- Date : 24/06/2020
- Read: 8 mins
A symbol of wealth for centuries, gold is today a key instrument alongside stocks, bonds, and broad-based portfolios and provides a great hedge against inflation
Indian markets were buoyant before the coronavirus started making its effect felt in the country towards the end of February. Market capitalisation on the major bourses averaged about $2.16 trillion around mid-January, but a month later, when the virus began to spread across India, the picture changed.
The Sensex plunged some 3.5% on February 28, registering its second steepest fall ever, and wiping off more than Rs 5 lakh crore of investors’ wealth. The total market cap lost during the period between January and early May was a whopping 27.31%.
Where does the investor go from here?
The question is pertinent, considering it is quite difficult to gauge the impact the pandemic will have on the economy. As IMF chief economist Gita Gopinath admitted, this is a crisis like no other in the past.
Keeping the faith
Analysts advise investors to stay calm, remain focused on their goals, and not shy away. They believe the markets will bounce back once the crisis is contained or liquidity increases. Their reasoning: the markets are resilient. For instance, it has been argued that the Sensex has grown at an average CAGR of around 15% over the last four decades – from 100 points in 1979 to over 41,000 points last year.
Along the way, it survived assassinations of incumbent and past prime ministers, the Kargil war, the 1991 balance of payments crisis, international sanctions after the nuclear tests, the 2008 global meltdown, two major instances of terrorist attacks on Mumbai, market collapses, and a series of scams. Even as recently as May 13, when PM Narendra Modi announced a Rs 20 lakh crore stimulus package, moribund indices came to life and jumped by more than 2%.
The question that remains, however, is this: what investment option is the most suited for these times?
Analysts differ on what constitutes a good investment during the current crisis, but few would disagree that one can’t go wrong by investing in gold. A symbol of wealth for centuries, gold today complements stocks, bonds, and broad-based portfolios as an investment instrument. Given that it is precious, indestructible, and liquid, it has for long been considered one of the finest hedges during times of financial uncertainty.
Gold as an investment tool
What made gold very attractive for institutional investors, according to the World Gold Council (WGC), are two developments since 2001. First, the price of the metal in the global market rose eightfold over nearly two decades from 2001 to 2018. Second, the demand for investment in general has expanded by about 14% every year over the same period.
As a result of this wave, people have increasingly begun looking at gold as an investment. For institutional investors, gold ensures better risk-adjusted returns than many other instruments, and also the means for diversification. For retail investors, other factors come into play. At first, there was the traditional love of gold for ornamental and sentimental purposes, but now the attraction has increased with gold being considered as an investment tool.
Gold ETFs (exchange traded funds) too played a role; when the first gold-backed ETF was launched in the US in 2003, it helped retail investors in several ways:
- First, access to the gold market became easier
- This led to the second development: gold’s relevance as a strategic investment became enhanced
- Third, gold became cheaper to own thanks to ETFs
- Finally, efficiencies increased as trading, transportation, and storage of the asset got easier
Gold’s long-term returns get highlighted in low interest regimes, particularly when viewed against negative-yielding debt globally.
According to the WGC, gold as an investment for Indian investors delivered average returns of around 9% over 2009–2019. This is comparable to returns from stocks, but better than that of bonds and commodities. Moreover, it marks gold as an effective long-term diversifier, a safe haven asset during crises, and a hedge against inflation.
This cannot be said of many other assets. For instance, the Sensex plunged some 56% between December 2007 and February 2009 during the global meltdown, and so did accepted portfolio diversifiers such as hedge funds and real estate. In contrast, the price of gold jumped 48% in rupee terms.
Similarly, gold has beaten inflation in India. Data shows that as of December 2019, gold posted an average annual return of 10% since 1981, better than India’s consumer price index in this period. Data also shows that the price of gold rose 11.5% at a time when inflation averaged 6%. Not only did gold lose in terms of value, it actually helped capital grow over the long-term.
