Personal Finance

How gold fits into your investment plans

Aarati Krishnan | Updated on February 10, 2019 Published on February 10, 2019

Don’t buy it for great returns, but as your insurance against market turmoil

Gold exchange-traded funds (ETFs) have turned out to be surprisingly good bets for Indian investors in the last one year with a gain of 8 per cent (as of February 8, 2019). This has topped the returns on most equity as well as debt fund categories. A year ago, very few investors would have been tempted to buy gold ETFs based on their track record. For the five years from 2013 to 2017, gold ETFs delivered a near-zero return even as equity and debt funds were notching up double-digit gains. But gold’s comeback over the past year underlines its role as portfolio insurance.

Gold and equity

Gold being a safe-haven asset, its prices should rightfully rise when there is stock-market mayhem and fall when stocks are going strong.

But running a correlation analysis of monthly gold returns in India with BSE Sensex returns for the last 15 years shows that while an inverse relationship does exist, it is not very strong.

The correlation coefficient between the MCX spot gold price and the BSE Sensex was minus 0.13; a number greater than 0.50 would denote a strong relationship.

But if we look back specifically at periods in which the Indian stock market suffered big meltdowns, gold has fared very well in those periods.

After the dot-com bubble burst, the BSE Sensex tanked by over 50 per cent between February 2000 and September 2001, but domestic gold prices gained 3 per cent. When global financial crisis triggered a 45 per cent fall in the Sensex between January 2008 and March 2009, gold jumped 28 per cent. The unexpected bear phase between December 2010 and December 2011, which saw the Sensex tank 25 per cent, again saw gold prices gain 32 per cent. The Sensex dip of 22 per cent between February 2015 and 2016 was accompanied by gold returns of 10 per cent.

The history of domestic gold price returns versus the Sensex suggests that until the turn of the millennium, gold prices in India did not make dramatic gains during stock-market meltdowns. In the crashes of 1992-93 or even 2000-01, gold prices in India made only marginal gains. But in the last 15 years, domestic gold prices have made material gains during equity meltdowns.

This could perhaps be explained by the fact that India’s stock-market meltdowns were increasingly triggered by global events and foreign investor pull-outs in the last 15 years, while local events were the triggers in the ’90s.

Global stock-market turmoil usually has investors rushing to buy gold and the US dollar as safe-haven assets. Domestic gold prices gain directly from both global gold and dollar strength.

Gold and debt

But if the only purpose of owning gold in your portfolio is to shield it from big equity falls, can’t fixed-income investments do the job? The 10-year returns on gold ETFs today stand at 7.5 per cent, a return that bank fixed deposits deliver with far less volatility.

While this is true, layering gold exposure on top of your equity and fixed-income allocations makes sense for three reasons.

One, when global equity markets suffer big meltdowns, domestic banks are unlikely to respond by offering you better interest rates. But gold usually flares up when stock markets crash. It can, therefore, boost your aggregate portfolio returns when you need it the most.

Two, long-term gold investments in India are more tax-efficient than bank deposits. Investments in gold ETFs fetch indexation benefits on capital gains tax, once you hold them for three years. Sovereign gold bonds offer complete tax exemption on gains if you hold them to maturity. In contrast, bank-deposit returns are subject to tax at your IT slab.

Three, there have been periods in global history when none of the financial assets have appeared safe. The US housing crisis of 2007-08 was one such episode. The past couple of years have seen Indian investors buffeted by uncertainty in both equity and debt markets. If equity investors have suffered through sizeable falls in mid- and small-cap stocks, debt investors have had to deal with roller-coaster rates, default fears surrounding AAA entities and NPAs/losses in the banking system.

Gold offers you exposure to a real asset that isn’t susceptible to such turmoil in financial assets.

Before you add gold to your portfolio though, there are three things to keep in mind.

Given that gold can deliver anaemic returns for really long spells, restrict the allocation to 5 or 10 per cent.

Because gold offers insurance against stock market swings, peg your gold weights to the amount of equities you own.

The best time to buy insurance is when the premium is cheap. That applies to gold, too. The best time to buy it is when past returns look dismal.

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