Consider the returns that gold has delivered over the last one, three and five years in the table below. The answer is, to put it mildly, disappointing.

Period Annualized Return
1 year 3.06%
3 year 2.96%
5 year -0.21%

Source: Value Research. Data as on 19th January 2018

Over the same time frames, large-cap funds have delivered 29%, 10.3% and 14.78%, all of it tax-free (with mid and small cap funds doing even better). As you absorb these two facts, the temptation to rush to the market with the family gold may seem irresistible, followed by a rush to your friendly mutual fund distributor.

But this may well miss out on one fundamental aspect of markets – they move in cycles.

The million rupee question here is then, has the gold cycle turned?

In the past one month, gold has delivered a return of 5.33%. This is not an annualised figure. If it continues along these lines, its annual return will be 86%. However, one swallow does not make a summer and gold return in Jan may be a freak accident.

Here are four reasons to be bullish on gold:

  1. The rupee is NOT backed by gold

This is a popular misconception. The rupees issued by the RBI are not backed by gold. If you go to the RBI and ask for a gold equal in value to the rupees you hold, you will be sent back with nothing. The rupee is backed by nothing. The RBI holds a small quantity of foreign currencies (called forex reserves) and even gold but these are much, much smaller than the money in circulation in the economy. By money in circulation, I don’t just mean the physical notes and coins with the public but also the electronic money held and loaned out by banks. On 5th January 2018, this amount (technically called ‘M3’) added up to about INR 1,34,000 billion. In comparison, the RBI’s forex reserves in Jan 2018 were about INR 25,000 billion.

  1. Election season is approaching

Election season (2019) approaching in India usually means a government spending spree, for instance on subsidies or welfare schemes. In order to gain votes, government do not like raising taxes to finance this spending. Instead, this extra spending is partly or wholly financed by the RBI printing more rupees. As more and more money circulates in the economy and the price of gold rises. This is because there is simply more money chasing the same quantity of gold.

  1. Mean-Reversion

Mean reversion is the tendency of an asset to go back to its long-term average. The 10-year annualised return on gold is a respectable 10.45%. This is, in fact, more than the 10-year return for large-cap equity funds which was 8%. If you go further back and look at the return the gold has delivered over the decades, you will find an average return of about 11% per annum. After five years near-zero price rise, is a revival due?

Year Gold Price (INR) Return
1968 162
1968-78 685 15.5%
1978-88 3130 16.4%
1988-98 4045 2.6%
2008 12500 11.9%
2018 31000 9.5%
50-year average annual return 11.2%

Source: Bankbazaar.com; Data as on 19th Jan 2018

Conclusion

Gold, a bit like America’s current president, arouses fervent supporters and opponents. Opponents argue that gold generates no return and sits unproductively in a corner, unlike stocks which are linked to corporate earnings and bonds with fixed yields. The answer may lie somewhere in between, with gold emerging stronger as a cyclical buy as stocks get more and more overvalued. It may well be time to add some bling to the portfolio.

Author
Neil Borate

Neil Borate is Deputy Editor, RupeeIQ. He can be contacted at neil@rupeeiq.com.