Gold as an Investment Asset  

                                                                                  By: Anshul Srivastava

For conservative investors who are looking to diversify their portfolio beyond Debt and Equity Investments, gold may serve as an avenue for diversification, but not without additional risks and costs.

In the current times, with high levels of volatility in various asset classes especially equity, when individuals are increasingly seeking portfolio diversification to be able to meet their various life goals with higher certainty, gold is fast emerging as an investment asset class along with more preferred asset classes like debt on account of a perception of an enduring and a stable asset class and due to the traditional affinity towards the asset class in the form of jewelry.

However, for conservative individuals who hold major proportion of their portfolios in debt instruments, the risk-return matrix needs to be evaluated carefully to arrive at optimal diversification which provides risk reduction as well as leads to enhancement of returns; which are the primary objectives of portfolio diversification.

Though, the exposure to debt can be taken through various instruments viz. small saving schemes and post office deposits, bank deposits, company fixed deposits, and debt mutual funds etc proper analysis of the risk return characteristics of all are warranted ., the investments in precious metals predominantly gold  requires a detailed understanding.

The Golden Allure

Gold has traditionally been used as a store of wealth and medium of exchange in the human civilizations, In the international scenario gold has been used as the relative standard for currencies .Till 1971 US dollar was measured against the gold where a specific value of dollars was assigned to one ounce of gold. In addition the physical accessibility and portability of gold make it a preferred asset to hold in the times of financial exigency. Jewelry constitutes more than two thirds of the demand of gold while industrial, medical and dental uses account for the usage of closely 12 % of the gold produced. India accounts for nearly 27% of the demand for gold jewelry in the world and thus gold holds an special allure for Indian investor.

For any asset class there are certain characteristics on which it is judged and we can compare gold and debt on the following.

S. No	Parameter	Debt Instruments*	Gold
1	Safety	Issuer Risk	Safe , risk of theft or burglary in Physical Form
2	Safety	Interest Rate Risk	Not there.
3	Liquidity	Highly Liquid	Highly Liquid
4	Growth	Moderate	Generally Moderate, very High in 3-5 yr Period
5	Taxation	Capital Gain Tax	Capital Gain Tax+ VAT at the time of purchase
6	Income Generation Potential	Yes	No.

Investment Avenues

As it has been mentioned above that investment in debt can be done in various forms, investment in gold can also be done in various form, which can include gold in the physical form in the form of jewelry, or bullion in the form of Coins, bars or biscuits. All these forms carry a risk and inconvenience, so if the aquisition is purely for the purpose of investment then using the vehicles like Gold Exchange Traded Funds (ETF) can be used to take advantage of the price appreciation of gold. .ETF is an open-ended mutual fund whose units represent physical gold that is 99.5% pure, with each unit representing 1 gram of gold. These units are traded on the stock exchanges like a single stock of a company. ETFs are exempt for Securities Transaction Tax and VAT, Which is applicable on physical gold and small amounts can be invested which can be accumulated for buying gold in future if required saving oneself from the upside price volatility of gold. While there is a fund management charge which is levied on the investors, the same can compensate for the inconvenience one saves as compared to holding physical gold.

 Following are the benefits that can accrue to investors of gold.

• Store of Wealth

Gold has been used as a store of wealth for centuries, even in the modern times of today where markets rise and fall, gold has been able to retain its value most of the times and if we look at the last ten years data gold has beaten all the other asset classes in terms of the returns generated.

• Safe refuge

During the time of calamities like war or any sort of economic crisis, currency and other investment assets like shares and debt securities may lose their value but gold does not lose its value and thus has been held by people as a protection against such risks for a long time.

• Inflation Hedge

Gold has long being used as the store of wealth. While the value of the currency might fall over time, gold has been able to hold its value and expected to do so in future thus providing a very effective hedge against purchasing power risk.

• Portfolio improvement

Adding gold to a portfolio introduces an entirely different asset class. Portfolios that contain gold are generally more robust and better able to cope with market uncertainties than those which don't. Recent independent studies have shown that traditional diversifiers (such as bonds and alternative assets) often fail during times of market stress or instability. Even a small allocation of gold has been proven to significantly improve the consistency of portfolio performance during both stable and unstable financial periods.

