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.
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.
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.
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.
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.
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:
- Global Supply
and demand levels ( Jewelry and Industrial)
- Activities of Central Banks.
- Gemological characteristics of the diamond
- Movement of Capital Markets
- Paper trading and short selling
- 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.