Asset Cycle - Commodity
- Plan Alfa Wealth
- Jul 2, 2021
- 4 min read
Is Gold really as safe as it sounds?
There is something about gold, we just seem to love it!
This is an expansion on our retirement planning and “Understanding Asset Cycles” article. This week we are taking a look at commodities, more specifically gold! A commodity is a basic good used in commerce. Traditional examples of commodities include grains, oil, and natural gas.
Gold is considered on the safest investment instruments by the Indian. As there has been significant affinity towards gold for jewelry, worship, and heritage. After all, it has been a part of our culture for centuries So, it is assumed that demand is only going to go up, but is it the case?
Let’s see how the Gold has performed in Dollar terms on a 5 Year basis from 2003. We have considered that you have invested at any one day and kept it for 5 years.
As you can see, there has been a five-year period over which Gold has generated negative returns so there have definitely been times when gold has significantly underperformed Fixed Deposit or Government bonds.
As the Dollar has always appreciated against the Indian rupee for the past 30 years, Gold has not yet delivered a negative return over 5 year period. But there have been many periods over which 5-year gold return is less than 5%. This simply means you would have been better off investing in Fixed deposits or Government bonds.
If you compare the returns and volatility of Gold vs Nifty, on average Nifty has outperformed Gold with far less volatility when we consider both 3 years and 5 year periods. Even so, why do people consider Gold as safe and Nifty as risky? It has less to do with statistical and economical parameters and more with our behavioral dynamics.
Traditionally, Gold has been consumed by Indians in the form of Jewellery, Mothers used to pass on Gold Jewellery or make gold jewelry for their daughters or daughters-in-law. Some of this jewelry used to remain in the family for generations unless some extreme conditions arose in the family. Thus, it was considered as a hedge for a rainy day in an uncertain future and not because of its price movements. Because of this nature, people could generate long-term returns from the Gold and enjoy the returns that any medium to high-risk growth asset class delivers like equity, Gold, or Real Estate.
Now, the third and biggest question arises, should we invest in Gold? We have seen gold is not as safe as we have assumed. Gold has its share of volatility and which is even higher than Nifty or Indian Equity for the horizon of 3 years or 5 years.
The advantage that the Gold brings to the table is its price movement has a low correlation to Equity. When the stock market crashed in 2008 and the Sensex crashed over 30%, Gold rallied and had phenomenal returns. The same trend was seen when the Stock Markets were seen to stagnate in 2012-2013. In the case of the US, 7 out of 8 financial crises which saw a sharp fall in equity returns saw the opposite trend in gold. The inverse relationship between stocks and gold means that the stronger the market retracement, the stronger turns out to be gold’s rally Thus, a good combination of Equity and Gold can significantly reduce the volatility of your portfolio. Thus, you can expect less drastic price movement, especially during a crisis.
So how should you allocate Gold in our portfolio? Going 80-90% of your portfolio with Gold is not a safe option. It will expose you to the extreme price movement of Gold, which you would not have considered. But you can allocate a certain portion of your portfolio into the Gold and significantly reduce the volatility. You should have a lengthy discussion with your wealth advisor about how your portfolio will look with a different allocation of Gold because, on the one hand, a risk-averse investor may gain significant peace of mind from such an allocation, but a very skewed portfolio to Gold may keep you from achieving your retirement goals.
Lastly, what is the best way to invest in Gold? As times are evolving, so are the ways of investing. There are many instruments to invest in Golds from digital to physical. Stay tuned as we explored each of the options.
Fun Fact About Gold: - There was a time when the Government of India used to collect 12-16% excise duty on Gold. Over time a few people have seen the high arbitrage opportunities in gold smuggling. The most prominent place for this smuggling was Mumbai, where many mafias arose. One of the biggest names that came from it was Dawood Ibrahim. Since 1991, the Government of India (GOI) has significantly reduced the Gold excise duty to zero. Thus, the arbitrage opportunity was gone and so were the Gold smuggling profits, and the gold smugglers moved to some other business. But from 2010, Government has started increasing the excise duty on Gold. Currently, it stands in the upper single-digit number. It will be interesting to see how the story plays out this time. Will the smugglers rise again or robust digital movement will prevent this from happening.
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