Diwali: Why you should not fuss over buying gold

Now, it’s not fair to look at stock market returns for a short period of a few weeks. So, let’s look at gold returns over a period of one year, from end October 2022 to end October 2023. The yellow metal has given a return of close to 22% during this period. During the same period, the BSE Sensex returned a little over 5%.

What about the returns over a two-year period, from end October 2021 to end October 2023? Gold has given a return of 28% during this period. In comparison, the Sensex returned 7.7% during the same period.

Clearly, over the last couple of years, gold has done much better than stocks as a whole. But these are point-to-point returns. Analysing data in this fashion has its problems.

Nonetheless, this does lead to the question: should people buy gold this Diwali and Dhanteras, given that its price has gone up quite a bit to over ₹60,000 per 10 grams?

There have been several stories in the media trying to answer this question. But they miss a very important point. Buying gold and ensuring that it is a part of your investment portfolio is important. Whether one buys it during this Diwali-Dhanteras season, or at any other point of time, is not really important.

Gold as an investment

The economist, Yanis Varoufakis, who was also a former finance minister of Greece, starts his new book, Techno Feudalism—What Killed Capitalism, with a very interesting line: “I must have been the only child raised to believe that gold was iron’s poor cousin."

This was primarily on account of his father who was a chemical engineer in love with different metals—everything except gold. As Varoufakis writes about his father: “He removed his gold wedding ring and showed it to me: ‘See how it gleams?’ he said. ‘Humans have always fallen for this metal because of its looks. What they don’t realise is that it is just that: flashy – not special.’"

Now, very few people think of gold totally like Varoufakis senior did. Of course, people buy gold as jewellery because of its looks and because of tradition as well. Data from the World Gold Council, an industry group, suggests that in 2022, jewellery made up for nearly 47% of the overall gold demand, down from close to 56% in 2021.

In fact, unlike other metals, a very limited amount of gold is used for industrial purposes. This, despite the fact that gold is highly malleable (can be beaten into sheets easily), ductile (can be easily drawn into wires) and the best conductor of electricity. Gold doesn’t have industrial uses primarily because there is very little of it going around. Also, what does not help is the fact that gold is as soft as putty, making it practically useless for all purposes that need metal. In 2021 and 2022, around 6-8% of gold demand came from electronics and other industries.

So, nearly half of gold demand comes for the making of jewellery and there is some demand as an industrial metal. But that still leaves us with more than 40% demand. Where does that come from? A lot of demand is primarily because individuals and institutions invest in gold. In fact, in 2022, nearly 24% of overall gold demand was for investment. In 2021, this was at almost 25%.

Indeed, people have been buying gold as an investment for many centuries. Why? Over the centuries, gold became a universal form of money. It’s not fragile and is durable. It does not rot. It is chemically inert unlike copper, silver and iron, which means its radiance is timeless.

Given its chemically inert nature, most of the gold mined since eternity is still around. The supply of gold rarely escalates suddenly. Also, given its high density, a lot of gold can be packed into a very small size. All these factors helped gold emerge as the premium form of money.

In fact, even after paper money started becoming popular a few centuries back, it was usually backed by gold or some other metal and it could be exchanged for gold and vice versa. Things started to change once the First World War broke out. In order to be able to print a lot of money to fight the war, many European countries had to break the link between gold and paper money.

Since then, the link between gold and paper money first became weaker and then gradually totally broken down. And the current money system is primarily backed by a government fiat, which deems digital and paper money to be money.

Nonetheless, people still look at gold as a form of money and rush to buy it when a major economic and/or a political crisis erupts. It’s a safe haven. Which is why gold has run up since the time the war between Hamas and Israel started.

In fact, let’s look at a longer period when gold delivered high returns. From the end of 2006 and until the end of 2012, gold delivered a return of 231% in rupee terms and 162% in US dollar terms. The BSE Sensex delivered a return of 41% during the period.

This was before, during and after the financial crisis of 2008 had broken out. Even before a few financial firms went bust and many had to be rescued by central banks and Western governments, smart investors had been moving their money into gold expecting trouble. As the crisis unravelled, more money went into gold leading to its price going up further and the story continued until the global economy gradually started to emerge out of trouble.

