Dilshad Billimoria of Dilzer Consultants shares her insights on how to make gold investments work for your clients.
Gold as an investment avenue has been an all-time favourite. It is bought for many reasons ranging from emotional to financial well-being, a hedge against inflation and simply a tradition to purchase at festivals.
So it is worthwhile to look closely at the factors that affect the price of gold and therefore the demand dynamics. Some of them are:
Weak U.S dollar: As long as demand for the U.S dollar continues, gold price continues to maintain equilibrium. However, like in 2008, with the credit crisis, US dollars were dumped, the demand for gold purchase as a safe haven went up and so did the prices.
Economic crisis: The 2008 credit crisis led to purchase of the solid metal leading to price hike in gold the world over. In fact, even governments resorted to buying gold as a liquidity measure.
ETF demand: Globally demand for ETFs has gone up, and this has led funds who manage ETFs to maintain the physical asset as the sales increase as collateral. This demand has led to increase in prices.
Rupee dollar parity: India is the largest consumer of gold (as per World Gold Council report 2011) some of which is consumed within the country and some of which is imported. While importing gold, the denomination used for exchange is US dollar, and if there is disparity of exchange rate (if rupee has depreciated) then although the international price of gold has fallen, Indian gold prices move up, since you need to pay that much more to buy the same quantity of gold in India.
Demand for jewelry: India has been a hub of jewelry consumption accounting to 27% of demand in gold. Higher population and increased demand for gold as a metal to provide for marriages and festivals increase the prices.
Global world reserves: Central banks hold some part of their reserves in gold. If for some reason, demand for gold reserves moves up, so does the price.
U. S government borrowing: If the U.S debt is considered as junk, the dollar is devalued and this leads to increased demand for gold as a safe haven.
Ways of investing in gold:
Physical: Physical purchase of gold is made (especially in India) by many people in the form of jewelry, gold coins, bars, tolas, etc. While this is a traditional form of holding the metal as an investment, there are costs of storage, pilferage, deterioration, quality and resale value which need to be considered in this buying decision. Taxation also plays a role.
Exchange traded funds (ETF): One of the best methods of investing in gold and participating in their upward movement is by investing through ETFs listed on the stock exchange. The benefits here are manifold - low holding costs, low expense ratios, surety of quality of gold held (ETFs have to hold gold of 0.995 gms quality). Each unit of gold held, is equivalent to 1gm of gold. This method of investing also provides ease of buying and selling the metal for the purpose of asset allocation and diversification to portfolio. Taxation is also favorable here, when compared to holding the physical metal, since the period holding is lower for consideration of capital gains tax.
How ETFs have performed
Performance as on October 8, 2010, Portfolio details as on August 31, 2010.
(Source: ACE MF, PERSONALFN Research)
Gold mining funds: Gold mining funds are feeder funds that invest in off shore gold mining companies. The most important difference in this form of investment is that the investment is made in gold mining companies and therefore does not directly mirror the demand and supply of gold in the market, but more the performance of equity shares of these companies. These funds are correlated to the equity market more than gold price movements.
Performance of gold mining funds
Performance as on October 8, 2010. Given the daily performance of the fund’s benchmark, i.e. FTSE gold mines is not available in public domain, we have compared the funds with International gold price
(Source: ACE MF, PERSONALFN Research)
Gold deposit scheme of banks: Last week RBI introduced the gold deposit scheme with the objective of moderating the demand for gold import and thereby reducing current account deficit and encourage savings. Investments in gold accumulation scheme of banks, gold linked account, will foster savings in gold to provide for inflation adjusted returns and thereby reduce the illicit import of gold by the unorganized sector to meet the demand for physical gold from the Indian consumer.
SEBI has allowed investment by ETFs in gold linked deposits of banks to the extent of 20% of their asset base. This move would help increase liquidity in ETFs, provide for better returns with a wider base, lead to a reduction in ETF expense ratio and better utilization of gold collateral held by ETFs.
At a macroeconomic level, this would encourage savings through the organized route of investing in gold, by reducing physical purchase of the metal and facilitate gold lending to jewelers by the banks, thus reducing the dependability of import of gold by jewelers. It would also reduce the risk of India’s rating downgrade due to high current account deficit and fiscal deficit,
Given these advantages, investment in this asset class can comprise 5-10% of one’s overall portfolio allocation.
The views expressed in this article are solely of the author and do not necessarily reflect the views of Cafemutual.