Gold on a high, but should you invest?

SAFE HAVEN, BUT...With price rise determining returns, experts advice only 5-10% portfolio allocation in the metal UNLIKE MOST OTHER METALS, INCLUDING SILVER, GOLD HAS RELATIVELY LOW INDUSTRIAL USE, WHICH MEANS THAT ECONOMIC ACTIVITY DOES NOT AFFECT THE DEMAND
The downgrade of the US' sovereign debt by Standard and Poor's to AA+ from AAA has given another shot in the arm to already rising gold prices. And yet the buying euphoria hasn't died down. In fact, there were reports of panic purchases of gold bars by mostly small investors. But does such a move fit into your overall asset allocation plan? And if you are one who has missed the bus, is it a good time for you to buy?
WHAT'S UNIQUE TO GOLD?
Gold has been the currency of choice since the Byzantine Empire. Post-1971, gold price was freed and determined by market forces. Though since then it has never been linked to currency, most countries hold gold reserves as a store of value. Unlike most other metals, including silver, gold has relatively low industrial use, which means that economic activity does not affect the demand. Gold carries no default risk.
FACTORS IMPACTING PRICES Global uncertainty: Primarily, depreciation in the relative value of the US dollar and financial stress in Europe is supporting the rise in gold prices. The US' slow economic recovery has resulted in its currency falling out of favour, which is used as a reserve currency by other countries. With the US dollar's relative value depreciating, many are beginning to buy gold to keep their reserves from falling in value. “Uncertainty in global economic conditions over the last two quarters has contributed to rising gold prices,“ said Lakshmi Iyer, head, fixed income and products, Kotak Asset Management Co Ltd. “Central banks now don't want to be overweight on the US dollar. The US sovereign debt downgrade will only add fuel to the fire, resulting in higher gold prices in the immediate (future).“
Financialandeconomicissuesthatgovernments in the West are faced with are unlikely to be resolved in a hurry, experts said.“Inthenexttwo-threeyearsanypositive signals of recovery in global growth is unlikely,“ said Atul Shah, head, commodities, Emkay Commotrade Ltd, the commodity broking arm of Emkay Global Financial Services Ltd. This means that gold buying will continue.
Inflation: Gold is an attractive alternative investment during inflationary times. In the emerging Asia context, many countries continue to have negative real interest rates.
According to a study by Oxford Economics titled The impact of inflation and deflation on the case for gold, “It is also possible that while gold's real price eventually falls back, this takes place not by a fall in the nominal gold price but by a substantial rise in the general price level, which means that the current price proves an accurate warning of high inflation down the road.“
Festive season: More relevant in the Indian context is the approaching festive season, which supports domestic demand and prices of gold. “We are entering festive season when domestic demand remains strong even at high prices,“ said Jain. Traditionally, Indian festive demand for gold does not depend on prices. WHAT SHOULD YOU EXPECT?
Experts suggest that for the rest of the fiscal year all the above factors will support domestic prices of gold and a worsening global economic situation will push investors to buy gold and may even give its price a further kick. But the rush to buy gold indicates that its price rise has too many negatives already factored in.
WHAT SHOULD YOU DO?
Gold remains the investment of choice as a safe haven and given the current situation and expectation of a slow global recovery, gold prices are likely to remain elevated for some time to come. However, this doesn't mean you necessarily buy gold now. Consider the risks and weigh your portfolio needs before buying.
Risks: Gold is a long-term store of value, but not a long-term return generator. Over the last 40 years, gold's compounded annual growth rate (CAGR) has been 9.5%. In the 10 years between 2001 and 2010, gold prices have witnessed a definite rally with a CAGR of 18.0%. As on August 8, the year-to-date rise in gold price has been around 19.3%.
Remember that there are no incomeoriented payouts such as dividends or interest, hence the investor is totally dependent on price rise for returns.
Portfolio allocation: This means you shouldn't have a very large portion of your portfolio allocated to gold. “Gold is primarily a hedge, we don't advise any predominant investment,“ said Rajmohan Krishnan, executive vice-president, regional head, north and south, Kotak Wealth Management. “If a client is keen we can increase it a little, but always maintain a 5-10% allocation and that too via gold exchange-traded funds.“
Since Indians have been traditionally investing in gold, most families would have some amount of gold jewellery and other physical gold. Check the value of your physical gold and add on only if required.