Invest in gold: Diversify your portfolio

Buying gold is the oldest kind of investing activity that is important to hedge against volatility and inflation. While it may provide a safe haven during ambiguous circumstances, its pros and cons must be taken into account

Traditionally, gold has been an important investment avenue for almost every Indian household. In fact, we Indians love gold and hold it in high regard.  We keep it safe for our future generations. In fact, the custom of gifting gold to brides was to provide her with a financial back up and secure her future. It is estimated that about a large part, around 700-800 tonnes of India’s gold imports go into the making of jewellery.

Women and families often think of gold jewellery as an economic substitute to money. Even now, gold has not lost its glitter amongst different investment options, like stocks, bonds, mutual funds and real estate, just to name a few. Historically, gold offers a perfect hedge and stability whereas the markets do not since it has an inverse relationship to equity investments.

Take for example, if the equity markets start performing poorly,  gold normally performs well. Considering gold as an investment option in your investment portfolio will act as a buffer for the overall volatility of one’s portfolio. Additionally, gold investment 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.

The world has become more inter-connected now and whether there are tensions in the Middle East, Africa or elsewhere, it is increasingly becoming obvious that political and economic uncertainty is another reality of our modern economic environment. Gold, too, is considered as a safe-haven during ambiguous circumstances.

In fact, history is full of collapsing empires, political coups, and collapse of currencies. During such times, investors, who have held gold, were able to successfully protect their wealth. In some cases, people even use gold to escape from turmoil. Consequently, whenever there is any news event that hints at some type of global economic uncertainty, investors often buy gold as a safe-haven.

Any rational investor should include gold into his/her portfolio to provide stability and diversify options against sharp movement in equity and bond prices. One can invest in gold in several ways.

• Gold exchange traded funds (ETF) are simple investment products that actually combine flexibility of stock as an investment and simplicity of gold as an investment. ETFs trade on the cash market of the stock bourses, like any other company stock, can be bought and sold continuously at market prices. Gold ETFs are excellent passive investment instruments that are based on gold prices. They invest in gold bullion. ETFs, because they are backed by gold, 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 investors who would like to invest in gold but do not want to suffer the hassles and bear costs of storing and safeguarding physical gold.
• Gold equity funds invest in 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, these funds 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 gold 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 mean they carry the risk associated with shares. Third, there also exists the 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 gold has become much easier and convenient now. With the Union Government’s SGB scheme, an investor can earn an assured interest rate, thereby eliminating risk and cost of storage.

The Sovereign Gold Bond 2018-19 Series has a subscription price of Rs 3,114 per gram and one individual can buy a maximum of four kg. SGBs provide attractive interest rate with an asset appreciation opportunity. The annual interest rate offered is 2.5 per cent and 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. SGBs are the most efficient way of investing in gold from an investment point of view if one can stay invested 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 gold ETFs.

Like every investment, investment in gold also has its pros and cons. However, including gold in the investment portfolio is very important 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 and 30 per cent .

(The writer is Assistant Professor, Amity University)