September 11, 2012

Gold: A good investment bet?
This article is a brief write-up on Gold and the different investment options.

by Dr. Renu Pothen

My Take
My Take
A PhD in Economics, Dr Pothen flagged off her career as an academic associate with the Indian Institute of Management, Ahmedabad followed by a stint at Pioneer Investcorp Ltd. In her current position, she heads Research at

Gold has been on a roll since the last few weeks and we have been flooded with investor queries on whether this is the right time to take an exposure into the yellow metal. The events that have triggered this restlessness among investors are the fact that gold crossed INR 30,000/10 gm and has been on an upward trajectory and with India getting into the festival and marriage season mode, there seems to be more optimism surrounding the yellow metal. In addition to this, gold funds like AIG World Gold Fund and DSP BlackRock World Gold Fund have been topping the charts in the 1-month returns on, which is making investors time their entry and exit into this asset class, which I don’t think even experts will be able to do.
We have all grown up seeing our mothers and grandmothers buying gold and flaunting it, but this was also done with the objective of passing it onto posterity. However, things have not changed even today, except for the fact that instead of buying gold for our current consumption in physical form, we consider the metal as an investment vehicle and hence look to other options to buy the same.

We at have always held a different view as far as gold is concerned. We have been advising investors to be cautious while adding onto this yellow metal inspite of the fact that it has delivered fabulous returns consecutively over the last 11 years. We are of the view that gold is one of the few asset classes that do not produce any cash flows which can be valued or discounted. Since there is no proper valuation metrics to analyse gold, it is impossible to put a fair value price for this metal. Another reason for being negative on gold is that this metal has always been thought to be a safe haven asset, however, a detailed analysis done by our team showed that there was an increasing correlation between gold and other financial assets, but it was still fairly low.
This increasing correlation with other assets could be possibly because of the increasing interest in gold as an investment and this could hurt its ability to act as a safe haven asset. Finally, the compelling reason for us not being too optimistic on this shiny metal has been the fact that the fundamentals driving theĀ  rise in price has not been very convincing, hence making us very cautious when we recommend the addition of this yellow metal in an investor’s portfolio.
In spite of our negative take on gold, we can understand the logic behind taking a small amount of exposure to this metal (say 5-10%) as part of an asset allocation strategy.

The reasoning behind this is that gold acts as an insurance policy at times when equity markets collapse on account of some major events like

war, terrorist attacks, etc, as gold will move in the opposite direction vis-à-vis all other assets in the portfolio.

In addition to this, we recommend investors to look at equities which invest into gold mining companies as they have actual earnings to show and hence can be valued. However, investors need to remember that profits of gold mining companies are also correlated to gold prices and hence are susceptible to volatility in gold prices.
In the Indian context, investors who do not have enough surpluses to shell out to buy gold at these astronomical prices can find shelter in the mutual fund industry which offers different options for investors who are looking to take an exposure into this yellow metal. Fund houses started launching Gold ETFs which directly invests into the physical metal and tracks the spot price with a slight tracking error, since 2007. The biggest drawback of these schemes is that investors with a demat account could only opt for this and systematic investments into the same were not allowed. This actually limited the participation of retail investors into these schemes and hence mutual fund houses then launched gold savings schemes. These inturn allowed small investors who did not have a demat account to take an exposure into this asset class and allowed SIP investments with as little as INR 100.The other option available to investors are the asset allocation funds where the fund managers allocate the portfolio between the different classes of assets i.e, equity debt and gold.
Finally, there are gold equity funds which are fund of funds investing in a parent fund that takes an exposure into gold mining companies. There are currently only two funds in this category, i.e DSP BlackRock World Gold Fund and AIG World Gold Fund. The former normally invests into large cap companies while the latter has a bias towards mining companies in the small and midcap space. The superb performance displayed by these funds in the last 1 month should not be the reason for entering them but instead investors should realize that the potential of these funds lies in the attractive valuations offered by the gold mining companies. These funds are not for the faint hearted but are for those who are looking at long-term investments in the yellow metal without being worried about short term volatility.
My final take on the yellow metal is that if investors are going to enter when prices are soaring and expect to make short-term gains at even higher rates then they are actually treading on the dangerous path.


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