Don’t get carried away by the gold rally

Don’t get carried away by the gold rally

Gold has been, for decades, bought as a medium to diversify and reduce portfolio risk and volatility. Gold is crowned with the status of a “safe haven" due to its ability to preserve investment value in turbulent times and hedge it against inflation. While the equity and debt markets have much to worry about before they see a takeoff, the global gold demand in the second quarter (April-June 2011) was the second highest quarterly value on record with India and China being the big contributors. Not surprising enough though with gold rewarding markets for 11 consecutive quarters.

The festive season is just around the corner and the yellow metal is back in the limelight; this time maybe for an unnoticed but worrying reason. Though gold has caught investors’ fancy for its steep rally over the past quarter, the volatility it has shown during the same period seems to have gone out of the frame. No prizes for guessing the reasons for missing it: our love for the metal as well as gold’s brand as a “saviour in jittery waters".

Changing prices

To give you a gist of what I’m pointing to: The average daily price change of gold in India has increased more than six times between 2001-2011. At the same time, the percentage spread between the highest and lowest price of the year has more than doubled. The standard deviation, which signifies the volatility in daily returns over a period, has increased more than 85 times when comparing periods of 1981-85 with 2006-10.

Difficult to digest, isn’t it? However, Kusum Vaya, one of our astute investors from Gujarat, witnessed it first-hand when she was planning to purchase some gold jewellery for her son’s marriage scheduled this November. Vaya was of the view that gold prices would shoot up as the festive season is close to the marriage dates. She was thus planning to purchase the required jewellery beforehand in August. On 11 August, she approached her family jeweller and informed her about her plans to buy gold at 26,200 levels. The jeweller, in turn, informed her that the gold was down at least 600 in the day and is expected to fall further in days to come. Vaya considered his advice and decided to wait for a week. The advise worked somewhat as gold corrected 300 more in the next few days. Vaya got tempted to hold on for a few days more to seek some more correction. To her despair, prices shot up in a matter of days and breached 28,200 levels; a rise of almost 10% in a matter of week. She found herself helpless and finally bought at 27,800 levels only to see the prices drop to 25,512 three days later—a fall of 8.2%.

What should you do?

Well, there would be many such investors who have been regretting for betting on gold’s “expected direction or volatility". With such increased volatility, the big question remains: should you hold/buy it now?

Gold still is and will remain a hedge against uncertainties and inflation. What has changed is our need and ways for buying the same. Gold has been increasingly bought in the form of gold bars and coins and it has started to increase its pie in the portfolio of most investors owing to lucrative returns in the past one year. The emergence of exchange-traded funds has also led to increased speculative buying of gold. There are investors who buy gold for hedging their equity positions for a week or two. In such cases, one loses out on the basic premise for which gold is usually bought.

Gold has very low correlation with most asset classes and thus plays an important role in a portfolio by reducing volatility. Gold is also immune to economic shocks and preserves portfolio during bad times. Thus, gold should be bought as a long-term asset to hedge against inflation and uncertainties. Ideally, an allocation of 6-10% of one’s portfolio should suffice. But if you are betting more, it’s time you reassess why you did so.

Hiren Dhakan is associate fund manager, Bonanza Portfolio.

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