Gold rise during Covid-19 crisis shows why your portfolio should have some allocation always

Domestic gold price has risen 43% in last 1 year but many have missed out because lack of proper asset allocation

Kumar Shankar Roy Apr 16, 2020

Gold investment“Should I buy gold now after rise? “Is gold better than equity?” “Should I buy gold after it falls?” Questions like this are irrelevant but are asked by most investors. Whenever an asset class performs exceedingly well or exceedingly poor, then most turn their attention onto it. This return/loss chasing habit is why many investors suffer. If you have an investment portfolio, you should have exposure to equity, debt/fixed income, gold, cash etc. It is not a question of either or.

Domestic gold price has risen 43% in last one year but many have missed out because lack of proper asset allocation. The recent rise in gold prices, nearly 15% in 3 months, is why people are ruing their decisions not to invest in gold. Today as gold experts announce gold price targets like Rs 55,000 per 10 gm, the truth is your investment in an asset should be because of its ability to diversify your overall portfolio risk. RupeeIQ tells you more about gold investing and different routes to take exposure.

Gold price

Uncertainty is good for gold

An unprecedented lockdown of many cities globally to prevent the spread of Covid-19 and its all-encompassing impact on the world economy has sent markets into a veritable tailspin. Consequently, central banks across the world have resorted to unprecedented monetary policies from cutting interest rates to near zero level to massive quantitative easing.

The uncertain impact of the Covid-19 on global economy resulted into a sharp fall in equity markets, commodity markets along with depreciating currencies has led investors to scout for relatively stable asset class. This is where in this unprecedented uncertainty and high risk aversion environment, gold seems to be an appropriately placed asset class for global investors.

Gold is traditionally seen as a safe investment in times of political or economic turbulence. This is why gold should be there in your investment portfolio. In fact, gold often performs better than others when there is turmoil. Typically, most financial assets fall during a crisis. But since gold is alternative currency, it becomes a safe haven for parking funds during crises.

Gold and interest rate relationship

Gold and interest rates, traditionally speaking, have a negative correlation. Usually gold price goes up when interest rates go down and gold prices go down when rates go up. This is because higher interest rates mean higher opportunity costs of holding non-interest bearing assets, such as gold who neither pay dividend nor interest. The higher interest rates are, the higher are carrying costs.

Another thing to note is gold performs in specific short periods of time, especially during capital market meltdown, global recession, geopolitical tension, etc. Therefore, many experts think it may not be an ideal long term asset class.

However, if you check gold price in rupee terms, the precious metal has been relatively a far stable performer aided by currency depreciation and strong domestic demand.

As economic growth is likely to be significantly impacted by the current lockdown situation due to rising Covid-19 threat on human life, interest rates could be lowered further to give a boost to businesses.

Gold prices have soared to hit its highest since late 2012 early this week. As financial asset classes go through volatility, only something like gold can be bought and sold due to its liquidity and low impact costs.

Every time the government prints more money, which is not backed by real economic output, the price of gold tends to increase. It may not increase on the same day or the same month or the same year – but increase it will.

Also read: Five reasons why gold should be in your portfolio in 2020

How much gold and which route

The exact answer to gold allocation in your portfolio will depend on various factors.

At the end of March 2020, the top multi asset allocation mutual funds in India have gold exposure in the 10-20% range in their overall portfolio. This is just an indicator. You should take a personal call on how much gold exposure should be there in your portfolio, preferably by consulting a registered financial advisor.

These are the various options to buy gold.

1. Gold ETFs (exchange traded funds)

Gold ETFs are open-ended mutual fund schemes that invest the money collected from investors in standard gold bullion of, usually 99.5% purity. These funds trade on a stock exchange just like the shares of an individual company. So investors can any time buying and selling units of gold ETF if there is enough trading happening on the exchanges. There is a price on exchanges and there is a NAV of gold ETF.

The difference in returns of physical gold and gold ETF is the expense ratio charged by the latter.

Gold ETFs give you very high level of liquidity and you can exit any day you want (depending on the liquidity on exchanges).

