Investing in India: Why you should look beyond gold

By Debanjan Guha Thakurta
The author is an analyst with Fundsupermart.com

All that glitters is not gold- Here’s why you should look beyond gold.

Key Points:
•    Gold has delivered solid returns for the past 5, can it continue that trend?
•    Gold has already reached its peak. When will it cool off?
•    No one knows the fair value of the Gold, which leaves  big scope of speculation
•    It is prudent to focus on the undervalued equity market, not on the metal

Unless you have been living under a rock, the buzzword nowadays is Gold.

Today, whenever you hear Gold, the first question that you tend to ask is how much more has the price of Gold increased? As Indians, Gold is a favoured investment over and above traditional Fixed Deposits and sometime even Real Estate. By now every one of us has either bought some gold or has made investments in Gold through Gold ETFs and Gold Funds.

The shiny yellow metal has always been used as a tool to hedge against inflation. During the current turbulent times, Gold is now seen as an asset which has the potential to outperform in the near term.

As Gold hits its epic high and with little scope for further upside, for investors with an appetite for Equities, gains made from Gold should be diverted to the equity space mainly through mutual funds route to  advantage the attractive valuations in that space . Unfortunately, this thought process does not exist and investors with an appetite for risk choose to stay invested in the yellow metal, on hopes that the price of Gold will further rise in days to come. Few investors know that globally Gold has come off its highs since September 2011 when Gold almost breached the US$2000 levels.

Taking a different stance from others, I opine that the shine of the Gold is all set to fade out in coming days.
We Indians know the art of saving but when it comes to creating wealth, we are miles behind from others, thanks to our conservative approach towards investing.

Reason for the Outperformance

No one can deny the fact that Gold has outperformed equities in the last decade, but the question, why it has increased so much and whether this trend will continue in days to come or not.

The major outperformance of the gold was witnessed during the last 5-6 years. This outperformance of Gold is primarily attributed to the flight to safety on the backdrop of the global financial crisis which led to corrections in the valuations of other investment asset classes around the world.

It is loosely believed that gold prices and value of US dollar are weakly correlated with one another. In a layman’s term a weak correlation means that when rises other fall and vice versa. In this case whenever the value of the US Dollar increased, the value of Gold fell and vice versa.

Investment Gold Prices London Stock Exchange
Chart 1: Showing returns of Gold in London Stock Exchange

The chart above reflects the trend line for returns of Gold from 1985. While Gold did not shine with returns  between early 1990’s to 2003-04, its value increased significantly after 2006-07 mainly on the back of widespread global economic slowdown following the collapse of Lehman Brothers and weak  dollar. Fearing that the value of dollar will slid even more, there was a flight to safety as people started to accumulate Gold leading to the biggest rally in the history of Gold prices.

Adding fuel to fire, the US downgrade by the S&P along with the mounting worries over Eurozone economies furthered helped the Gold to carry on its winning momentum.

An opportunity missed to create wealth?

Although Gold has come off its highs last September, Gold prices in India continue to rally. Gold price is a reflection of Spot Gold on the London Metal Exchange (LME) and therefore price of Gold in India follows this market like any other country. Gold being largely an imported commodity in India, it needs to be paid off in US$ and therefore the price of procuring Gold has gone up since a greater sum in Rupees has to be paid. Sadly, investors continue to focus more on Gold and less on the equities, ignoring the fact that equities have the potential to generate the extra alpha in the portfolio of the investors.

Its investment prudence when an investor does not look at Gold as a wealth creator but purely as hedge over his portfolio.  A good portfolio should consist of 60-70% equity, 20-30% in debt and the remaining in Gold related investments.

Equities are the growth enhancers of any portfolio and should form the core part of portfolio.

Investment India Stock Exchange Sensex
Chart 2: Showing the outperformance of Sensex

As evident from the chart above, the Sensex has outperformed both the Gold index and the world equity Index consistently.

