Should you bet on the yellow metal?

The year 2010 was quite an eventful year. Uncertainty in global economic scenario continued. We witnessed financial crisis in European countries like Greece, Portugal, Ireland and Spain. We also witnessed further quantitative easing by Major developed economies which kept interest lower. It was perfect setting for Gold price to do well and it did well. In India Gold has given return of over 19 per cent since 1st January till date while Nifty Index gave 15 per cent return for the similar period. 

A conventional approach to decide whether to have gold in portfolio or not in 2011 would be to ask the question, “Will gold continue to climb next year and outperform equities in 2011?” Quest for the answer often results in confusion as one comes across conflicting views. The truth is the answer is difficult. No one knows with certainty as the gold price in 2011 will depend on future events which are very difficult to predict. 

So what shall one do in 2011? The answer is one must have some exposure (10 per cent – 30 per cent) in Gold not only in 2011 but also in 2012,13,14 and so on. Why?, because gold enhances portfolio performance. It either generates higher return for the same risk or reduce risk for expectation of same return. Let us understand how this happens. 

The Gold price tends to move many times in different direction than Indian Equity or say Nifty Index. One of the reason why it happens is because Gold and Nifty prices depend on totally different factors. Nifty index depends on factors like performance of Indian Economy, Net FII inflow, domestic money supply etc. while the gold price depends on global factors like global interest rates, quantitve easing or debasement of global currency, demand and supply of Gold etc. When there is global economic crisis the gold price strengthens and equity prices weaken. This unique characteristic of Gold is equally important for the investors. It is also called co relation. Lower the co relation of two assets, more diversification benefits the portfolio gets. The graph shown here will explain the point. 

As we can see from the graph that often Gold prices and Nifty prices went in different directions even though ultimately both have given positive returns in the end. 

The blue line in the middle is value of portfolio which has invested roughly 40 per cent in Gold and 60 per cent in Nifty. One can see that the portfolio value line is smoother than both the assets. Smoother the line lesser is the volatility or lesser is the risk. The graph clearly shows that how in 2010 adding Gold to the portfolio has lowered the overall risk for the investors.

Also 2011 will not be majorly different. As explained earlier since the driver of gold prices remain different than drivers of Nifty index, Gold is likely to behave differently than (will continue to remain uncorrelated with) Nifty. And due to this investors will gain immense diversification benefit by having gold in the portfolio or reduce risk without sacrificing the returns. 

Investment in Gold can be done very conveniently through Gold Exchange Traded Funds (ETFs). Gold ETFs are backed fully by physical gold. The Physical Gold is kept in vaults of custodians who are regulated by SEBI and RBI. The units of Gold ETFs trade on stock exchanges like any other shares and it can be held in demat account. Typically one unit represents around one gram. Gold ETFs introduced in India Since March 2007, have witnessed rapid growth since then. Gold ETFs are set to grow further as more and more investors discover benefits of investing in them.