Gains from sale of gold ETFs or gold mutual funds are taxed like that of the physical gold. Short-term capital gains on units held for less than 36 months is added to investor’s income and taxed according to the applicable slab rate. Long-term capital gains on units held for more than 36 months are taxed 20% with indexation benefits.

You need to have a demat account for gold ETF. There is no fixed income/interest on gold ETFs/funds. The investment performance depends on how closely your ETF/fund tracks gold price.

2. Sovereign gold bonds

With the Government of India’s Sovereign Gold Bonds (SGB) scheme you can earn an assured interest rate eliminating risk and cost of storage. SGB issues are planned by the government. For instance, the latest Sovereign Gold Bonds will be issued in six tranches from April 2020 to September 2020 as per the calendar. Click here for government notification.

These gold bonds are denominated in multiples of gram(s) of gold with a basic unit of 1 gram. The tenure i.e. maturity period of the bond is for a period of 8 years with exit option after 5th year to be exercised on the interest payment dates. Gold bonds are not liquid enough compared to gold ETFs. For building a portfolio, gold ETFs are best suited. Gold bonds are okay for a portfolio if you can hold for 8 years.

Every investment depends on entry and exit price. The price of SGBs is fixed in Indian Rupees on the basis of simple average of closing price of gold of 999 purity, published by the India Bullion and Jewellers Association Limited for the last three working days of the week preceding the subscription period. The issue price of the gold bonds can be cheaper by Rs 50 per gram less for those who subscribe online and pay through digital mode.

Unlike gold ETFs that are held in a demat account, SGB investors are issued a holding certificate for the same. The bonds are, however, eligible for conversion into demat form. The redemption price of SGBs is in Indian Rupees based on simple average of closing price of gold of 999 purity, of previous three working days published by IBJA Ltd.

The real edge of gold bonds over any other gold investment avenue is the fixed interest rate. SGB investors are compensated at a fixed rate of 2.5% per annum payable semi-annually on the nominal value. This means you can earn 2.5% per annum irrespective of how the price of gold moves. Also, gold bonds can be used as collateral for loans. The loan-to-value (LTV) ratio is to be set equal to ordinary gold loan mandated by the Reserve Bank from time to time.

Lastly, the interest on gold bonds is taxable as per the provision of Income Tax Act, 1961 (43 of 1961). Do note that the capital gains tax arising on redemption of SGB to an individual has been exempted. The indexation benefits will be provided to long term capital gains arising to any person on transfer of bond.

Also read: Sovereign gold bonds a cheaper way to buy precious metal that also pays 2.5% interest

3. Multi asset allocation funds

These are open ended mutual funds. In these funds, the investor has no say on how much allocation will be done to equity, debt, gold or cash. Though most multi-asset funds invest across equity, bonds and gold, one such fund could be quite different from another. They give you a readymade portfolio, and the entire asset allocation is the fund manager’s headache.

You buy units at the NAV. This makes these funds quite easy to exit like gold ETFs.

How your multi-asset fund gets taxed depends on its underlying asset allocation. If it is a fund-of-fund (FoF), then it gets taxed like a debt fund. If it invests directly in equities and bonds, then it gets taxed like an equity fund, if your fund had invested in equities of at least 65% of its corpus. So, 15% tax for redemptions made before one year, 10% long-term capital gains tax on units sold after a year, provided the gains are in excess of Rs 1 lakh.

Mutual funds are, as you know, market linked investments. So there is no guarantee of either gain or or loss.

Related: 

Investing in Sovereign Gold Bonds? Here is what you need to know

In a turbulent market, consider alternative assets like gold


Kumar Shankar Roy

Kumar Shankar Roy is contributing editor with RupeeIQ. Kumar is a financial journalist, with a functional experience of 15 years. He tracks mutual funds, insurance, pension, PMS, fixed income/debt and alternative investments markets closely. He has worked for The Times of India, The Hindu Business Line, Deccan Chronicle Group, DNA, and Value Research, among others, across different cities in India. He is deeply interested in marrying data insights with actionable opinion. He can be contacted at kumarsroy@rupeeiq.com.

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