Investing In Gold

Buying gold is the oldest kind of investing activity and the one about which opinions are most polarised. There’s the traditional Indian view of gold—it is an excellent passive investment, protection in bad times and households should invest in it. Here, gold is seen as an easily bought and easily liquified asset that can be relied upon to appreciate well. The second view is that gold is a commodity to be traded like other commodities. This is the view taken by punters and traders but is the least relevant to the individual saver. The third view is that while gold can certainly be viewed as an investment, it’s just not a very good one with the returns generally poorer than other investments.

Gold funds are topping the return chart after a lull of last three years. From gold exchange-traded funds (ETFs) to gold stocks to buying physical gold, investors now have several different options when it comes to investing in the royal metal.

The Importance of Gold In the Modern Economy

Given the fact that gold no longer backs the U.S. dollar (or other worldwide currencies for that matter) why is it still important today? The simple answer is that while gold is no longer in the forefront of everyday transactions, it is still important in the global economy. To validate this point, one need only to look as far as the reserve balance sheets of central banks and other financial organizations, such as the International Monetary Fund. Presently, these organizations are responsible for holding approximately one-fifth of the world’s supply of above-ground gold. In addition, several central banks have focused their efforts on adding to their present gold reserves.

After a dream run on the back of the global economic meltdown in 2008, gold funds ran into rough weather in the last three years. Now, once again on the back of global uncertainties (think of Brexit, future of the European Union, Trump Presidency in the US, and so on), gold is riding high again as cautious investors are looking for safe havens to park their money. Many pundits forecast better days for the yellow metal as its safe haven status gain more currency

Brexit alone may keep the markets world over hooked and demand for gold may remain high. However, once the mood changes, the yellow metal may soon lose its charm. Once investors regain confidence, they typically dump safe investment options and move to risky options like stocks and bonds to earn extra returns. Obviously, that will hit gold prices. In short, if you are investing with a long-term perspective, scale down your return expectations. Many experts believe that gold may offer only single digit return over a long period.

Gold is a hedge, not an investment
Many investment experts believe that gold is not an investment option. It is rather an insurance premium to hedge against economic shocks. They argue that gold is not at all like other investment options like stocks, bonds, etc. For example, when you are investing in a stock, you own a part of a company that is engaged in a business. Similarly, a bond pays you interest. Gold, in comparison, is a commodity that would go up or down depending purely on the demand for it. Gold does offer exceptional returns when investor sentiment turns bleak and all other markets are down and out. However, these phases normally do not last long. Critics also believe that most investors are not aware of the annualised returns offered by gold as they simply compare the price of gold in different points.

Gold as a Diversifying Investment

Many investors believe that gold is a diversifying investment. Regardless of whether you are worried about inflation, a declining U.S. dollar, or even protecting your wealth, it is clear that gold has historically served as an investment that can add a diversifying component to your portfolio. Gold is not correlated to stocks, bonds and real estate. However, others argue that this strategy of diversifying just for sake of diversification could hurt investors with a corpus of small to medium size in the long run. This is because it may hit the overall returns from the portfolio. The focus should be about optimising returns and meeting financial goals without exposing oneself to unnecessary risk.

Limited Exposure To Gold

Most investment advisors ask their clients, to limit their exposure to 5-10%. A large exposure could offer great stability during crisis, but it can also drag the overall returns down in the long term. For example, some top gold ETFs have given around 25-30% annual returns between 2008 and 2011. The returns fell to around 10% in 2012, and to -14% in 2013. Even in 2015, gold ETFs gave negative returns. That means after reaping phenomenal returns between 2008 and 2011, the investors also had to deal with negative returns (losing money) in 2013 and 2015. Even in 2014, the returns were barely 1%.

Not a Good Investment

Gold belongs to a class of investments that will never produce anything. Any growth in its value depends entirely on the belief that someone else will pay more for it eventually. Gold is an unproductive asset. Unlike shares or bonds or deposits, money that you invest in it does not contribute to any kind of economic growth. A pile of gold will stay the same pile of gold no matter how much time passes. An equivalent amount of money deployed in a business or any other productive economic activity will generate actual wealth and will grow larger in a very fundamental way. The only use of gold is some industrial applications but those are satisfied by just a small part of its production and this demand plays no role in its price. The value of gold has always been driven by the fear that other asset classes will lose value.

In the hours immediately after the Prime Minister announced demonetisation, the crowds that materialised at jewellery shops are testament to this. In India, purchase of large amounts of gold is mostly limited to those with cash to hide.

There are gold-backed mutual funds available from many fund houses that closely track the value of gold. However, if you don’t mind locking money away for up to eight years, then the Government of India’s gold bonds are a great option. These are issued from time to time and their value increases exactly with gold, plus there’s an extra interest of 2.5% per year. Moreover, unlike gold mutual funds, the gains from the gold bonds are tax-free. This makes them the exact equivalent of holding gold, except with a 2.5% a year bonus.


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