Early this year, when the gold price was setting new records, there were a number of theories on why one should invest in the yellow metal. According to one argument, the weak dollar was trying the patience of the Chinese, who were contemplating transferring their billions worth of reserves out of dollars into euros and other currencies. The already beleaguered dollar would plummet, and since the dollar and gold move in opposite directions, guess which direction gold would take.
Whether or not that argument was logical, the role of gold in asset management has suddenly become very topical. Remember, gold is not among the top asset classes in giving long-term returns. Like every other commodity, gold goes through cycles—only, the cycles tend to be longer. In recent history, there were basically just two predominant bull runs in gold. One was when gold rose from about $100 (currently Rs4,290) in 1976 to $850 in 1980 an ounce. The price subsequently fell to $250. In the second, which began around seven years ago, gold touched $1,032.50 in March this year. It may look spectacular in the short term, but not in a historical perspective. Considering that it was available at around $680 an ounce last year, gold appears to be a great investment. When you take into account the price five years ago ($350), it definitely impresses. But, what if you were holding on to your investment since 1980, when it was trading at $850?
In fact, where performance is concerned, gold (physical gold or holding in exchange-traded funds, not shares in a gold mining companies) can never substitute equity simply because the metal is not an inherently productive resource.
Let’s give it some perspective. On 2 January 1992, the Sensex, the Bombay Stock Exchange’s benchmark index, closed at 1,969.16 while the price of gold was $350.90*. On 2 January this year, when the index closed at 20,465.30, gold was at $846.75*. So, over a period of 16 years, the Sensex gave an absolute return of 839.29% while the figure for gold was 141.30%.
It’s not that we are using the India growth story to make a point. Wharton finance professor Jeremy Siegal, in his book Stocks for the Long Run, says a dollar invested in gold in 1801 would have grown to $1.95 by the end of 2006. But that same investment in long-term bonds would have grown to more than $1,000, and to around $300 in treasury bills. But had it been in a basket of stocks, it would have been worth more than $755,000—that too without taking into account dividends or bonus shares.
Gold moves in the opposite direction to the dollar as it is seen as an alternative asset. After World War I, when battered European powers started borrowing from the US, dollars began circulating worldwide. By 1944, with the passage of the Bretton Woods international monetary agreement, the dollar was the only world currency pegged to gold; other currencies were pegged to the dollar.
In the 1990s, the US was the only superpower, and the dollar reigned. But 1999 saw the introduction of the euro, and it was only a matter of time before there would be alternatives to the dollar.
Now, with the US facing a massive current account deficit and a credit crisis, the dollar is depreciating. But till another currency takes centre stage, gold will be sought after.
Geopolitical events, a dramatic rise in crude oil price and unstable currencies drive gold price volatility. Just look at the recent past. The week of the US Federal Reserve’s decision on interest rates (1 May) saw gold prices trip. By 5 May, though sentiment on gold remained weak on expectations of a stronger dollar, gold did rise. Analysts link that to Indians buying on account of Akshaya Tritiya, an auspicious day for Hindus to buy gold.
Gold, of course, has had an amazing run over the last seven years, earning returns of about 300%. But even at the current prices, it has gained just at an average 4% a year over the last 100 years. Adjusted for inflation, this is a mere 0.6% a year.
So, for investment, gold must be considered a valuable tactical asset to add diversity across the risk spectrum. It could turn out to be very useful to hedge risk due to its low correlation with other major asset classes. And, please limit it to a very small part of your overall portfolio.
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(* These are the historical spot bullion prices of the second London fixing. This London “afternoon fix” (3pm) gold spot price is actually set during the US morning (9am) by representatives of the London gold market)
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