How gold fits into your in­vest­ment plans

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

The Hindu Business Line - - YOUR MONEY - AARATI KRISHNAN

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 stock­mar­ket 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 10year 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 tax­ef­fi­cient 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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