Wednesday, October 20, 2010

Gold's glittering, despite the Sensex surge

Gold's glittering, despite the Sensex surge


With the macros stacked heavily against the dollar, bullion can only gain from here. So, retail investors, go buy gold

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The Sensex, which has surged close to its lifetime high, has lately hogged media attention and investor mindspace. Apprehensions of an impending correction are gone. And with foreign institutional investors having pumped in close to `1 lakh crore in our stock market, there seems to be no stopping the gallop just yet.
But this article is not about the stock market, but about another asset that has been keeping pace with the Sensex — gold.
As of October 14, gold prices were ruling at `19,880 per ten grams — translating into a year-on-year growth of as much as 24%.
Normally, gold and stock prices have an inverse relationship. When stocks rise, gold prices are generally subdued and vice versa. However, over the last couple of years, this trend has been bucked. Both stock prices (at least in emerging markets) and gold prices (globally) have been on the upswing.
The main reason for this seems to be the easy monetary policy the Western governments have been pursuing. The US, expected to undertake a second round of quanitative easing not long after the $2.4 trillion stimulus released into the economy in 2008, seems determined to let an already weak dollar become even weaker. And since the world's reserve currency is rapidly deteriorating in value, gold will be a very preferred investment choice till an alternative to the dollar comes into the global picture. Not just private investors but also central banks across the world are stacking up gold. All, because the world is fast losing trust in the dollar.
Last year, the Reserve Bank of India purchased 200 tonnes of gold from the IMF for around $7 billion. This was reportedly done to diversify the country's foreign exchange reserves. Among others, the Middle East nations, China and Russia are also buying gold. Several other central banks may also be buying without publicly announcing as much.
What does this mean for us retail investors? Well, go and buy gold!
The yellow metal, by virtue of being the highest-quality asset on earth, should always be a part of any portfolio at any time. More so in the current context. And the best way to buy gold is to invest in gold exchange traded funds (ETFs).
ETFs are essentially mutual funds listed on the stock exchange. You can buy and sell them just like you would buy and sell a share. In the case of a gold ETF, the underlying asset is standard gold bullion. In other words, a gold ETF is just like any other mutual fund scheme — the only difference is that the monies collected, instead of being invested in equity shares, are invested in gold. Generally, the price of one unit represents approximately one gram of gold. Since these are passively managed funds, the NAV will basically track the price of gold in the open market. Currently, MFs such as Benchmark, HDFC, Kotak, UTI, Reliance, Quantum and SBI offer gold ETFs.
Now, in a country where gold worth over `70,000 crore per annum is sold in the form of jewellery, coins, biscuits and bars, the total assets under management of these schemes amount to just around `2,645 crore. This clearly suggests that investors are either unaware or uncomfortable with buying gold in the electronic form. This basically requires a shift in mindset and it shouldn't really be that difficult when you consider the fact that we already own other equally valuable assets in a similar form. Think of the money in your bank. Whether you have `10,000 or `10 lakh or over a crore, the physical cash (hopefully) is not lying in your safe — your bank pass book indicates the amount you own. Similarly, there was a time, not too long ago, when physical share certificates needed to be delivered and stored. Then we shifted to electronic holding and an investor's life was never more convenient. Now, similarly, gold can be held in the dematerialised, electronic form — a safer and more efficient way to own the precious metal.
For starters, with an ETF, there is no doubt on the purity — you can't get purer gold even if you tried and you don't even have to depend upon human honesty or scruples. So impurity risk is non-existent. Security is of course taken care of by the fund unlike in the case of jewellery or other forms of physical gold where the threat of theft always looms large.
As for denomination, one can buy one gram at a time, literally. With Quantum, you can even buy half a gram at one time.
Though a traditional systematic investment plan, as we understand it, is not possible in the case of gold ETFs, one can buy units every month on one's own. In fact, one of my friends has been diligently picking up 5 grams of gold per month and by now he is already the proud owner of 150 grams of the highest quality of gold. When it comes to selling back, the making charges of jewellery cannot be recovered. Coins and bars also suffer from similar problems. Units of gold ETFs on the other hand can be sold by either a call to your broker or with a few clicks of your mouse if you have an online trading account. Free of wealth tax and subject to long-term capital gains tax of 10% as against 20% in the case of physical gold, tax benefits round off the manifold advantages of holding gold in the electronic form.
There is an unscientific but interesting correlation between the Dow Jones index and gold prices. In 1933, gold was trading at $32 per ounce and the Dow was around 50. In 1980, gold was at $850 and Dow at around 870. By that measure, considering the current price of gold and the Dow Jones index level, some investors hold that gold is undervalued over eight times currently.
The comparison may be anecdotal. But as mentioned in the beginning, gold is rising essentially since the dollar has been and is expected to continue to lose further value. Another way of saying the dollar is losing value is that the rupee is gaining in value. Therefore, extrapolating this logic, as gold increases in value, the rupee too simultaneously strengthens. Now since internationally gold is priced in dollars and not rupees, the rupee appreciation against the dollar translates into a lower return for domestic gold owners. However, this circular reference issue should not deter investors — even in rupee terms, gold has returned 26% per annum over the last three years and 24% over the last year.
When markets are erratic and unpredictable, it is wise to step up exposure to an asset that would infuse a semblance of stability and strength to the portfolio. And the cleanest, simplest and the most efficient way to do this is to invest in a gold ETF. Given the rampant way in which industralised nations are debasing their currencies, one cannot help feel that at the end of the day, bullion will prove more valuable than the billions.

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