Investing in Gold – Look before you Leap

From the beginning of April to the middle of May this year, Nippon India ETF (largest Gold ETF in India) has added 35,000 new investors – that is 17% increase in customers in just six weeks. What’s the fuss all about?

Let us look at the return of Nippon India ETF Gold beES (largest gold ETF with AUM of Rs. 3,996 Crores)

Wow! today we are ecstatic to look at the returns and express our desire to invest in gold.

But hold on, let’s have a look at the scenario a year back..

Alas! At the same time last year, you would have felt there is negligible return and expressed your frustration of being stuck for so long over nothing.

Let us dig deeper into the history and see what’s there.

Looking at the gold prices for that last 50 years, it is clear that gold is definitely a good buy in long-term and being a safe haven investment – has shown spike in prices whenever the economy stooped low and equity shattered (eg: 2007-08 financial crisis or 2020 covid crisis). And the yellow behaved flat when market confidence remained high (eg: 2013 to 2019)

Now, let’s look at few of the intermediate time periods when gold didn’t do well.

2012-2019: It took gold 7 years to surpass its 2012 peak once again

1996-2003: It took gold another 8 years to surpass its 1996 peak once again

And there are more such instances in past of weak returns like period of 1980-1990, etc.

What drives gold prices in India?

Since most of India’s gold requirements are met by imports, we have two major factors to look at:

1. Global price of gold denominated in USD
2. USD-INR exchange rate

Part-1 – Global price of gold denominated in USD

Gold plays a dual role – both as a commodity and a currency.

1. Gold as a commodity

• Demand – Like any other commodity, gold price is very much determined by its demand and supply force. Demand comes from jewelry industry, making medicinal or industrial products.
• Supply – On the other hand, its supply chain is truly as it is mined in all continents except Antarctica. Gold is almost indestructible and all the gold ever mined still exists in some form. And any positive supply shock does not disrupt gold price much as the annual mining production is only a tiny fraction of the total gold holdings.

2. Gold as a currency

• Interest Rate – Gold is inversely related to US Treasury rate. When it comes to safety, one can either invest in T-Bills or gold. If interest rates are high, people flock towards interest bearing T-Bills and vice versa. This also explains why gold prices go up as inflation in the economy goes up.
• Central bank’s decision – They hold a significant amount of gold reserve (especially developed countries) and can affect its price due to the sheer volume of transactions.
• Economy Outlook – Gold is considered as safe haven and becomes dearer when risk and uncertainty in economy crops up. Thus, the gold prices go up during times of crisis and vice versa.
• Global Gold ETFs – Though ETFs intend to keep themselves aligned with gold prices instead of trying to influence it, but many large ETFs hold significant amount of physical gold and any significant outflow/inflow from such ETFs can affect demand/supply in the market affecting the gold price.

Part-2 – USD-INR exchange rate

India has been a net importer all these years which makes INR depreciate 3-4% against USD every year adding up to the gold price.

Thus, Gold price in India = Gold price in USD * USD-INR Exchange Rate

Predicting gold price?

Now, to predict the gold prices in short term, you need to get all of the above. Phew. Good luck with that!

We take the humble stance that predicting short term is not our forte and would stick to long term views based on historical evidence.

How to think of gold allocation in a portfolio?

The way we think about gold, as an asset you buy and pray it doesn’t do well because that would mean the remaining portion of your portfolio allocation in other asset classes will most likely not do well.

It is more like a safety tool you keep and hope it never comes into action. if gold returns are very high, then usually it means that – we are in the middle of some crisis scenario like the current Covid-19 crisis. This will also mean many of your other assets such as your equity allocation, own business/sector etc is not doing well.

So, for diversification benefit, gold should comprise 5%-15% of your portfolio (including physical gold possessions) and nothing more than that.

Conclusion: If one plans to buy gold for investment reason – then ideally he should buy it in demat mode / Gold ETF rather than buying physical gold. Presently, even Sovereign Gold Bond (SGB) issued by Govt of India is a great option. You not only benefit from gold price appreciation over the period but also get fixed annual interest @ 2-2.5%. Plus you have the convenience of no theft, transparent pricing and assured quality.