Tuesday, October 21, 2014

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
Debt Instruments*
Issuer Risk
Safe , risk of theft or burglary in Physical Form
Interest Rate Risk
Not there.
Highly Liquid
Highly Liquid
Generally Moderate, very High in 3-5 yr Period
Capital Gain Tax
Capital Gain Tax+ VAT at the time of purchase
Income Generation Potential
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

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.

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.

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.


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.

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