• Diversification

Diverse investments help protect the portfolio against fluctuations in the value of any single asset class. Gold is a very effective portfolio diversifier as it has a weak correlation with equity and its movement is independent of the movement in the other asset classes.

• Liquidity and Tangibility

Gold is an asset which has both the qualities of being tangible and liquid also. The other tangible asset like real estate rate low on liquidity. And with the options like gold loans available in the market , one does not need to part with the gold while monetizing it up to limit of  Loan to Value decided by the lenders

 Pricing

There are various factors involved in the pricing of gold, which makes the gold pricing a complex process. The main factors that affect gold pricing are:

1.  Global Supply and demand levels ( Jewelry and Industrial)
2. Activities of Central Banks.
3. Gemological characteristics of the diamond
4. Movement of Capital Markets
5. Paper trading and short selling
6. Market Expectations

While the supply and demand level tend to affect any industry , more recently the factors which are affecting the gold prices range from trading to market expectations following the Global Financial Crisis and Euro zone Crisis. The expectation from the central banks of the major economies of the world also plays a part in the movement of the price of the gold. India, being the largest consumer of gold in the form of Jewelry in the world, the dynamics of pricing also includes the factors like seasonality where in wedding and festive season see a considerable spurt in the demand for gold thus sustaining the price at a higher level domestically.

Returns

Gold gives a moderate return in the long term with the shorter time periods in between in which it give very high return in the short term. Since the price of the gold depends on many factors most of which are international in nature, the price of the gold cannot be predicted with certainty, From 2010  till 2012 gold had given very high return but post 2012 , the returns have been minimal, thus only a small portion of the total investment portfolio should be attributed to gold.

In 2012 gold was 31900 and in today it is around 27000, the return over the last 3 years has been dismal.

However, from the Financial Planning perspective investment in both gold and debt requires a detailed understanding of the asset class, along with a thorough mapping of such investments to the individuals’ life goals and their risk appetites.

Gold Insurance

The holding of gold in a physical form gives rise to additional risks of theft, loss etc., therefore it may be necessary for individuals to seek insurance for such holdings. The most common insurance under this category is jewelry insurance which is provided as a part of householders’ policy, or even a standalone insurance policy. However the terms of coverage and the policy wordings need to be examined thoroughly to ensure a complete peace of mind.  Debt products are generally safe based on the reputations of the issuers and the rating given by various rating agencies, so the need of insurance does not arise.

The cost associated with gold insurance should also be taken into account while considering investment in diamonds.

Taxation

It is essential to note that gold investment in physical form, may give rise to wealth tax beyond a certain limit in addition to the normal Value Added tax (VAT) at the time of purchase and Capital Gains tax at the time of sale. This is often the most overlooked aspect by individuals investing in gold The wealth tax is charged at the rate of 1% of the total wealth exceeding Rs. 1 crore as on March 31 every year. Debt also attracts capital gains tax which has a specific treatment under the Income tax act of 1961.

Conclusion

Gold has traditionally been an attractive buy at all the auspicious occasions in the Indian set up, but if you are looking at gold as pure investment then the same should be done after proper analysis in the right instrument preferably with an expert advice.

Managing the Lifestyle in inflationary times

Managing your Life style in inflationary times

                                                                    By: Anshul Srivastava

Life style is defined as a “way of living” of individuals, families and societies which is apparent in their physical, psychological, social and economic environments. It is reflected n behavior patterns, activities, attitudes, interests, opinions, values and allocation of income. There are various factors that affect lifestyle including culture, family, reference groups and social class.

The concept of lifestyle differs from person to person depending on the socio economic factors and it is very dynamic in nature. It depends on the age and stage in life cycle and social status. A younger individual in his mid twenties would like to buy an expensive electronic item like and i pad or a television while the buying decision for an older individual in forties would be more inclined toward buying a luxury car or planning for a vacation abroad.

The improvement in the lifestyle as one moves ahead in life can be attributed to two factors.

1. Increase in the income levels
2. Technological advancement

While increase in income level may induce the person to use a costlier thing to satisfy the same need (A car in place of bike to commute), technological advancement may necessitate the use of some equipment which might not be required in past (eg Mobile Phones)

The luxuries of the past are becoming the necessities of today. For example the use of purified water or purifying equipments which is an additional expense in most of the households today was not present 20 years ago. This along with the use of more than one mobile phone per household has also added to the cost which was not present in the households more than a decade ago. More such innovations might come in future.

