Gold for every season

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More than just infatuation, the yellow metal has become the protector of wealth for Indians

Gold is money, everything else is credit

— J P Morgan’s words to Congress in 1912

Gold is inexorably entwined in the socio-cultural framework of the country. For centuries, India’s fascination for gold is well known. Gold has been sought after as a store and protector of wealth, and has managed to retain its appeal, generation after generation, owing to innovation.

For modern investors in the present scenario, gold is more compelling than ever. The rise in demand for gold over the past decade, from 576 tonnes in 2002 to 986 tonnes in 2011, is testimony to this.

A variety of factors has worked in gold’s favour in the Indian market and will continue to do so in the coming months.

Risk management: Rising market volatility, global economic uncertainty and geopolitical unrest have increased interest in gold in the short- and long-term. Inherently one of the least volatile asset classes, gold tends to behave like a currency. Assets with low volatility help reduce risk in the portfolio, adding a beneficial effect on expected returns. In 2012, gold gained for the 12th consecutive year with 7 per cent annual returns in the global market.

Gold also helps manage risk more effectively by protecting against infrequent or unlikely, but consequential negative events, often referred to as ‘fat tail risks’. For instance, in 2008, a year wracked by one of the worst financial crises in modern history, gold gave returns of 28.5 per cent per annum. Meanwhile, investors lost more than 50 per cent on the Bombay Stock Exchange.

Portfolio diversification: Most investors primarily hold traditional financial assets such as stocks and bonds. By including new asset classes with low historical correlation to those in the portfolio, investors can further reduce portfolio volatility.

Gold has historically shown very low correlation to major asset classes and even other commodities because risks that affect gold prices are different in nature from those that affect other assets. Statistically, portfolios that include gold are more robust and less volatile than those that do not.

Even banks across the world have recognised the potential of gold as a portfolio diversifier. The global financial crisis has renewed the official sector’s appetite for gold. According to the World Gold Council’s Gold Demand Trends report, official sector purchases rose from 77 tonnes in 2010 to a record 440 tonnes in 2011; global central banks bought 97.6 tonnes of gold in Q3 2012. In six out of the last seven quarters, central bank demand for gold has been around 100 tonnes, which is a sharp increase from as recently as 2010. This trend continued in the first half of 2012. According to the same report, gold currently constitutes 12 per cent of all international reserves held by central banks. With credit ratings of countries such as the US being downgraded, gold will continue to remain an attractive reserve asset for central banks to guard against rising economic uncertainty.

Hedge against inflation: Inflation is either a result of economic prosperity – rising consumer wealth raises demand for luxury goods such as jewellery – or of relaxed monetary policy and increased money supply at a time of economic distress. In this case, the price of gold may rise as investors seek to protect their wealth.

Hedge against currency fluctuations: Gold is sensitive to fluctuations in the currency market. Gold’s inverse relation with the world’s main reserve currency – the dollar – is one of the most stable and enduring economic relationships.

A weaker dollar makes gold cheaper for nations other than the US dollar bloc. This increases demand for bullion outside the US and helps to drive prices up in dollar terms. Gold is employed as a hedge against fluctuations in currencies, particularly the dollar. For this reason, gold has consistently proved to be one of the most effective assets in protecting against a weak dollar.

The past few years have also witnessed significant changes in the Indian gold market. Rising inflation and an increase in personal wealth has led to a surge in the launch of gold backed savings and investment vehicles.

One of the most popular among them is gold exchange traded funds. Gold exchange traded funds were launched in India in 2007 when month-on-month net inflows into gold ETFs were a paltry Rs 3 crore to Rs 44 crore. According to data compiled by mutual fund industry body AMFI, there are over 25 different gold ETF schemes offered by 14 different fund houses with assets under management (AUM) at an all time high of Rs 11,918 crore at the end of November 30, 2012.

The benefits of investing in gold – as an individual investor and at an institutional level – are evident. Gold has stood the test of time; there is no asset class that you can rely upon more, to provide stability as well as ensure good returns.

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