor.

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Madhusudhanan Raghunathan
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