After doing pretty well for the last two years, gold prices have been grinding down continuously for the past few months and are now almost 21 percent below the highs hit last year in the Indian markets. The fall is pretty similar to the one in global markets.
Correction in gold prices
Though it is difficult to pinpoint one reason for the fall, it does seem that a combination of factors is at play here. The US dollar gaining the upper hand against major currencies and the rise in bond yields were the main ones. Then, after the ending of lockdown after the first wave, across the world, the appetite for riskier assets returned with a vengeance, as has been witnessed in the stock market rally. All these and maybe many other factors have been putting downward pressure on gold prices.
So, can the gold prices fall any further after the 20 percent fall? It is possible.
Will gold prices fall though? That is hard to predict.
But before you take a call on whether to invest or buy more gold, you need to understand how it behaves in general.
Gold prices are more dependent on the supply-demand equation and geopolitical events, etc., impacting that supply-demand equation. Gold is not like other asset classes that can be valued based on cashflow or intrinsic value. Because of this, gold prices tend to stay dormant for extended periods of time, which are then followed by sudden and volatile spurts in prices.
So, at least theoretically, if you get your timing with gold investment right, then you can generate good returns in the short term. But timing is not what comes naturally to most common investors. So what is the next-best approach? The answer is that investors should do what is practically feasible for them and not try being unnecessarily adventurous.
That said, given the recent fall in gold prices, what must you do now?
Allocating to the yellow metal
In general, having about 5-15 percent allocation to gold in your long-term investment portfolio is a prudent approach. Remember that gold shouldn’t be the core asset, the way equity or debt is, in your portfolio. It’s more of a diversifier and a natural hedge in your portfolio
Common investors should only look at gold for a small part of the portfolio and to increase asset-level diversification.
Now, how can you have a 5-15 percent allocation to gold?
Trying to invest a lump-sum will expose you to the risk of getting your entry timing wrong. So, gradually build your allocation to gold and at times when gold prices fall suddenly (like they have in recent times). During swift and deep corrections, you can do a bit of lump-sum investing as well.
Given that both Sovereign Gold Bonds (SGBs) and Gold ETS have their own distinct features, you can hold a combination of SGBs and gold ETFs.
SGBs offer an additional 2.5 percent interest plus the possibility of gold price appreciation. Also, there is no taxation of gains at maturity for gold bonds. But these do have a long maturity period of 8 years (Selling before five years in the secondary market is a low liquidity risk). But when it comes to liquidity, gold ETFs are more suitable.
So how to go about investing in either of these?
-If you invest in gold for the long term and don’t plan to sell before 7-8 years, then gold bonds are a better option.
-If you want to buy and sell gold regularly to make short-term profits, then liquidity is important and, hence, investing in gold ETFs is advisable.
-If you want to take both the approaches mentioned above, then having a combination of bonds and ETFs to gradually build gold allocation in your portfolio can be considered. That way, you will have a good mix of liquidity (via ETFs) and higher returns (via bonds).
If your allocation to the yellow metal is lower than what is ideal for your portfolio (5-15 percent), then the current fall in gold prices can be a good opportunity to increase allocation to gold in your portfolio.
There are some views that the prices may fall even further as the gold's near-term outlook and trends look weak. Accumulating in a gradual manner may be advisable.