While I don’t know whether this target will be met or not, I am certain that the way investing in gold is being approached now (and also in the days and weeks to come), is probably going to be sub-optimal. That’s just saying ‘wrong’ in a gentler way.
Let me start by sharing some statistics on gold that you often see quoted in social media posts (with one addition—the price of gold in US dollars).
As you can see, the case for gold (in Indian rupees) is very strong when compared to the performance of the BSE Sensex. Why take all the risk when you can simply buy and hold gold and earn the same return? (If we include dividends, the Sensex returns would be marginally higher.)
Having said that, most social posts are silent on how the price of gold moved in the international market, i.e. in US dollar terms. Once you compare that to the performance of stocks, your infatuation with gold would be diluted quite a bit.
What’s going on here? And why should gold in dollar terms matter to you?
Well, you see, we buy gold for two reasons. First, for protection (my former boss called gold a form of ‘insurance’. No one could have said it better). This is generally, what most of us do. And second, some others, buy gold to make a ‘return’. Perhaps even making a case that gold could do very well. Like the ₹1 lakh per 10gm forecast.
If you are buying gold for protection, perhaps 5-10% is all you need to allocate. The fact that you earn a solid return is just pure incidental.
But then, when gold starts to move, like now, one is tempted to take more exposure in the hope of making a big return. And this is where things get interesting.
You see, if the ‘insurance’ portion of your portfolio does not perform, it does not matter. It’s a small allocation. But if something does go wrong, the payoff could be large enough to offset losses or meet unforeseen needs.
But when this allocation goes large, well, things get complicated.
Most of the historical return on gold, in India, is driven by the depreciation of the Indian rupee. In fact, this reason alone accounts for a little more than half the return over a 20-year period, and nearly three-fourths over a 10-year period.
So, when you are betting on gold, you are really betting on the depreciation of the Indian rupee. And that’s one big call to make (there have been periods when the rupee appreciated sharply as well. Post the 2008 financial crisis for instance.). If at all it can be made with a reasonable degree of certainty. Can you make such a call?
In effect, when you start chasing gold today, you are chasing the idea of a fall in the value of the Indian rupee vis-à-vis the US dollar. Or you are expecting shift in the global order from paper currency to hard assets?
The first, like I said is a tough call. The second, it’s a long-term trend with no new short-term trigger in sight. So, why would you go about chasing the price of gold today? Especially since it’s run up quite a bit.
Here’s something else for you to consider.
When gold is expected to do very well, it can often be a counterpart to a macro event that’s not so good. So, if you are expecting a 50% surge in price of gold, what are you expecting, say, for stocks which don’t thrive in times of pessimism? How are you balancing that side of your allocation?
So, you see, gold has a place in your portfolio. And there’s even a broad range of a generally acceptable allocation. If we went through a disciplined asset allocation exercise, most of us would fall within the range. Perhaps, you should stick to that.
And in case you venture to chasing gold, remember that investing in gold is perhaps as complicated as picking the right stock. And even then, there’s so much that can go wrong.
Rahul Goel is the former CEO of Equitymaster.