A open Treasure Chest - Sensex

In the backdrop of a slowdown within the Indian economy and the Eurozone crises, stocks on the flagship Sensex are trading at attractive levels, based on FY13 earnings, making a case for markets to outperform in the near term. The informed investor should act to partially book their profits made from gold investments and should try to invest in Equities in such a scenario.

Mirae Asset Mutual Fund in one of their recent reports reported that, “the forward P/E is close to 12.92 (12% discount to the 10 year average), while based on FY14 earnings the PE is 11.21. The 10 year average forward PE multiple for Sensex is 14.7 times earnings”. “Based on current market levels of close to 16,000 the risk-reward ratio looks favorable”.

It is expected that when the global economy will recover, there will be fresh demand for equities. While the FIIs and NRIs are investing in equity market, we Indians are parking our hard earned cash in bank accounts. For the informed long term investor, this is his opportunity to take advantage and get away from the herd mentality of parking funds in bank accounts.

In 1980, Gold prices fell around 70% from its peak, so before investing into Gold remind yourself that the yellow metal had a superb run and may be its just time, when the Gold prices will start to cool off.

Let us see why one shouldn’t invest in Gold

1. Slowing Demand

The fundamentals of demand and supply for gold have not given me much reason to recommend the inclusion of Gold in one’s portfolios. In India, jewellery has been one of the key drivers of the demand for gold.
According to World Gold Council “Gold demand in India was affected in Q1 2012 by a number of factors; a new tax on gold jewellery, two increases in the import duty for gold and weakness and volatility in the rupee. Jewellery demand fell 19% to 152.0t from Q1 2011”.

Investment demand, another purported key driver of demand has not had much reason to cheer either. Gold demand stemming predominantly from ETFs and similar products which increased due Akshaya Trithiya has now slumped down and they were down by 46% from the previous year at 55.6t”.

Moreover, the fresh tension at the Eurozone is another cause of worry. Many of the nations are facing the problem of slowdown and if the Central Banks of the respective countries decide to sell their Gold reserves to raise money, then there will be more supply of Gold in the system which is bound to lower the gold prices according to the laws of demand and supply.

2. No fair value of gold

The truth is that there is no standard valuation method which can be used to measure the exact value of Gold.
While stocks and bonds produce a series of cash flows which can be discounted to present value to gauge attractiveness, gold produces no cash flows for investors to value or discount. As a matter of fact, gold actually costs investors cash flow – it makes you pay to hold it. Be it holding physical gold in a vault of some bank, or, holding gold on paper via an ETF, gold does cost investors cash to hold.

The lack of a proper valuation method to analyse gold leaves us with guesses as to what could possibly be the fair value price of the metal.

This makes the yellow metal very volatile which leaves a room for speculation on Gold prices. One can always find some analyst saying that prices of gold is further going to rise and one set of analysts offering different opinion.

A case for investment into Equities.

Good returns on equity investments are typically made on investments made in bad times. I believe dips should be seen as buying opportunities and one should increase their asset allocation in the equity space.
Investors should not think about short term gains when investing into equities. Investing systematically makes more sense in this current equity market volatility.

Conclusion

Volatile and falling markets are the best time to enter in to the equity markets, but sadly, investors follow the opposite route and they don’t mind to book losses in equities and invest in Gold or in Debt.

Let us start thinking beyond investing in Gold. Boost your investment returns by adding Equity into it. It will be volatile in the short term, but it will be the clear winner on the long term.

With equity markets slumping in recent times, I think that there lays an opportunity for investors to consider adding to their favorite markets by observing their respective valuations and through rupee cost averaging for the longer term. For investors who have not yet invested into gold or precious metal funds, remember that in the immortal words of Shakespeare, “all that glitters is not [just] gold”.

This article is for information purpose only. This article and information do not constitute a distribution, an endorsement, an investment advice, an offer to buy or sell or the solicitation of an offer to buy or sell any securities/schemes or any other financial products /investment products mentioned in this article or an attempt to influence the opinion or behavior of the investors /recipients. Any use of the information /any investment and investment related decisions of the investors/recipients are at their sole discretion and risk. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Opinions expressed herein are subject to change without notice.