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Gold as an investment

Currently, the fundamentals of gold as a commodity are good as there is a huge mismatch in demand and supply, writes Ashish Kapur.

india Updated: May 21, 2008 20:23 IST
Ashish Kapur

Historically, gold has proven to be a sound investment when it comes to fighting inflation–higher inflation leads to higher gold prices. Besides investment in gold has always played a significant role in religion, rituals and human sentiments, making it an indispensable investment option. This is truer for Asian investing than any other investing community around the world. Foreign investors, bankers and central banks of different countries use gold as a hedge against a declining dollar. During geopolitical and financial market instability, gold has proven to be a safe investment haven. Moreover, gold has generated phenomenal returns as an investment option in the past three years. It has generated almost 100 per cent and more than 30 per cent absolute return in last three and one year respectively. From Rs 6,300 per 10 grams in May 2005, currently, gold is quoting at around Rs 12,000 per 10 grams.

Currently, the fundamentals of gold as a commodity are good as there is a huge mismatch in demand and supply. From the supply side, gold mining has been stable for the last five years at 2,500 tonnes a year. New mines that are being developed are serving to replace current production, rather than cause any significant expansion in the global supply. The long lead times in gold production, with new mines often taking up to 10 years to come on stream, means mining output is relatively inelastic and unable to react quickly to a change in price outlook.

Gold, with its traditionally negative co-relation with other asset classes such as stocks, fixed income securities and commodities, has made it a popular investment for portfolio diversification. An individual can invest in gold through various routes. The most conventional route is to possess it in physical form. However, this kind of investment is not only risky but also requires high carrying cost.

The other option is to invest in gold bonds or certificates issued by various central and commercial banks. These bonds generally carry interest rates and a lock-in period varying from three years to seven years. On maturity, depositors can take the delivery of gold or amount equivalent depending on their options.

In the recent past, launch of Gold ETFs (Exchange Traded Funds) has been a welcome development. These are expected to address issues of higher prices, purity, costs of insurance and storage, and liquidity associated with investing in physical gold.

Gold ETFs are open-ended mutual fund schemes that will invest the money collected from investors in standard gold bullion (0.995 purity). The investor's holding will be denoted in units, which will be listed on a stock exchange. These are passively managed funds and are designed to provide returns in tandem with movements of physical gold in the spot market. In the last one year, almost all Gold ETFs have generated similar returns to gold bullion index.

World Gold funds are the latest option for investing in gold. These are mutual funds, specialising in investing in the shares of gold mining companies. It would be misleading to equate investment in a gold mining equity with direct investment in gold bullion as the appreciation potential of a gold mining company share depends on market expectations of the future price of gold, the costs of mining it, the likelihood of additional gold discoveries and several other factors.

Most gold mining equities tend to be more volatile than the gold itself. Gold mining stocks have earnings and resources to leverage the price of gold. Hence as the price of gold rises, profit of gold mining stocks rise more in percentage terms. As supply side of gold is not increasing, existing gold mining companies are likely to witness a significant increase in profitability and value in the next couple of years. Hence, as long as demand for gold rises, World Gold funds are likely to be the most remunerative option for investors.

The author is CEO, Invest Shoppe India Ltd