If it glitters, it must be Gold!

Fixed Income and equities have generally sought more favour with investors as these are income-generating assets. Fixed Income generates interest; equities provides dividend and Gold is considered a good hedge against inflation. It has been historically viewed as a safe haven. Whenever an economy encountered a big crisis, investors tend to rush towards gold as a stable investment option. When gold was selling at $625 an ounce (Rs8,600  per 10 gram) only six years back in 2008, the world was plunged into a financial crisis of an unusual magnitude. Since then, there has been a rush for gold as an investment. Stock markets crashed, interest rates plunged, and investors lost faith in financial assets and pleaded for gold as a safe investment.

That presumption was intact by subsequent trends in gold prices. Over the next five years, prices shot up in India as much as 3-1/2 times, making gold not only safe but also the most lucrative investment. The stock market took all that time to recover from the 2008 shock but has not, even now, come up to pre-crisis levels and trading in narrow range. Gold became a preferred part of the portfolio and gold-backed exchange traded funds (ETFs) were a favorite with investors.

What is surprising now is not the fall itself but its speed. In a span of just days, gold prices dropped 13 percent in the steepest fall in 33 years got major setback for global economy. It wasn’t gold alone that got caught in the bear grip. Prices of other commodities such as silver, crude oil, copper and so on also declined, but not as sharply.

The trigger for the collapse of gold prices was mainly the decision of the Cyprus government to raise money by selling gold valued at $ 523 million. That was fuelled by the European Central Bank which even supported by other countries in Europe which have already been facing sovereign debt crises, creating the scare that the market for gold will be flooded. Hence, the price of gold has dropped significantly. Many investors trimmed their position in ETFs and leave turmoil in the minds of all retail investors.

Have the metal outperformed stocks, another major assets class, in giving returns? The answer is not exactly, as equities have historically performed better than gold, barring minor aberrations here and there.

Gold was Rs1,450/- in the year 1980 and today it is Rs25,800/-. The rise of 18 times in last 33 years generate just @ 9% p.a. To put it simply, if you have invested one rupee each in gold, silver and stocks 34 years ago. As on date, you have achieved the return in terms of percentage as 11.21% in Gold, 11.05% in silver and 16.65% in stocks. Around the same time, if we go after adjusting for inflation (assumed annualized 7.63%), the asset classes have grown   annualized rate in real terms in Gold – 2.72%, Silver – 2.57% and equity –  7.74%.  In other words, in all these years, investment in stocks would have given layman better returns than in gold and the other asset class, albeit minor aberrations like in 2002-2003 and 2001-2002 when the return on the BSE Sensex was less than that on gold.

Huge gains have been experienced by Gold investors this year, but the recent underperformance of gold versus stocks is bothering to those who waited to bulk up on the precious metal, or those who added to positions over the past three months. Typically, gold does tend to outperform when equity moves lower, or at least sharply lower.

Charts and market signals continue to point out reasons why dispirited gold investors may maintain their gold exposure. Key to the case for gold is current market technical concerning stocks, since investors tend to move into gold as a haven during times of extreme weakness for equities. So as long as macro concerns persist and stock markets stay weak, gold will continue to remain a favorite of investors with potential to rise further.

A research on investor psychology shows the investors’ interest in gold will continue till stocks don’t rise. The last 5 to 6 years increase in gold prices have mainly come from speculators who invested in ETFs, gold futures etc. and not from jewelry demand. Speculators can move out as swiftly as they moved in. Though in the short-term gold prices may correct, it won’t be a downward trend and prices will restore again by the end of this calendar year. Despite the import drop, domestic gold prices continue to rule high with the yellow metal being seen as a strong hedge against inflation and favorite among Indians and Chinese. Let gold and silver be part of social requirement and not exceed 10% to 15% of investment portfolio.  If the percentage has not been achieved, one can raise the allocation to gold in a phased manner. In reality, Sensex / Equity are to be said as gold for building wealth and whenever it glitters and turn into Gold.