Gold prices have experienced a steep upward movement since May 2019. This curve became steeper with the onset of COVID-related uncertainties in the global economy. As gradual opening of the economies can taper off some of the gains made by gold, many would be concerned about the risks of investing in gold in the current economic scenario.
Let’s first focus on the pros and cons of investing in gold as an asset class and its various avenues.
What works in favour of investing in gold
Equity as an asset class is negatively correlated to gold. Gold usually generates higher returns during bearish equity markets, high inflation, economic shocks and geopolitical tensions. This negative correlation allows gold to act as a hedge against volatile equities.
The demand for gold is sustained by diverse factors such as consumption in the form of jewellery, use of gold by various central banks as their reserve assets and as a hedging instrument against market, inflation and currency risks. These diverse sets of factors sustain the demand for gold in all economic conditions, and thereby help it play the role of a safe haven asset.
What works against it
Like all commodities, traditional means of deriving valuation or expected returns do not apply to gold. Gold’s price is determined solely on the basis of demand and supply factors. Thus, unlike equities, investment decisions related to gold cannot be based on the basis of intrinsic valuation of gold.
Those maintaining their gold exposures through gold jewellery and coins would have to incur additional cost for safekeeping in the form of household or bank lockers. These costs can negatively impact the yield from gold investments.
Another major risk is the negative correlation of gold prices with economic and geopolitical stability. As and when economic and geopolitical conditions start to stabilise, gold prices tend to correct accordingly. Thus, those investing in gold during the peak run the risk of incurring notional losses as macroeconomic conditions start to stabilise.
Gold-related investment options
Physical gold: Buying jewellery and gold coins is still one of the most popular modes of investing in gold. But holding gold in physical forms comes with two main disadvantages. Apart from the additional cost incurred for safekeeping, buying physical gold also comes with purity-related concerns. Additionally, one may also face challenges in accessing physical gold stored in bank lockers or selling it during a political turmoil or natural disaster.
Sovereign gold bonds (SGB): SGB is issued by the RBI in tranches through scheduled commercial banks, recognised stock exchanges, designated post offices, etc. The minimum and maximum investment allowed to each individual investor per financial year is 1 gram and 4 kg, respectively. In addition to the potential of capital appreciation, SGB investors also benefit in the form of interest of 2.50 per cent annually payable in half yearly rests. While the interest income is taxable as per the tax slab of the investor, any capital gains resulting from the redemption of SGB is tax-exempt. Indexation benefits are applicable on long term capital gains arising out of transfer of bonds to other individuals. Another major advantage of SGB is the ability to use it as a collateral for availing bank loans.
The biggest advantage of the SGB is its low liquidity. SGB comes with an 8-year tenure with premature redemption allowed only after the fifth year of investment. While SGB can be traded in stock exchanges, low trade volumes restrict its liquidity.
Gold Exchange Traded Funds (ETFs): Gold ETFs are passively managed funds closely tracking the prices of physical gold. Just like any other ETFs, units of gold funds can be bought or sold in stock exchanges.
What works against gold ETFs is the additional cost incurred in the form of brokerage and annual maintenance charges for the demat account. Liquidity can also be a major concern for gold ETFs as they usually have very low trading volumes in the exchanges.
Gold fund of funds: These are open-ended mutual funds primarily investing in gold ETFs. Just like other mutual funds, gold schemes can be purchased and redeemed at NAVs and can also be invested in through the SIP/STP modes. Gold funds have higher liquidity than other modes of gold investment, as they can be redeemed directly from the fund houses on any business day. Higher liquidity, along with the availability of SIP/STP/SWP in gold funds, also allows higher flexibility to their investors in implementing their asset allocation strategy.
Is it a good time for you to invest in gold?
Given the negative correlation between gold and equities, retail investors should maintain gold exposure of at least 5-10 per cent in their investment portfolio. Hence, those without adequate gold exposure should consider starting investments in gold, preferably through gold funds, in a staggered manner. If gold prices witness a steep correction in the future, investors can implement their asset allocation strategy to make lump-sum investments in gold. This will average their investment cost and also set their asset-mix right.(
The writer is CEO & Co-founder, Paisabazaar.com)