The yellow metal could add lustre to your portfolio

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Sachin Kapoor, Principal Advisor, Clovek Wealth Pvt. Ltd.

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The year 2019 marked gold’s best run since 2010, as it rose by 18.4% in dollar terms. Now, as the pandemic prompts investors to look for safer avenues, gold has scaled record highs in major currencies except the US dollar. Mint decodes if it makes sense to add gold to the portfolio.

What is behind the rally in gold prices? As per a Gold Outlook 2020 report published by World Gold Council, one of the key drivers of the gold rally is negative interest rates in developed economies, given that 90% of developed market debt is in negative yield today. Gold does not pay any interest, as compared to bonds, therefore, the negative interest rates on bonds have erased this difference. Also driving the rally are continuous buying of dollars by central banks in the wake of geopolitical tensions, aggressive rate cuts and asset purchase programmes by central banks in response to the covid-19 pandemic, and fears of rising inflation in the medium term.

Is investing in gold a risky proposition? In dollar terms, gold has a very long bear cycle. If a US investor entered the gold in 1980, at a price of $850 per ounce, they would have only realized this price much later, in 2008. At the other end of the scale, the price of gold in rupee terms, corresponding to the US dollar, in 1980 was ₹6,710 per oz (1 ounce = 31.1035 gm) and ₹39,724 in 2008. While for a US investor, the return was nil after 29 years, an Indian investor would have earned 6.34% per year due to the depreciation in the local currency. The added element of currency return with the asset return makes gold less risky for an Indian investor.

Will the rupee depreciate against US dollar in future? The difference between interest rates of two countries drives the depreciation of the currency of the higher interest rate country against that of the lower rate country. India being an emerging and high inflation economy is expected to maintain high interest rates as opposed to the US. This means gold, as an asset class, should keep benefitting from this difference.

Is gold a suitable portfolio diversifier? Historically, gold has maintained a low-to-negative correlation with other asset classes including equities. In economic turmoil, when the equities get beaten down, gold has historically delivered positive returns. The standard deviation (a technical term for volatility) of the yearly return for gold from 1 January 2000 to 31 December 2019 (i.e. the past 20 years) is 12.61% as against 31.92% for Sensex. Adding gold reduces standard deviation of the portfolio due to low correlation of gold with other assets.

How much gold should one keep in portfolio? Gold is a good diversifier, and so it should have some allocation in the portfolio. In normal times, it maintains pace with inflation and protects purchasing power of the capital. During bad times, it acts as a wonderful hedge in the portfolio. For a common investor, it makes sense to allocate 10-15% in gold at all times. Buying sovereign gold bonds gives a 2.5% coupon every year and tax efficient maturity proceeds. Savvy investors can play the cycles to make an extra buck.