Gold is recognised as an unofficial global currency, today. The acceptance of the precious metal as an investment avenue and safe-haven asset has been scaling new highs from time immemorial. The universal appeal the metal has enjoyed ever since its discovery stems from the fact that most ancient words on gold from different civilisations virtually mean the same thing – shinning yellow. For examples, in Latin it is called ?Aurum?; ?Aurora? in Roman; ?Hari? in Sanskrit; ?Goud? in Dutch; and in Arabian it is ?Su?a & diya?. To speak about the contemporary period, there has been resurgence in the activity in gold, especially since the fourth quarter of 2005. Gold prices went uphill until mid-2006, in the process breaching many marks with aplomb in a record-breaking streak before halting at a nearly 26-year high of $732 (a troy ounce) during May 2006.

Having been made a freely tradable commodity across the borders, a similar trend was witnessed in the domestic bullion market as the ?yellow metal? hit a record peak of Rs 10,763 per 10 grams during the period. Sustained investment interest, especially among institutional investors and hedge funds, drove gold prices to a new 26-year high. Even after its prices slumped over 20%, the yellow metal is clawing back towards the $700 mark by mid 2007 on the back of flare-up of crude oil prices, worldwide. In fact, fear of rising inflation that has, of late, made gold a favorite investment asset, which is not a new phenomenon; as it has recurred at regular intervals for many years. As a result, despite the fact that a whole lot of new investment avenues have come up recently, the popularity of gold has not waned. Rather, the metal has seen an uptrend. Furthermore, identifiable investments in gold in 2006 were up 46% at $12.4 billion, over the previous year.

A real protector against inflation

An empirical study on the price behaviour of gold compared with inflation in India (namely WPI) reveals some interesting findings (Period from 1974-75 to 2005-06). First and foremost, a high correlation of more than 93 percent between Indian gold spot prices and WPI proves the credential put forward on behalf of gold as an efficient hedger against inflation. Even the rate of change in prices for gold and WPI is positively correlated.

It has also been established that the inflation-linked bond yields moved with gold prices. Hence, investment advisors worldwide recommend that investors should include gold in their portfolio to the extent they are exposed to bonds.

Further, gold being the least affected by industrial demand cycles compared with others (as their major price driver is the industrial demand) shows that the precious metal is more sensitive to inflation than its competing asset classes. This characteristic of gold enables it to provide effective early warning indicator of inflation making it a far superior commodity than its competitors.

An efficient portfolio diversifier

The most effective way to diversify your portfolio and protect the wealth created in the stock and financial markets is to invest in assets that are negatively correlated with those markets. Gold is an ideal diversifier for a stock portfolio simply because it is among the most low-to-negatively correlated assets to stocks.

Conversely, the high correlation of more than 95% for the last two years ended June 2007 between the global prices and the Indian spot prices has helped the cause of investors. Moreover, the correlation shoots to 99.67% if the effect of the exchange rate fluctuation has been taken care of, thus illustrating efficient price discovery in the Indian markets.

Another reason for gold to be included in the portfolio: the metal has relatively low volatility compared with BSE-Sensex as shown in the adjoining table.

Also, a study by World Gold Council reveals negative to low correlation of gold with the other investment avenues, emphasising gold as an efficient portfolio diversifier. These factors are in addition to the fact that gold has always been a safe-haven asset and a hedge against inflation.

These two major factors which have driven up the popularity of gold are further corroborated by a study conducted by Raymond E, PhD from Penn State University, in February 2006. The study shows that the best one-year return during the past 25 years has been from rare coin at 198.8% followed by gold bullion at 100.2%, while returns form stocks stood at 31.1%.

Increasing means of investment in gold

Today, investment in gold has become simpler with a wide range of products available in the market suiting various investor category needs. Raw bars and coins, along with jewelry, have been the traditional means of investment and they continue to remain so.

Of late, gold futures and gold ETF have also marked their entry into the Indian market. Recently, gold funds tracking the performance of global gold-mining companies have also graced the Indian market. Notably, investment through gold futures has become an instant hit making Multi-Commodity Exchange of India (MCX) emerge as the third-largest bullion exchange in the world in less than four years of its inception.

Such a phenomenal development compels one to have a further look at the benefits of futures trading in gold. The need for commodity futures market arises mainly owing to the hedging function that it performs with the help of investors? interest in gold stemming from its anti-inflationary strength. The booming Indian jewellery exports industry, through participation in exchanges, could also mitigate the adverse effects of its exposure to vicious global price swings and thus, manage to garner healthy margins.

?The author is chief economist, Multi Commodity Exchange of India