Research at Oxford Economics, a leader in global forecasting and quantitative analysis, says that gold will also perform well during periods of deflation. So much so, the features that mark deflation – low interest rates, curtailed consumption, reduced investment, and heightened financial stress – will work together to propel demand for gold in India.
Gold is looked as a hedge against downturns not only by institutional and retail investors, but also by governments. Indians learnt this first-hand in 1991, when the Chandrashekhar government had to pledge the country’s gold to tide over an embarrassing financial crisis.
In January 1991, India faced a major balance of payments crisis, thanks to a number of factors that came into play over the 1980s, such as an over-valued rupee and fast depreciating foreign reserves. It was so bad that the government could barely afford imports for three weeks.
The crisis was exacerbated first by the Gulf War, and then by Moody’s, which downgraded India in February 1991, making even short-term loans impossible. Left with little elbow room, the government pledged 47 tonnes of gold to the IMF for an assistance of $2.2 billion, and another 20 tonnes to the Union Bank of Switzerland for $600 million.
Even South Korea had to turn to gold to pay off a sovereign IMF loan of $58 billion to survive the after-effects of the 1997 Asian financial crisis. In response to a government appeal, an estimated 3.5 million ordinary citizens – a quarter of the country’s population – donated their personal gold to pay off part of the national debt.
The current scenario
This same trend is continuing globally in spite of the coronavirus crisis and what IMF’s Gopinath has termed the Great Lockdown. As per the latest WGC quarterly report released in April, central banks of various countries have continued buying gold in ‘significant quantities’ in the January–March 2020 quarter.
However, it concedes, the rate of purchase is lower compared to the same period last year; the total purchase by the global central banks stood at 145 tonnes in the period under review, 8% lower year-on-year. The report also said the coronavirus outbreak has undermined global consumer demand in the January–March period even as it ‘ignited safe-haven ETF inflows’.
Apparently, investors across the world sought out gold ETFs as safe-haven assets, attracting ‘huge inflows’ of 298 tonnes, and pushing global holdings in these products to a new record high of 3185 tonnes in the January–March quarter. As per the report, global inflows into gold-backed ETFs saw a sevenfold year-on-year increase in the first quarter, amid worldwide uncertainty and volatility in the financial markets.
However, if you are planning to buy gold, do note that the price of gold is on an upswing, primarily due to a weaker rupee and rising dollar, according to the report. In the quarter under review, the average gold price in India was at Rs 41,124 per 10 gm – 26.6% higher year-on-year, while March witnessed prices rising to an all-time high of Rs 44,315.
As mentioned earlier, it is precisely the current situation – marked by economic uncertainty, market volatility, and high inflation – that makes buying gold such an attractive proposition. One can buy gold in three primary forms: physical gold, gold ETFs, and sovereign gold bonds. Let us look at each:
- Physical gold: Gold is available in its physical state in the form of biscuits, jewellery, or coins; there is no limit to how much physical gold one can buy. However, with physical gold comes a risk: its purity may be suspect. Also, returns on physical gold are usually lower than the actual returns on gold.
- Gold ETFs: If you have a demat account, you can pick up gold ETFs from the stock exchanges, that too at almost the actual rate. You can even trade it on the exchange. While there is no lock-in period, long-term capital gains (LTCG) tax is applicable. Do bear in mind that the minimum amount one can buy is one gram. As with physical gold, returns are less than actuals.
- Sovereign gold bonds: Issued by the Reserve Bank of India, these are government securities issued in multiples of one gram of gold, the minimum being one gram for one buyer and the maximum being 4 kg. Returns from these are higher than that from actual gold due to the interest payable, which is taxable. These bonds have a maturity period of eight years and can be traded on an exchange. Buying gold? 5 things to check before you buy
Disclaimer: This article is intended for general information purposes only and should not be construed as investment or legal advice. You should separately obtain independent advice when making decisions in these areas.