Can Gold Give Your Portfolio An Extra Shine?

Gold has long been a culturally significant asset in India and has transitioned from being a physical commodity to an attractive investment option through gold funds. These funds, including gold exchange traded funds and gold fund of funds, provide a convenient means to gain exposure to gold without the complexities of owning and storing physical gold. The article explains what lies beyond the glitter [EasyDNNnews:PaidContentStart]

Gold holds a special place in Indian culture, history, and economy. More than just a commodity, it represents wealth, status and prosperity while playing a vital role in religious and social traditions. For Indians, gold is not merely an asset but a cultural essential, deeply woven into weddings, festivals, and as a safeguard during economic uncertainties. Often passed down as heirloom jewellery or coins, it serves as a form of intergenerational wealth. As one of the world's largest gold consumers, India relies heavily on imports, significantly impacting its trade balance. 

While traditional preferences leaned heavily toward physical gold, a gradual shift is occurring, with the younger generation increasingly turning to digital gold investments through online platforms. Indian gold buyers have recently benefited from favourable market conditions following Donald Trump’s victory in the US presidential election. Since November 14, gold prices have dropped by around 8 per cent on the Multi Commodity Exchange (MCX). This price decline coincides with the wedding season, which traditionally drives a surge in gold demand. 

The current dip in prices offers an attractive opportunity for buyers who were previously hesitant to invest in gold. However, it is currently trading at around ₹76,814. In October, gold ETFs experienced a significant surge in investor interest, with net inflows reaching ₹1,961 crore, according to the latest data from the AMFI. This marks a substantial rise from September's inflow of ₹1,233 crore. 

The October inflows set a new record for monthly net inflows in the gold ETF category. Since January 2020, gold ETFs have accumulated a total net inflow of ₹24,153 crore. According to the World Gold Council, the total physical gold holdings of Indian gold ETFs have nearly doubled over the past four years, reaching an all-time high of 54.5 tonnes as of October 31, 2024, compared to 27.4 tonnes held four years ago. 

Gold Funds
Gold funds are mutual funds that primarily invest in gold, stocks of companies involved in gold production and distribution, or shares of mining firms. They offer a convenient way to gain exposure to gold as an asset without purchasing it in its physical form. There are primarily two ways to invest in gold funds, aside from the gold sovereign bonds offered by the RBI and they are gold ETFs and gold FoFs (funds of funds). 

Gold ETF is a type of mutual fund that mainly invests in gold. In this case, the fund houses buy gold from banks, both in India and internationally, and store it in secure vaults. They then list this gold on stock exchanges as ETFs and issue units that represent the physical gold. So, when you buy these ETFs, you are essentially buying a share of the gold held by the fund. 

These funds are traded on stock exchanges like regular stocks, making it a simple way to invest in gold without owning the physical metal. Some new investors may notice that the net asset value (NAV) of different gold ETFs can vary, even though they all invest in gold. This is nothing to worry about. The difference in NAV happens because of the number of units each fund issues, even though the value of the underlying gold remains the same. 

Gold FoFs invest in gold ETFs rather than directly holding physical gold, offering indirect exposure to the precious metal. Their returns are closely aligned with gold prices, similar to gold ETFs. A gold fund and an ETF are a part of each other. When you invest in a gold fund, the gold fund further invests in a gold ETF. It just provides you with the extra convenience of investing in a mutual fund at an additional fee. 

Does Adding Gold Lower Portfolio Risk?
To assess the effectiveness of adding gold to an equity portfolio, we analysed data from December 1, 2014 to November 30, 2024. The analysis reveals that gold exhibits lower annual volatility, with a standard deviation of 12.60 per cent, compared to the Nifty’s higher annual volatility of 16.56 per cent during the same period. Additionally, the low correlation coefficient of -0.066 between gold and Nifty underscores gold's effectiveness in reducing portfolio risk. For instance, an investor with a portfolio allocated 80 per cent to Nifty and 20 per cent to gold achieves a lower annualised standard deviation of 13.32 per cent, compared to the higher risk of investing entirely in Nifty. 

This demonstrates that incorporating gold into a portfolio not only helps stabilise the overall portfolio during volatile equity market periods but also aligns with the principles of diversification. A negative correlation indicates that two variables tend to move in opposite directions. However, it is important to note that this relationship may vary depending on the observation period, and past performance does not guarantee future outcomes. 

Also, when we observed the returns of these investors, X, Y, and Z, based on their investment patterns mentioned in the table during these periods, an investment of ₹5 lakhs by each investor has turned into ₹14,10,202, ₹12,57,267, and ₹14,29,210, respectively. A point to note here is that adding gold to your portfolio may lower the entire portfolio returns compared to investing only in equity represented by Nifty. However, the volatility of the portfolio with gold as component remains lower. Adding gold alongside equity not only reduces volatility but also generates better returns with reduced risk. 

Should Gold Be Your Primary Investment?
As Indians, especially those from the older generation, have a strong affinity for investing in gold. However, as per the above analysis, gold has underperformed compared to Nifty in terms of returns, despite its lower risk. The year 2008 was a landmark year for gold as an investment, as it was the only asset that appreciated during the global financial crisis, while equity markets and fixed-income assets, especially in America, collapsed. If you had invested solely in equity during that period, you could visualise the significant impact it would have had on your portfolio. 

In contrast, adding gold as a hedge alongside equity would have protected your portfolio from the uncertainties of that time. Thus, consider gold as a hedge or a good way of diversification and not as your primary investment. This also doesn't mean gold should dominate your portfolio, but having a small allocation to it can be beneficial. Gold is an asset that is majorly uncorrelated with equity and debt, making it an effective safeguard against market volatility. 

Historical Performance of Gold Funds 

Conclusion
Gold has long been a culturally significant asset in India and has transitioned from being a physical commodity to an attractive investment option through gold funds. These funds, including gold ETFs and gold FoFs, provide a convenient means to gain exposure to gold without the complexities of owning and storing physical gold. A small allocation to gold in an equity portfolio can help reduce risk and stabilise returns during periods of market volatility. However, it is important to remember that gold should not dominate one's investment portfolio. 

While gold serves as an excellent hedge against economic uncertainty and market fluctuations, it typically underperforms in terms of returns compared to equities, as demonstrated by historical performance analysis. Like any investment, gold carries its own risks, and investors should approach it with a balanced perspective, keeping long-term goals and risk tolerance in mind. For a well-rounded and diversified portfolio, gold investments should be complemented with other assets such as equities, bonds, and real estate. 

In conclusion, gold remains a crucial component in any portfolio, whether you are a short-term or long-term investor. Even in the short term, uncertain geopolitical events or market corrections can negatively impact equity investments, making gold a valuable hedge. Investor may allocate 10-20 per cent of their overall portfolio to gold funds, ensuring that this allocation is balanced with other asset classes. Remember, the key to successful investing is diversification, and the allocation to gold funds should be proportionate to your equity investments to achieve optimal long-term returns.

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