The rising importance of having Gold in the portfolio

With the advent of festivals and wedding season, Gold is on many investors’ mind. However, instead of looking at Gold as just jewelry, investors should understand the importance of including Gold in their investment portfolio.

In the ever-changing financial environment, investors look for secure and dependable assets to protect their wealth. With the consequences of geopolitical tensions, inflationary pressures, economic slowdown and shifting monetary policies, the value of Gold in investment portfolios cannot be over emphasized.

Historically, Gold had been considered to be store of economic value since time immemorial. Its fascination stems not only from its outward beauty, but also from its longevity and scarcity as a natural resource. In many cultures, Gold assets were not just seen as a sign of family prosperity but also as a protection in bad times (when income is down). Even today, Gold is considered as a safe bet in economic recessions or bear markets. Over sufficiently long investment horizons Gold retains its purchasing power.

Suggested reading: why should commodities be a part of your portfolio at all times?

Gold as hedge against inflation

From ancient times, precious metals like Gold retained their purchasing power over time. That is why precious metals are considered as stores of economic value or hedge against inflation. In the chart below, we have plotted CPI inflation over the last 12 years versus Gold returns. You can see that Goldas an asset class have generated inflation beating returns in most years. Therefore, you should have Gold in your asset allocation to protect your portfolio against inflation without adding too much volatility.

Source: World Bank, MCX, as on 31^st December 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.

Gold for asset allocation

Gold has low or negative correlation with the returns of the two most popular asset classes i.e. equity and fixed income. In fact, historical data shows that Gold is counter-cyclical to equities i.e. Gold outperforms when equity is underperforming and vice versa. Adding Gold to your asset allocation will provide stability to your investment portfolio, especially during times when economic outlook is uncertain.

Source: NSE, MCX, as on 31^st December 2023. Nifty 50 TRI has been used a proxy for equity as an asset class. Nifty 10 year Benchmark G-Sec Index is used as proxy for fixed income. For Gold we are using MCX spot prices. 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.

Gold and interest rates

Gold has a complex relationship with interest rates. Both Gold and US Treasury Bonds are seen as safe haven assets. When the Fed hikes interest rates, US Treasury Bond Yields go up making them attractive for risk-averse investors. However, when the Fed cuts interest rates, Gold becomes attractive relative to US Treasury Bonds. With the turn of interest rate cycle and lower interest rates expected in the future, Gold can continue its rally in the near term.

Gold and currency

Gold has an inverse relationship with US Dollar. When the dollar weakens, Gold rises and vice versa. Similarly, Gold also has an inverse relationship with the Rupee. When the Rupee weakens, the INR price of Gold increases since India is an importer of Gold. In the long term Gold can be a hedge against currency depreciation.

Gold and geopolitical risks

Geopolitical risks have come to the fore in recent times, due to escalating conflict in the Middle East. This conflict may have an impact on crude oil prices. Historical data shows that crude oil and Gold prices are positively correlated; we had discussed the relationship of inflation and Gold returns earlier in this article. Geo-strategic dynamics can also have an impact on Gold, since it is seen as a safe haven asset. Rising geostrategic risks e.g. United States / China relationship in terms of trade and military power can be positive for Gold as asset class.

How to invest in Gold?

Traditionally, purchasing Gold meant purchasing physical jewelry, Gold bars or coins. Today, various investment vehicles make it easier than ever to add Gold to your portfolio:-

1. Gold ETFs: Exchange-Traded Funds (ETFs) provide a way to invest in Gold without the need for physical storage of the precious metal. ETFs track the price of Gold and are traded on stock exchanges just like shares of listed companies. They are backed by physical Goldof 99.5% purity (as specified by SEBI regulations). You will get the price of pure Gold if you sell your Gold ETF units. You need to have a Demat and trading account to invest in Gold ETF.


2. Gold fund of funds: Several mutual funds offer Gold Fund of funds, which are mutual fund schemes investing in Gold ETFs. You do not need demat account to invest in Gold FOFs. Investors can include Gold investment by buying the Gold FOF units either in lumpsum or from their regular savings through SIPs over long investment horizon.

Why you should invest in Gold ETFs / FOFs instead of physical Gold?

The traditional way of buying Gold in our country is in the form of Gold jewellery. Gold jewellery almost always has impurities. When you are buying Gold jewellery, you are also paying for the weight of impurity at the same rate as Gold. However, if you want to sell Gold, the jeweller will deduct the price of impurities.

The other major drawback of Gold jewellery as an investment is making charges. Making charges can vary considerably depending on design and craftsmanship, but it has no investment value because you will only get the value of pure Gold when you sell your Gold jewellery. Finally you have to incur costs e.g. bank locker rents for storing your physical Gold safely.

There are no impurities in Gold ETFs or Gold FOFs since they represent the market value of 99.5% pure physical value. Liquidity of Gold ETFs / FOFs is high because you can sell units of ETFs in the stock exchange or you can redeem units of your FOF with the asset management company (AMC) on any business day. Furthermore, there are no storage costs since ETFs / FOFs are financial assets. Gold ETFs and FOFs are much more cost efficient investment options compared to buying physical Gold.

Taxation of Gold ETFs / FOFs

Gains from Gold ETFs / FOFs held for less than 2 years are classified as short term capital gains. Short term capital gains in Gold ETFs / FOFs will be added to your income and taxed as per your income tax slab rate. Long term capital gains will be taxed at a flat rate of 12.5%.

Conclusion

Investing in Gold isn’t just about wealth preservation; it’s about positioning yourself for a more secure financial future in an unpredictable world. Consult with a financial advisor or a mutual fund distributor to determine the right Gold allocation for your individual circumstances, risk appetite and financial goals.