Now, let’s take a look at how gold has performed starting from before the pandemic and up until now. From the end of 2019 up until 31 October, gold has given a return of more than 56%. The BSE Sensex has given a return of a similar 55% during the period. Of course, almost every fund manager has been talking about stocks delivering returns, but no one talks about the solid performance of gold.

The gold returns during the period have been driven by the spread of the pandemic, the very high inflation faced by much of the Western world, the Russia-Ukraine war and the most recent war between Hamas and Israel.

What does this tell us? Gold tends to do well during troubled times and in the process helps protect the returns generated by the overall investment portfolio. Further, it’s not possible to know exactly in advance when gold prices will start to rise and deliver high returns. So, one has to always have a certain proportion of the overall investment portfolio invested in it. Depending on one’s risk appetite, this can be anywhere from 10-20% for most investors.

Which is why the question whether one should invest in gold during this festival season is basically a useless one. It’s a decision that needs to be made looking at the overall investment portfolio and not what time of the year it happens to be. Of course, this does not really apply to someone looking to buy gold jewellery and has the resources for it.

Rupee vs dollar returns

Gold is bought and sold internationally in US dollars. Nonetheless, anyone investing in gold in India will earn returns in rupee terms. Every gold investor needs to remember this.

Let’s try and understand this in detail. On 5 and 6 September 2011, gold reached its then peak dollar price of $1,895 per ounce (one ounce equals 31.1 grams). Anyone who would have invested in gold in dollars at that point of time would have barely made any return. The price of gold, as of 31 October, stood at $1,997 per ounce, an absolute return of just 5.4%. And that’s terrible. But in rupee terms, gold has given a return of 117% during the same period.

The returns in rupee terms tend to be higher simply because the rupee keeps losing value against the dollar. One dollar was worth ₹45.7 on 5 September 2011. It was worth ₹83.3 as of 31 October. So, a depreciating rupee spruces up gold returns. And given that inflation in the US tends to be typically lower than Indian inflation, this is likely to continue in the years to come.

Long-term returns

At the beginning of this piece, we saw that gold has done better than stocks over the last couple of years. Nonetheless, looking at just a couple of point-to-point returns isn’t the right way of doing things. Let’s look at the performance of gold over the long-term.

Gold has given a return of 419% over a 15-year period, from October 2008 to October 2023. The BSE Sensex has returned around 553% over the same period. This is primarily because stocks were heavily beaten down at the end of October 2008, due to financial institutions getting into trouble all across the Western world. Over a 16-year period, the BSE Sensex has given a return of 222% and gold a return of 511%. This was because in October 2007, stock prices had run up way too high.

Further, gold has given a return of around 99% over a 10-year period. The BSE Sensex has given a return of 202% during the same period. Now, given that no one can time investments at such a detailed level, it is important to have both gold and stocks in a portfolio.

Also, a bulk of the gold returns earned over a 15-year period would have come in the first five years, when the world was in the midst of a financial crisis. This again tells us that gold is a hedge against things going wrong. It’s an insurance against the status quo being disturbed. Which is why one should be invested in gold all the time.

In a way, it’s like buying term insurance. Also, unlike term insurance, gold keeps giving some return, given that the rupee keeps losing value against the dollar. Of course, for this to happen, one has to be careful about not buying all the gold for the portfolio at one go and keep buying it gradually. Effectively, a systematic investment plan (SIP) on gold isn’t really a bad idea.

Take the case of Kotak Gold Fund (regular) which has been around for 12 years and is an indirect way of investing in gold. If one had chosen to invest an equal amount in the fund through the SIP route every month, it would have earned a return of 8.1% per year over a 12 year period. The SIP returns over the 10-year and 5-year periods work out to 9.5% per year and 10.6% per year, respectively.

Now, these are very decent returns—better than those earned by investing in bank fixed deposits.

Finally, another factor going in favour of gold is that governments don’t hate it, which is not the case with cryptos. In fact, governments themselves keep buying gold. In 2022, nearly 23% of gold demand came from central banks and other institutions. It was at 11% in 2021. A recent report in the Financial Times points out: “Central banks have bought 800 tonnes [of gold] in the first nine months of the year, up 14 per cent year-on-year."

All in all, gold is something that one should gradually keep accumulating. At the same time, look at it as an insurance against things going wrong rather than just as an investment. Hence, buying gold only because the festival season is on, doesn’t make much sense.

Vivek Kaul is the author of Bad Money. He has investments in gold.