Add Glitter To Your Portfolio

The price of gold has steadily risen over the decades. This underscores the attractiveness of gold investments as they tend to keep pace with inflation. Furthermore, investing in this precious metal is often seen as a means of preserving and safeguarding one’s wealth.

Gold has experienced a significant uptrend, surging by more than 8 per cent since the beginning of this month. This significant rise can largely be attributed to the escalation of geopolitical tensions associated with the Israeli-Palestinian conflict. This surge in gold prices comes after a relatively subdued performance of gold in the first nine months of the current year. Gold has a well-established reputation as a crisis hedge due to its unique characteristics. 

This includes its immunity to credit risk and its negative correlation with riskier assets like equities. Historically, we have observed that gold tends to exhibit a negative correlation with equity returns and maintains a very low correlation with fixed income returns. Therefore, it serves as an ideal hedge in the context of the Indian market, a concept we will delve into in the subsequent paragraphs. The graph below illustrates the trajectory of gold prices dating back to 1979. 

As the graph demonstrates, the price of gold has steadily risen over the decades. This underscores the attractiveness of gold investments as they tend to keep pace with inflation. Furthermore, investing in this precious metal is often seen as a means of preserving and safeguarding one’s wealth. With reference to the chart, if an investor had allocated ₹1,000 to gold at the outset of 1979, their wealth would have grown to ₹92,240 today, boasting an annualised return of 10.62 per cent. This exemplifies how gold investments offer a protective shield for investors’ capital. In India, the affinity for purchasing gold is deeply ingrained in our cultural traditions, and it spreads over various occasions and events. 

Indians have a propensity to invest in gold during numerous festivals, guided by auspicious days within the Indian Hindu calendar, such as Dhanteras during Diwali, Dusshera and Akshaya Tritiya. The act of acquiring gold during Diwali is often regarded as an invitation to Goddess Lakshmi, the deity of wealth and prosperity. This ritual reflects a belief that investing in gold can usher in prosperity and happiness into one’s life. Nevertheless, the question arises as to whether every investor should indeed consider gold as a primary investment choice. To answer this, we will explore the advantages and disadvantages in the following sections. 

Gold as an Asset Class
In the earlier paragraphs, we highlighted the upward trajectory of gold prices, underscoring its potential to offer returns that surpass the impacts of inflation. But now, a pivotal question arises: Should you consider integrating gold into your investment portfolio for the purpose of diversification? The resounding answer is ‘Yes’. A wellstructured and diversified portfolio should encompass various asset classes, each contributing stability and consistency to the overall mix. Constructing a portfolio comprising asset classes that are either directly correlated or positively linked may not yield the desired results. 

Instead, it can expose your investments to significant losses in the event of adverse market developments. To avert such scenarios, it is essential for every portfolio to incorporate a range of asset classes, ideally featuring inverse relationships or very low correlations. This strategy serves to bolster portfolio stability. The primary asset classes typically include equities and equity-related instruments, debt and money market instruments, gold and real estate, among others. In this context, investing in gold plays a pivotal role in reinforcing portfolio stability, primarily due to its inverse relationship with the equity markets. 

The importance of asset correlation lies in the fact that effective asset allocation aims to blend assets that exhibit low correlation with one another. This strategic approach is designed to mitigate portfolio volatility. The concept of asset correlation hinges on quantifying the relationship between the movements of two or more assets, which is expressed as a numerical value between +1 and –1. The value of +1 signifies perfect correlation, indicating that the assets invariably move in the same direction and in the same proportion. 

Conversely, the value of –1 represents negative correlation, signifying that the assets move in precisely opposite directions. A correlation of zero implies no discernible relationship between the assets. In the case of gold, its correlation with equity is notably low. What makes this noteworthy is that when the equity markets experience declines, gold often demonstrates strong performance. The graph below illustrates the rolling correlation of returns of one year between the Nifty and gold over the years, further emphasising the benefits of diversifying with gold. 

Given this data, a clear trend emerges – gold tends to excel when the Nifty experiences declines. This relationship becomes especially evident during significant financial crises, such as the one in 2008. Amid this market crash, gold proved to be a resilient investment, delivering a remarkable 28 per cent return, in stark contrast to the Nifty’s staggering negative 52 per cent return. In 2008, the Nifty had an average monthly return of –5.45 per cent, while gold boasted a positive average of 2.47 per cent. This historical performance aligns with an average correlation of – 0.04 between the daily returns of gold and the Nifty since 2007. 

Let’s delve into the dynamics between gold and the Nifty during the tumultuous year of 2020. This particular year was marked by the global outbreak of the pandemic, which cast a substantial shadow over the world’s economy. The equity market faced a substantial drawdown, and a nationwide lockdown dealt a severe blow to the economic landscape. During March, precisely when the lockdown measures were enforced, the Nifty experienced a significant decline. Interestingly, it was during this challenging period that gold began to exhibit a strong performance. 

