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Why Gold Is An Essential Evil In Your Portfolio?

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Importance of Gold in Portfolio

Gold prices touched all-time highs at ₹59,500 per 10gm. Since the beginning of 2022, gold prices have gone up by ~20%. Gold was the best-performing asset class last year beating other asset classes like equities and debt by a huge margin. 

Reasons why gold prices soared: 

  • US dollar rates hit a 9-month low, causing the price of gold to rally in the domestic and international markets. 
  • Budget 2023 increased import duty on silver from 7.5% to 10% bringing it to par with gold. The 5% agriculture and infrastructure cess make the total duty payable at 15%. Overall imported jewelry in all precious metals and article made of gold and silver now attract an import duty of 25% as against 20% previously.
  • Capital gains tax has been exempt from the conversion of physical gold into Electronic Gold Receipts (EGR), boosting the financialization of gold.

What has one missed because of the absence of Gold in the portfolio?

Gold as an asset class is considered to be a haven. This is because of its inverse relationship with that of other asset classes such as equity. When equity markets are under stress, gold prices tend to go up as investors seek to shift their investments to gold. Historically gold returns have averaged around 9% for Indian investors. In the last 5 years, gold prices have almost doubled delivering CAGR returns of 14.5% compared to the Nifty 50 which has gone up by 63% in the same period. 

A peculiar thing about gold is that it can lie low for long periods and then compensate through spectacular results. The sharp rally seen particularly post covid is a case in point. 

However, over longer periods, the high returns have more than often compensated for occasional sub-par ones. 

Historical Gold prices

Source: Google Finance

Physical Gold v/s ETF v/s SGB

Gold is a go-to investment in India and is considered very auspicious. The government has introduced alternatives to physical gold in the form of Gold ETFs and sovereign gold bonds. One can opt for which form they choose to invest in based on their needs,

Physical gold is freely available in India and can be liquidated easily in return for cash. It is however taxed as capital gains depending on the holding period and it can be difficult to store as it has a high risk of being stolen.

Gold Exchange Traded Funds (ETFs) are mutual funds that invest in gold bullion and track gold’s domestic prices. They are backed by gold with a purity of 99.5%. Gold ETFs are in dematerialized format and are an alternative to physical gold. One unit of Gold ETF is equivalent to one gram of gold and is listed on exchanges like NSE and BSE.

Sovereign Gold Bonds are government securities issued by RBI, they are denominated in gold, with each unit being one gram of gold. These debt securities offer fixed interest on the investment and can be sold in the secondary market and earned through capital gains. SGBs are held in the form of certificates and can also be converted into dematerialized forms. Hence there is no risk of theft or additional storage costs.

Why Gold Is a Good Investment?

  • Diversification tool: The idea behind portfolio diversification is that there should be very little or no correlation between financial instruments and products. Historically it has been proven that gold has a negative correlation with equities and fixed income instruments. The year 2008, which witnessed the global financial crisis, was superb for gold but disastrous for equities everywhere in the world.
  • Hedge against inflation and protection against deflation: Historically, during the periods of extreme inflation, gold prices have risen and the stock markets, globally, have crashed. With high inflation, the local currency loses its purchasing power but gold tends to hold the value and rise against the domestic currency. During the episodes of decreasing prices, that is deflation, people tend to hold liquid cash as well as gold, soaring the price of the yellow metal.

Performance of Gold during periods of high inflation

  • Safe Haven Asset: Demand for gold rises during geopolitical uncertainties, pandemics, and crises as physical gold which is a high-value asset, can be easily transported, and also liquidity is such that it can be easily converted into cash in any part of the world.
  • Demand and Supply Factor: Continuous supply of gold is difficult as extracting gold from mines is a multi-year exercise involving a lot of efforts, but demand for gold can shift in no time depending upon the economic conditions and thus fluctuate.
  • Liquidity: The globally accepted commodity which is bought and sold in huge volumes, can be easily converted into cash, making it liquid.

Gold is one of the most liquid assets traded in the world

How Much Gold Should an Investor have in his/her Portfolio?

Now that it’s clear as to why gold should be a part of the investment portfolio, the next important step is the percentage of allocation. It should be noted that there is no specific ratio or a perfect method to calculate the allocation of gold in one’s portfolio. However, historical evidence suggests that along with the percentage of allocation, the reason for allocation is equally important. 

  1. If one invests in gold to achieve portfolio diversification, then historically it has been seen that a 10%-20% allocation does reduce the average returns slightly, but it significantly reduces the standard deviation. A greater allocation (more than 20%) towards gold reduces the average return substantially but unlike the above situation, the allocation fails to reduce the standard deviation.
  2. If one invests in gold from a safe haven perspective, there isn’t a simpler way to quantify the allocation of gold, but a wide range of 5%-20% is considered, depending upon the economic conditions. 

While it is true that historical perspectives are used many times in the above article, they should only be used as guidance to invest in the future.

Conclusion

If one already holds gold in the physical form or through SBGs and ETFs it is best to reach out to a registered financial advisor who can help balance the portfolio to match the risk profile and financial goals of the holder. It is important to have a diversified portfolio that matches investor needs. Thus gold will and should remain a necessary part of an investor’s portfolio.

While it is true that historical perspectives are used many times in the above article, they should only be used as guidance to invest in the future.

Disclaimer: Above piece is only for information purposes. Please consult a SEBI Registered Investment advisor before taking any investment decision. 

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