6 min read.Updated: 19 Apr 2020, 07:53 PM ISTRenu Yadav
Restrict allocation to the yellow metal to 10-15% of your overall investment portfolio
Gold is good for diversification as it generally performs better when other asset classes are not doing well
With the world economy heading into a recession amid the covid-19 crisis, gold prices are soaring to new heights every day. The yellow metal has surged around 7% in the first 15 days in the month of April, according to data (wholesale market price) published by the Indian Bullion and Jewellers Association Ltd. In the past three trading sessions as on 16 April, it has gone up by almost ₹1,500. It touched a high of ₹46,000 per 10 grams of gold of 999 purity on 13 April 2020. In fact, gold futures expiring in June touched ₹47,000 per 10 grams of gold on 16 April for the first time during intraday trade on MCX, a commodity exchange.
The metal has also emerged as one of the best performing asset classes for investors. It has delivered a return of 11% (in rupees terms), according to data from the World Gold Council (WGC) data as on 9 April, compared to a correction of over 25% in equities as on 13 April 2020.
No wonder the investment demand for gold has gone up substantially. “Precious metals such as gold have always been viewed as a safe asset class and are chased by investors in times of uncertainty or market turmoil. The recent surge in prices is more driven by macroeconomic concerns due to the covid-19 or novel coronavirus crisis," said Ankur Maheshwari, CEO, Equirus Wealth Management.
There is a rush towards investing in gold globally. According to a WGC report, the assets of global gold-backed ETFs (gold ETFs) and similar products added 298 tonnes, or net inflows of $23 billion, across all regions in the first quarter of 2020, the highest quarterly amount ever in absolute US dollar terms and the largest tonnage addition since 2016. Even in India, the assets of gold ETFs surged 34% from ₹5,767 crore in December 2019 to ₹7,949 crore in March 2020, according to data from the Association of Mutual Funds in India (Amfi). Gold ETFs in India invest in physical gold with each unit of the ETF typically representing 1 gram of gold.
In fact, gold ETFs are trading at a huge premium to their net asset value (NAV), which shows that buyers are willing to pay more to buy gold. For instance, the SBI Gold ETF closed at a premium of 9% to its NAV on 13 April 2020, while Aditya Birla Sun life Gold ETF and Kotak Gold ETF closed at a premium of over 7% each. Gold ETFs have two types of prices—one is at which it trades on the exchange and the other is the NAV based on the valuation of gold, as per the Securities and Exchange Board of India’s (Sebi) guidelines.
Even returns from gold funds, which invest in gold ETFs, have shot up. SBI Gold fund delivered a one-year return of 64% as on 13 April 2020, the highest in the category, while Kotak Gold has delivered 54%, the next best return.
A key question for investors is whether or not the rally will continue, which may help them make their investing decisions.
Kishore Narne, associate director and head, commodities and currencies, Motilal Oswal Financial Services Ltd, believes gold prices could rally 30-35% in the next 12-18 months. “Governments across the globe are coming up with stimulus packages to revive their economies. They will be printing more money to fund their stimulus which will debase the currencies and provide support to gold prices. Abundance of liquidity and historically low interest rates which we are witnessing right now are conducive for a rally in gold prices," he said.
But if the central banks start selling their gold holdings to fund their stimulus packages, the rally may come to a halt, say some experts.
“We may see the rally coming to a halt if some vaccine is invented for the covid-19 pandemic. Also, there is a possibility that the central banks start selling their gold reserves to fund their economic stimulus packages. This can curtail the rise in prices," said Kartik Jhaveri, founder and director, Transcend Consulting Ltd, a financial services firm.
Chirag Mehta, senior fund manager, alternative investments, Quantum Mutual Fund, doesn’t think that’s possible. “Governments across the globe have announced stimulus worth $7 trillion and if you look at the gold reserves of the US (who have the biggest reserves), it is around 8,000 tonnes which is equal to $400 billion. It is very small compared to the stimulus packages," he said. “Also, gold is considered as a pillar to the currencies so they may not like to liquidate their gold holdings," added Mehta.
The case for gold ETFs
The premium on gold ETFs over their NAVs is primarily because of supply disruptions owing to the lockdown. “The premium on gold ETFs over their NAV has gone up due to the lockdown which has restricted the movement of physical gold, disrupting the supply," said Lakshmi Iyer, chief investment officer (debt) and head of products, Kotak Mahindra Asset Management Co.
Recently, SBI Mutual Fund stopped taking lump sum investments as well as systematic investment plans (SIPs) and systematic transfer plans (STPs) in its gold fund, citing closure of vaults during the lockdown as the reason.
“The current premium in domestic gold prices are abnormal which is also reflected in gold ETFs’ traded prices. Increased demand for gold ETFs is further pushing up the premiums," said Mehta. If the demand continues to surge, the current inventory will go down, and the premiums will go up further. “However, after the lockdown gets over, the premium may go down as more supply comes in," he added.
what should you do?
Gold is a good asset class for diversification, especially in turbulent times, as it is not only a hedge against inflation but generally performs better when other asset classes such as equities and debt are not doing well. However, limit your allocation to the yellow metal. “I don’t think people should invest more than 15% of their assets in gold. As unlike other assets such as equities one can’t predict the returns from gold as it is not a productive asset like equity," said Suresh Sadagopan is founder, Ladder7 Financial Advisories.
Moreover, buying gold ETFs at such high premiums may not make sense as the rally is only due to the short-term supply disruption. “Investors should not rush to buy gold ETFs at such a high premium and invest in a staggered manner," said Jhaveri.
While investing in gold ETFs, you should look at the tracking errors of the underlying ETFs. Tracking error is the difference between the returns of gold ETFs and physical gold, which is the benchmark in this case. Liquidity is another factor to look at. “For ETFs, it’s also important to look at the bid (price that buyers are willing to pay) and ask (the price sellers are willing to pay) spreads (difference in these two prices) and the trading volumes," said Kavitha Krishnan, senior analyst manager, research at Morningstar India. Investors should look for a tighter spread, where the difference between the bid and ask prices is low, and higher trading volumes.
Some experts believe that sovereign gold bonds (SGBs) are a better option than gold ETFs. “If someone is looking for long-term investment in gold, then I would recommend SGBs as they are not only tax efficient but also provide an assured 2.5% fixed interest (over and above the returns from gold," said Sadagopan. The government has announced the dates for the issuance of gold bonds. There will be six issues starting April to September.