This trend continued into 2022, where even as the equity market faced difficulties, gold delivered returns in the double digits. This comprehensive analysis of gold as an asset class and its intricate relationship with equities reveals its potential as a valuable diversification tool within your investment portfolio. We now outline the methods of investing in gold, and in the subsequent section we will explore these approaches in greater detail. 

Buying Gold
Today, individuals have a myriad range of choices when it comes to investing in gold. Gold investment can take place in both physical and digital forms. In days gone by, the conventional approach was to acquire physical gold, often in the shape of coins, bullions or jewellery, primarily for personal consumption. However, contemporary investors seeking exposure to gold can opt for digital avenues, steering clear of the necessity to hold physical gold. These digital options include gold mutual funds, gold exchange-traded funds (ETFs) or sovereign gold bonds, which provide an alternative to traditional physical gold investments. 

Let’s explore the various avenues for digital gold investment. It’s worth noting that physical gold investments carry their own set of challenges, including the need for secure storage in a safety vault or bank locker, which adds to the overall cost, limited flexibility in investment amounts and concerns about purity, among other drawbacks. Investors have a diverse array of gold investment options at their disposal, each offering unique benefits. Let’s delve into these alternatives, considering their advantages and nuances: 

Physical Gold
Traditionally, many Indians have opted for physical gold investments, typically for consumption rather than as a financial asset. Gold in the form of jewellery, bullion, coins or bars is often exchanged during significant life events, such as weddings. However, there are notable drawbacks to physical gold investments. Storing gold securely in safety vaults or bank lockers adds to the overall cost, and investors face limited flexibility in the amount they can invest. Additionally, concerns about gold purity may arise. To circumvent these challenges, investors can explore other options. 

Gold Mutual Fund
Gold mutual funds, classified as open-ended funds, offer a modern avenue for investing in gold without the need to possess physical holdings. The value of these funds is closely tied to the prevailing price of gold. Fund managers allocate investments to gold mining companies’ stocks or gold ETFs, which in turn hold physical gold of higher purity. Consequently, shifts in the global gold market prices can influence the performance of gold mutual funds. While these funds may offer lower returns in comparison to equity funds, they often serve as a reliable source of returns during market downturns given the inverse relation between gold and equity. 

Gold Exchange-Traded Funds
Gold ETFs are transparent and efficient investment vehicles, particularly suited for small investors looking to diversify their portfolios with gold. Investing in gold ETFs ensures the purity of gold and provides liquidity. To invest in gold ETF, you will need a dematerialisation account. Notably, the expenses associated with buying and selling gold ETFs are significantly lower than the costs linked to purchasing, storing and insuring physical gold. As per data from the Association of Mutual Funds of India (AMFI), the assets under management (AUM) of gold ETFs reached ₹23,762.77 crore at the end of September 2023 from ₹16,225 crore as of June 2021, indicating a substantial jump of 45.9 per cent. 

Sovereign Gold Bonds
SGBs represent government securities denominated in grams of gold, presenting a viable alternative to holding physical gold. Investors purchase these bonds at the issue price using cash, and upon maturity the bonds can be redeemed in cash. The Reserve Bank of India issues these bonds on behalf of the Government of India. SGBs alleviate concerns such as making charges and gold purity, which are often associated with jewellery. Moreover, the quantity of gold for which the investor pays remains safeguarded as they receive the prevailing market price at the time of redemption or premature redemption.    

Conclusion
Gold serves as a reliable safe haven, particularly during periods of geopolitical uncertainty. In an intriguing departure from the typical narrative of gold’s ascent in the face of a weaker dollar, its status of being a safe haven has become increasingly pronounced even amidst a robust dollar environment. Furthermore, our projections anticipate that gold will reach new all-time highs in the coming 12 months. This outlook is underpinned by the Federal Reserve’s commitment to a ‘higher for longer’ stance, which, while intended to stabilise the economy, carries the risk of triggering a broader credit deflation and a significant recession during an election year. Hence, we can see a drop in yield sooner than later. 

Now that we understand the diversification benefits and stability that gold investments can offer, it’s important to note that investors should exercise prudence when allocating their assets. It is advisable to limit gold exposure to a range of 5-10 per cent within your portfolio. Gold should not be expected to generate returns on par with equities. However, its presence can play a pivotal role in stabilising the overall performance of your investment portfolio. If your portfolio lacks sufficient exposure to this asset class, you may consider adding gold during price corrections. Conversely, if your gold allocation surpasses your portfolio’s actual requirements, a reduction in this allocation may be prudent.