Gold as an Investment: How to Invest in Gold
In the last few years the role of gold has increased not only as a store of value but also as an important alternative asset class providing a diversification benefit. Investors have a liking for gold for several reasons like:
- Symbol of security
- Signs of prosperity
- Hedge against inflation
- Economic uncertainty
- Low real rate of interest
The Key Advantages of Investing in Gold
Gold has a very low or negative correlation with other asset classes and hence offers a diversification benefit to investors. By adding gold to one’s portfolio, one can potentially reduce overall portfolio risk and preserve wealth.
Gold has, over many centuries, maintained its value against inflation. It helps to preserve the value of money or the purchasing power. Historically higher inflation has led to higher gold prices. Gold has consistently beaten the inflation rate and helped to preserve purchasing power over the last 5 to 15 years.
Low Volatile Asset
Gold as an asset class has been less volatile than equities, and over a longer period of time (5 years and above) investment in gold has contributed to stability in overall portfolio.
Protection against Currency Weakness
Gold helps to protect value of money against currency weakness especially against the US dollar. Since gold is denominated internationally in US dollars, US interest rates have a great impact on its prices. During times of low interest rates and rising inflation, investors seek the safe haven of gold.
Hedge against Event Risk
Gold is tended to be the best hedge against any event risk. During the Asian financial crisis (July 1997 – November 1998) price of gold rose 8.2%. When the dotcom bubble finally busted (February 2000 – September 2001) gold price rose 8.6%. During the recent economic meltdown (December 2007 – November 2008) price of gold rose a whooping 23.6%.
Different Ways of Investing in Gold
One can buy physical gold like gold bars, coins, or jewellery from the bullion markets or jewellery shops at the prevailing market price. The main disadvantage of owning gold physically is that there tends to be a wide spread between bid and ask prices. Besides, there are security issues relating to holding of gold in physical form.
Gold Exchange Traded Funds (ETFs)
Gold ETFs are essentially passively managed mutual fund schemes that track the gold price index. These funds are designed to provide returns before expenses that closely correspond to the returns provided by the physical gold. Each unit typically represents a unit (like gram or ounce, depending on in which country you live) of gold. These schemes are listed in the Stock Exchanges and therefore have the flexibility of trading like a share.
Gold Mutual Funds
These are funds managed by professional fund managers that invest in the stocks of companies that mine precious metals namely gold. This kind of fund is useful for investors who are hesitant to invest in physical gold, but still desire to have some exposure to the precious metal. The drawback, however, is that the risk is the same as that of investing in equity, since ultimately it amounts to having equity exposure in a listed company.
Gold Fund of Funds
These are mutual funds that typically invest in units of gold ETFs. The main advantage of investing in this kind of fund is that the investor need not hold or open a trading account for investing in the fund. Secondly, an investor gets the benefit of making investments in a systematic manner using the SIP (Systematic Investment Plan) route.
Stocks of Gold Mining Companies
Investors can directly buy stocks of companies that mine for gold. But one requires sound knowledge to identify the future prospect of such companies. However, equity risk does exist while investing in gold mining companies as like any other company.
Gold options and futures are investment products with gold as the underlying asset. This kind of investment is meant for sophisticated and experienced investors having a high risk appetite.
Gold as an Investment: Conclusion
It is expected that demand for gold from emerging economies like India and China will continue to grow in the medium term. Moreover, inflation related concerns due to higher prices of crude oil will support the price of gold in the short to medium term. Fundamental weakness in the developed world along with large public debt in the Euro Zone could lead to weaknesses in major currencies like US Dollar, British Pound, European Euro or Japanese Yen or the like. This coupled with robust demand from China and India could help gold prices to remain firm over the medium to long term. One needs to have a 5% to 10% allocation to gold as a part of the long term asset allocation in one’s portfolio.