Summary:
- Gold has long been considered as a “safe haven” and store of value.
- Since 1980, gold has delivered 9% annualised average return. Much of this has come come during 2000 and 2010. Most of the time, gold has delivered single-digit return. Most of the time, return from gold has been below the fixed deposit return.
- A large portion of return (~80%) from gold has come from sharp rupee depreciation against US dollar. This is gradually becoming weak.
- Gold cannot be substitute to equity in your portfolio. Compared to 9% for gold, Sensex return has been ~15% (excluding dividends) Once can have 5% to 10% allocation to gold as portfolio insurance.
- As a wrote earlier, the best way to buy gold is through sovereign gold bonds as that can boost gold return by 2.5%.
Recently, I wrote about
how you can buy gold. After remaining flat for many years, gold prices seem to show some signs of life. As a result, there is more interest in gold. Famous investor
Mark Mobius recommended that at least 10% of a portfolio should be in gold. So, should we buy gold in our portfolio? If we indeed buy than how much should we keep gold in our portfolio?
Gold – as an asset class?
The price of any asset depends on how much cash you can generate from that asset class. Where it is equity or bonds or real estate, we tend to get some recurring income. This income is in the form of dividends, interest payment or rent. So, there is a fundamental basis of pricing a financial or real asset. Gold, on the other hand, doesn’t generate any cash flow. Its price is mainly dependent on how much anyone is willing to pay for it. It is dependent on supply and demand dynamics. While supply from primary source (gold mines) and secondary source (people selling their gold jewellary, coin) is somewhat limited, demand can vary a lot.
Gold is considered a store of value. This means that purchasing power of gold remains the same. It’s a hedge against inflation. As it’s supply cannot be controlled by governments, it is also a hedge against irresponsible governments. It is also a source of universal value. If you try to sell your house in India in London, you won’t get any buyers. However, a gram of gold will fetch the same amount anywhere in the gold. So, definitely gold has some qualities which are not present in any other asset class.
How has been the performance of gold?
Gold has delivered an annualised return of 9% since 1980 every year.
However, the performance of gold has not been uniform. Much of the return from gold came during 2000 to 2010. During this period, gold delivered annualized return of 15%. In 1980,1990s and since 2010, the gold has delivered low single digit return. So, out of 4 decades since 1980, return from gold has been below the fixed deposit rate.
What has been the source of gold performance in INR?
Gold price is denominated in US dollar. So, when we look at performance of gold in Indian rupee, it has two elements:
- Performance of gold in USD
- Performance of INR relative to gold
I the below chart, I show how the gold price in rupee and USD have performed since 1979
In the 1980s and 1990s, when India as an economy was in rather weak spot, INR depreciated heavily against USD. So, while Gold fell in USD terms, Gold rose in INR.
Since 1979, ~90% of the performance of gold has come due to INR depreciation against USD. While INR is likely to depreciate even in future, India is in much better spot. So, pace of INR depreciation is going to be slower than what has been the case in past.
Gold vs equity market
Amidst all the talk about gold, some people start talking gold as an alternative to equity market. I think gold is NOT an alternative to equity. One can have an allocation of 5% to 10% to gold in one’s portfolio. This is purely as portfolio insurance. When equity markets fell, we should have some source of ready cash that can be used to increase allocation to equity during market crashes. However, anything more than 10% can seriously hamper portfolio performance. The below picture shows how much one can lose by investing in gold at the cost of equity:
Except for the period between 2000 to 2010, BSE Sensex has performed far better than gold. In our calculations, we have ignored the dividends. So, just to summarize, gold is no match to equity over medium to long-term.
Disclaimer: The above content is just for information and should not be construed as an offer to buy or sell or recommendation. Contact your financial advisor for guidance on any investment related query.
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