The yellow metal is an essential ingredient of any investment portfolio for many centuries. It is not just private individuals who invest in gold but also institutions. The central banks or the reserve banks around the world invest in gold in a major way. They keep it as part of their reserves. When they find the prices low, they buy gold, and they also sell gold when they realise that the prices have moved up too high.
This is part of their reserves management business. They also use the backing of gold for the currency issue in their respective countries. The interest of the central banks is mainly in the context of their reserves management. When it comes to individual investors, the considerations are quite different. While traditionally in India gold has been mainly used for ornaments for men and women, and also for use of the same at social events and weddings, this is just a small aspect of the use of gold. But gold has passed this stage and the investment in gold has come to be considered for several other reasons other than its social and aesthetic value.
Gold, like real estate, is something that does not give you regular cash flows in the form of coupons or dividends. In these assets, your gain will be more in the nature of capital gains that you make as the assets appreciate in value over a long period of time. That is how one benefits from an investment in real estate or gold. It is worth allocating some amount for investment into gold. In the case of individual investors, the allocation to gold as per accepted standard allocation models is just 5 % and one may take the liberty of moving it to 10 %, but not more than that. It is because it is considered a passive approach to portfolio investments. There are two exceptions to the above statement on the earnings from gold. The first exception is that if one has huge quantities of gold and if it is of the highest purity standards, then it can be placed as a deposit, say, in London. This will earn you a small interest for the period for which the deposit is placed. Back in India, the RBI issues Sovereign Gold Bonds which carry a 2.50 % per annum interest. The former is mainly meant for large institutions, whereas the latter is meant for all categories of investors.
Gold appreciates and gold prices move up in times of economic uncertainty. As we had seen last year, the spread of the pandemic and the fall in economic growth led to a rise in gold prices. When the uncertainty factor is removed, the price of gold loses its buoyancy. Yet another factor that drives up gold prices is rising general inflation. When prices of goods rise, the purchasing power of money comes down. Gold is considered to be an asset that retains its value and acts as a hedge against inflation. This has been the traditional thinking and it has been validated over the years through practical experience.
Looking at the returns which gold has generated over the years, it can be easily seen that there are years when it does well and then there are years when it gives a small return. So, there is nothing that is predictable or patternized about the returns. As of May 7, 2021, the returns from physical gold are 9.27 % for five years, 15.20 % for three years, and 2.61 % for one year. This is a typical pattern of gold performance over the years. Therefore, for portfolio returns and growth, it is imperative that along with gold one should invest into the two primary asset classes, fixed income, and equity. Equity assumes more importance as the growth which equity can give to the investment portfolio is simply unmatched by any other asset class.
One can also choose to invest in gold through gold funds which are managed by mutual funds. Here, there is no need to hold physical gold, but your gold entitlement will be in paper form. This also allows you to sell or redeem the gold units when you need to move out of gold. There are also gold exchange-traded funds. All of them obviate the need to hold physical gold. Apart from this, the Gold Sovereign Bonds mentioned earlier also makes immense investment sense. It has a tenor of 8 years and it can be exited on completion of five years of holding. There are many modes by which one can make investments in gold. You can also choose to invest in a systematic way with regular amounts being invested every month. The earlier you start your investments in gold the better it is. Gold prices in India have been moving up and it is supported by a weakening Rupee too.
But, in international markets too the prices may rise over the long term. The weakening US dollar NSE 2.59 % almost always pushes gold prices higher as gold is quoted in terms of dollars. The fundamental factor that needs to be borne in mind is that the reserves of gold in the mines are dwindling, and as the production and supply of the yellow metal become slower and rarer the prices would get a boost. That would also be a good reason to commit 5 % of your portfolio to gold investments.
Published in The Economic Times