With the Diwali approaching, buying gold jewellery is part of festivities of many Indian households. The wedding season will begin a few weeks after Diwali and gold will be on the shopping list of many families. Gold is considered to be an auspicious metal according to our ancient cultural traditions, at the same time, it has great economic significance as an asset class.
Gold is considered to be a store of economic value-
From time immemorial gold has been a store of economic value. Gold over sufficiently long investment horizons retains its purchasing power. In the chart below, we have plotted CPI inflation over the last 20 years versus Gold’s returns. You can see that gold has an asset class has generated inflation beating returns in most years; higher the inflation, higher the returns. Over the last 20 years, Gold gave 13% CAGR returns.
Source: World Bank, MCX, as on 31st October 2023. Disclaimer: Past performance may or may not be sustained in the future. The chart above is purely for investor education purposes and not for asset allocation recommendation
Why should you have gold in your portfolio?
The chart below shows the RBI repo rates over the last 23 years. Repo rate is the benchmark interest rate; i.e. interest rates of traditional savings products like Bank FDs, Government Small Savings Schemes etc are linked with the repo rate. Though interest rates go and up down cyclically, you can see that the interest rate in our economy has been secularly declining. Secular decline in interest rates is not at all surprising because most developed economies saw interest rates falling as their economies grow. As the Indian economy grows, interest rates are likely to fall further in the long term. Therefore, you should consider other asset classes for your long-term investment needs instead of relying on traditional savings or fixed income products.
As mentioned in the previous section, Gold as an asset class has the potential to give inflation adjusted returns. Therefore, you should consider Gold as a part of your investment portfolio.
Source: RBI as on 31st October 2023. Disclaimer: Past performance may or may not be sustained in the future. The chart above is purely for investor education purposes and not for asset allocation recommendation.
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Gold and real bond yields -
Evidence from developed markets suggest that Gold gives higher returns when real bond yields (Government Bond yield minus Inflation) fall, and gives lower returns when real bond yields rise. The chart below shows the real 10 year G-Sec Yields (10 years G-Sec Yield minus CPI Inflation) and Gold returns over the past 20 years. You can see a similar relationship between Gold and real Government bond yields in India also. You can see that Gold returns were high when real yields were falling and low when real yields were rising.
Source: Investing.com, MCX, as on 31st October 2023. Disclaimer: Past performance may or may not be sustained in the future. The chart above is purely for investor education purposes and not for asset allocation recommendation.
Why is this a good time to invest in Gold?
You can see that real bond yield has spiked up over the last 1 year or so. As on 31st October 2023, the inflation adjusted 10 year G-Sec yield is nearly 2%, while 20 year average inflation adjusted (real) 10 year G-Sec yield is just 0.8%. At some point of time, we will see mean reversion i.e. the real bond yields will revert back to the long term average.
Gold has the potential to give higher than average returns when real bond yields fall. Gold prices have already risen by more than 10% this year and crossed the Rs 60,000 per 10 grams. This may be a good price level to invest in Gold because prices may rise further due to higher demand, especially during the upcoming wedding season. Irrespective of the price level at which you invest in Gold, you must always have long investment horizon for Gold.
You may also like to read invest in gold and silver like a pro: diversify your portfolio.
Gold will provide stability to your portfolio in volatile markets -
Gold is also an important asset class for asset allocation purposes. The primary purpose of asset allocation is to balance risk and return. Historical data shows that gold is usually counter-cyclical to equities i.e. gold outperforms when equity underperforms and vice versa. Adding gold to your investment portfolio will bring more stability in volatile markets.
Source: NSE, MCX, as on 31st October 2023. Equity is represented by Nifty 50 TRI. Disclaimer: Past performance may or may not be sustained in the future. The chart above is purely for investor education purposes and not for asset allocation recommendation.
How to invest in Gold?
Many families will buy Gold jewellery on the auspicious occasion of Dhanteras or Diwali. But Gold jewellery is not efficient as an asset for the following reasons:-
- Almost all gold jewelleries have impurities. The impurities will be deducted from the value of your gold if you want to sell the jewellery for cash.
- The cost gold jewellery includes the cost of craftsmanship. The cost of craftsmanship has no value if you want to sell the jewellery for cash; you only get the value of the pure metal.
- Since gold jewelleries are valuable items, you will store them in a secure place like bank locker for which you have to incur storage charges like locker fee.
- Physical gold is a not as liquid as gold in form of financial assets. For selling physical gold, you will have to locate a jeweller who will buy your physical gold. The jewellers will have their own process of determining purity and giving you a value.
How to invest in Gold as a financial asset?
Gold Exchange Traded Funds are financial instruments that track the price of pure Gold. Gold ETFs are backed by physical Gold. One Gold ETF unit is equal to 1 gram of gold and is backed by 99.5% pure physical gold bars. You will get the price of pure Gold if you sell your Gold ETF units. You need to have Demat and trading account to invest in Gold ETF.
One of the several advantages of Gold ETFs versus Gold jewellery is that you do not have to pay a large sum to invest in Gold. The minimum amount that you have to invest in ETF is the price of 1 unit, which is equivalent to 1 gram of Gold. The other advantage of ETF is liquidity. You can sell units of your Gold ETF at any time during trading sessions in the stock exchange from the comfort of your home or office.
If you do not have Demat account, then you can invest in Gold fund of funds, which are mutual fund schemes investing in Gold ETFs. Gold Fund of Funds offer all the advantages and conveniences of mutual funds, including investing through Systematic investment Plan.
Suggested reading: how to select ETFs using Nippon India MF victer framework?
You should consult with your financial advisor or mutual fund distributor if Gold ETFs or Gold Fund of Funds is suitable for your investment needs.
Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.