Equity markets have sharply corrected over the past month. The Nifty Smallcap Index is down 23%, the Nifty Midcap Index is down 18% and even the benchmark Nifty 50 is down 10.7%. Bond markets and debt funds have been hit by the IL&FS default and downgrade. BOI Axa Credit Fund is the latest among debt funds to suspend inflows after undergoing 5.17% drop in a single day. There is little evidence to indicate that the pain is going to get over anytime soon.

In such a scenario, where should you deploy your money?

One asset that has held its ground, better than equity or debt is gold, up 3.25% over the past month.

Why should you buy gold?

Quite simply, assets turn to revert to their long term average returns. This is called mean reversion. Over the past five years, gold has undergone a prolonged correction. The 5-year annualised return of gold is approximately 0.4% compared to its 50-year return of 11.2%. It is now giving some signs of coming out of this correction. Gold is up around 6.3% over the past year with approximately half that gain coming over the past month. Much of this has been driven by rupee depreciation. Gold is priced in dollars and rises in value when the rupee falls. In other words, gold is a good hedge against rupee depreciation. It can move higher if the rupee depreciates further.

It is also important to remember that the supply of gold is finite whereas the supply of money chasing it, keeps increasing every year as Central Banks print more money. Over the long term, along with the price of other physical assets like real estate, the price of gold also rises, due to scarcity.

Which gold mutual fund should you buy?
You can buy gold physically from a jeweller, through a Sovereign Gold Bond or as digital gold from a platform like Paytm. However gold mutual funds offer the best deal for investors who desire a high level of liquidity and low holding costs for gold.

If you have a demat and trading account, you can buy a gold ETF (exchange traded fund), a type of gold mutual fund which is continuously traded on the stock exchanges. If you are going for ETFs, it is important to buy one which is extremely liquid.

If you buy an illiquid ETF, even a relatively small purchase or sale order on the exchange will drive the price against you. You will either pay a hefty premium on the gold ETF units, or end up not getting any. Liquidity is best available in the largest gold ETFs. They are Reliance ETF GoldBeES (AUM of Rs 2,252 crore) and SBI Gold ETF (AUM of Rs 628 crore). These ETFs have delivered 1 year returns of 5.36% and 5.25% respectively, much of it coming in the past 1 month.

If you do not have a demat and trading account, you can buy an ordinary gold mutual fund which in turn invests in a gold ETF or holds physical gold directly. The difference between these funds and ETFs is that you can buy them directly from the fund house and sell them directly to the fund house instead of going to a stock exchange (for ETFs). As a result, you do not need a demat and trading account.

However there is one important point to note while buying these funds – many of them hold gold ETFs as the underlying asset and hence their prices fluctuate as per the ‘last traded price’ of the underlying ETF. This means that their NAV can be distorted by the fluctuations of ETF prices due to illiquidity. Hence it is especially important for you to buy large, liquid gold funds which are not easily distorted by poor liquidity in the underlying ETFs.

Here as well, Reliance Gold Savings Fund and SBI Gold Fund rank the best in terms of size and price tracking. Note that the additional layer of expenses (a fund holding another fund) does impact returns. Both these funds have 1-year returns of 4.30% compared to 5.36-5.25% on their underlying ETFs.

Staff Writer

This article is written by RupeeIQ editorial staff.

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