The term lifestyle inflation is derived from the word” lifestyle”; it could be defined as the increase in expenses as a result of improved standard of living fueled by increased income. As the level of income rises, things like costly laptops, cellular phones, imported watches, electronic goods, cosmetics, fashion accessories etc which did not come under the head necessities hitherto will fall in the same category. In addition, the up gradation from one category of services to another on account of the increase in income more than offsets the percentage increase in income.

As an Example; going to a movie for a family of four would have been a transaction in the range of Rs 200-250/- close to 10 years ago, which might cost anywhere between  Rs. 1000-1500 if one decides to go in a prominent multiplex theatre today.

This implies inflation in prices somewhere in the range of 17%-20% per year over a period of 10 years, which is far more than the data released for inflation by official agencies.

While inflation affects common man, lifestyle inflation has the power to affect super rich also. According to a recent study by Swiss Banking major Julius Bayer “the rise in this Lifestyle Index, which measures the prices of high-end products used by HNWIs, is in fact much higher at 11.7 per cent than the overall consumer price inflation of 5.1 per cent for the region in the same period. It is not about managing inflation alone while it has a lot to do with keeping in pace with and living in accordance the latest technological developments around us which will go beyond mere numbers which is based on technological innovations which need not be anticipated. It is essentially a social consequence of financial inflation; other consequences could be economic and political.

One may like to guess that economies of scale should maintain the cost of lifestyle assets in line with economic inflation but it need not happen because of demand and other aspects.

While making decisions pertaining to lifestyle inflation, one should clearly differentiate the lifestyle choice and the investment decision. For Eg. Buying a Picasso or a hussain investment decision or lifestyle choice need to be carefully analyzed before being exercised.

The below mentioned projections and facts coupled with the demographic trends clearly indicate that the lifestyle inflation is a factor which most of the Indians will have to deal with in the times to come.

Projections about Indian economy mentioned in “The Bird of Gold: The rise of India’s Consumer Market” a Mckinsey Report published in 2007:

·         “Income levels will almost triple and India will climb from its position as the 12^th largest consumer market today to become the world’s 5^th largest consumer market by 2025.”

·         “Average real household disposable income will grow from Rs.113,744 Indian rupees in 2005 to 318,896 Indian rupees by 2025, a compound annual growth rate of 5.3 percent.”

·         “India’s middle class will swell by over ten times from its current size of 50 million to 583 million people. By 2025 over 23 million Indians- more than the population of Australia today- will number among the country’s wealthiest citizens.”

·         “By 2025 food, beverages & tobacco will still be the biggest category, although its share will have dropped from 42 % to 25%. Transport and health care will be the second and third biggest markets respectively. Communications, which accounts for only 2 percent of spending today, will be one of the fastest expanding categories with growth of over 13 % a year. Other categories that will see annual growth of over 8 % include transportation, personal products and services, health care, and education and recreation as these categories evolve into sizable markets.”

Thus we could imagine a scenario of 20 years later when one bottle of  drinking water could cost us  Rs. 500 and the cost of communication and commutation will form a bigger part of our expenses. This may happen in spite of reduction in per unit cost of the same on account of the increased consumption on our part. Advancement in technology may take us far like we have moved from the traditional landline phone to a gizmo like an  I phone in past 20 years, it is indeed difficult to predict what lies 20 years ahead of an I phone.

In this materialistic world, improved income induces one to indulge in acquiring and accumulating luxury products and services. While it cannot be said that it is completely unwise to do so, but short and long term financial goals should always be kept in sight. As the earning increases and one move ahead in the journey of life, the commitments have to be chosen wisely. If one follows certain thumb rules like, putting savings first and debt last , buying affordable house, cars and other life style products, and most important not falling into a debt trap then the risk of financial distress can be considerably reduced.

Certain ground principles if followed could help one not fall in the debt trap

1. Never borrow for a depreciating asset
2. Don’t borrow for an asset which doesn’t have a salvage value

While it is imperative for the lifestyle to  change, but keeping an eye on the expenses and keeping the principles of financial planning in mind, one can counter the impact of such changes.