Math and risk of Gold Investment. Keep eye
Posted on Thu Jun 10, 2010 at 06:00:10 PM EST
Keep an eye on Re value before going for gold
RECENTLY, the yellow metal was in the news for touching new highs. Those who dislike the volatility of equity markets seem to have a case for investing in gold, if one looks at the recent price movements. The fact is that since January 1, 2006, the price of gold has moved from Rs 7,500 per 10 gm to Rs 19,000-mark in June 8, resulting in a compounded annual return of over 21%. A great ride up by any stretch of imagination.
FUNDAMENTAL CHARACTERISTICS OF GOLD PRICE MOVEMENTS
In the long term (ie over 10 years or more) gold works as a hedge against inflation. That is, investing in gold will protect one from the fall in purchasing power, because the price of gold will rise in line with the increase in inflation. The other key characteristic of gold is that it is considered a safe haven investment. (In equity markets, one tends to buy well-managed FMCG companies when the markets are uncertain, since in case of a market crash, the drop in prices of these stocks is less pronounced.) US dollar is considered the other safe haven investment, and therefore, there is normally an inverse linkage between price of gold and the rise in dollar -- if the dollar falls, the price of gold rises.
DO GOLD PRICES MOVE IN TANDEM WITH $ PRICE MOVEMENTS?
At initial glance, over the past four-and-a-half years, over which period I have based my article, the returns for gold in both $ per ounce, and rupee per 10 gm, seem similar. Even the dollar price has shot up from $531 to $1,250 per ounce for a return of over 20% compounded annually. However, a closer look will show a sharp variation. For example, taking a two-year investment horizon starting January 2008, we find that gold moved from $848 per ounce to $1,098 per ounce, or a return of 29%. However, Indian investors were laughing all the way to the bank with a return of nearly 55% during the same period.
THE IMPACT OF EXCHANGE RATE
If one were to look closer, the reason for this sharp spike in Indian returns would be apparent. The dollar-rupee exchange rate resulted in a 19% depreciation of the rupee during these two years, resulting in the sharp divergence in returns. From this, we learn that if the international price of gold was to go up, but the rupee was to strengthen against the dollar (which is a distinct possibility over the medium/long-term), the appreciation in the Indian price of gold will be tempered, compared to international prices.
GOLD NEEDS AN ALLOCATION
Financial planners would like their clients to allocate some of their funds to buying gold, just as they would recommend investments in equity, fixed income, cash and property. If one were to generalise, in normal times, 5-7% of one's net worth can be suitably allocated to gold. In times of uncertainty, this can be increased to 10-12%. However, Indian investors must keep an eye on the exchange rate movements. A strengthening rupee may further weaken your case to go overboard with gold. Only some of what glitters is indeed gold.
The author is the Managing Director and
Chief Financial Planner of
International Money Matters Pvt Ltd
RECENTLY, the yellow metal was in the news for touching new highs. Those who dislike the volatility of equity markets seem to have a case for investing in gold, if one looks at the recent price movements. The fact is that since January 1, 2006, the price of gold has moved from Rs 7,500 per 10 gm to Rs 19,000-mark in June 8, resulting in a compounded annual return of over 21%. A great ride up by any stretch of imagination.
FUNDAMENTAL CHARACTERISTICS OF GOLD PRICE MOVEMENTS
In the long term (ie over 10 years or more) gold works as a hedge against inflation. That is, investing in gold will protect one from the fall in purchasing power, because the price of gold will rise in line with the increase in inflation. The other key characteristic of gold is that it is considered a safe haven investment. (In equity markets, one tends to buy well-managed FMCG companies when the markets are uncertain, since in case of a market crash, the drop in prices of these stocks is less pronounced.) US dollar is considered the other safe haven investment, and therefore, there is normally an inverse linkage between price of gold and the rise in dollar -- if the dollar falls, the price of gold rises.
DO GOLD PRICES MOVE IN TANDEM WITH $ PRICE MOVEMENTS?
At initial glance, over the past four-and-a-half years, over which period I have based my article, the returns for gold in both $ per ounce, and rupee per 10 gm, seem similar. Even the dollar price has shot up from $531 to $1,250 per ounce for a return of over 20% compounded annually. However, a closer look will show a sharp variation. For example, taking a two-year investment horizon starting January 2008, we find that gold moved from $848 per ounce to $1,098 per ounce, or a return of 29%. However, Indian investors were laughing all the way to the bank with a return of nearly 55% during the same period.
THE IMPACT OF EXCHANGE RATE
If one were to look closer, the reason for this sharp spike in Indian returns would be apparent. The dollar-rupee exchange rate resulted in a 19% depreciation of the rupee during these two years, resulting in the sharp divergence in returns. From this, we learn that if the international price of gold was to go up, but the rupee was to strengthen against the dollar (which is a distinct possibility over the medium/long-term), the appreciation in the Indian price of gold will be tempered, compared to international prices.
GOLD NEEDS AN ALLOCATION
Financial planners would like their clients to allocate some of their funds to buying gold, just as they would recommend investments in equity, fixed income, cash and property. If one were to generalise, in normal times, 5-7% of one's net worth can be suitably allocated to gold. In times of uncertainty, this can be increased to 10-12%. However, Indian investors must keep an eye on the exchange rate movements. A strengthening rupee may further weaken your case to go overboard with gold. Only some of what glitters is indeed gold.
The author is the Managing Director and
Chief Financial Planner of
International Money Matters Pvt Ltd
BY LOVAII NAVLAKHI
By djain128, Section Finance & Investing
Posted on Thu Jun 10, 2010 at 06:00:10 PM EST
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