In an economic scenario thwart with uncertainty, the naturally optimistic are betting on the equity markets, which offer bargain deals, while the pessimists are running for wealth protection, predicting darker days still to come. In such a situation, it is the realist and opportune investor who can take advantage, as well as prepare for the worst. This requires some financial planning to go into ones portfolio to finely balance opportunity, prudence and safety. While safety is sought in many forms, one that comes to mind immediately is the most time-tested of all assets, which can also hold its own no matter what: gold. Gold being the one asset with a high intrinsic value, has in the past acted as hedges against inflation, currency debasement, falling equity markets and even helped keep abreast the falling purchasing power of nations.

While 2008 was pretty much gold?s year as a commodity and an asset class, it has now fallen from its all time high and along with equities showed a sudden decline recently. The speculations surrounding this range from the gold bubble bursting, correction in gold prices to gold losing its natural characteristics are all partially true and yet none explain the complete picture. This is as the simple truth is that this entire economic meltdown, which has led to erratic movement in various assets, defying their natural tendencies at times, is basically what Nassim Nicholas Taleb refers to as a ?black swan? event.

While the history of the gold price movement is still being scrutinised, trying to understand as much as we can about gold and the likely economic impact of this global meltdown is the best way one can prepare for what is to come.

Gold investments

While Indians are by far the largest natural buyers of gold, we tend to have a major preference towards gold jewellery when compared to some of its other forms. While these jewellery no doubt hold a high emotional and intrinsic value in the world, they are not the smartest way to go in terms of investments. The main reason for this is one: the uncertainty of quality and two: the high additional cost incurred for the making, which in terms of an investment is pretty worthless if not harmful to the value of gold.

The other options like buying gold coins or bars also pose a problem of quality, authenticity, storage and even insurance, which increases the cost of the asset greatly.

While banks, which sell gold, cut out some of these problems, the insurance issue still remains, as well as the fact that banks do not buy back the gold they have sold.

This leaves purchasers with a relatively illiquid form of gold, which then has to be independently sold to either a jewel shop or another buyer. All in all, this brings us to gold exchange traded funds (ETF?s), which tend to take away the hassle of storage and insurance both, since the gold is stored and insured by the asset management company (AMC).

The gold is also supposed to be authenticated and quality tested, providing investors a chance to invest easily into this asset by merely purchasing units. These units are like shares and change in value as the NAV moves up or down.

The only downside is the psychological edge of owning psychical gold on your own is not there, unless the units are redeemed via the fund.

Swati Kulkarni, UTI Gold exchange traded fund (ETF) manager, felt, ?Typically, gold ETF?s don?t take calls on gold prices. They only provide investors with an alternative investment, and, irrespective of the gold price movements, gold ETF?s will invest in gold. They also provide investors the most efficient exposure to gold. This is a more sophisticated way to get exposure to gold as an asset class.?

On the other hand, Arvind Chari, Quantum Gold ETF?s fund manager, opined, ?A gold ETF is an easier way to invest in gold. We use gold as portfolio insurance. Gold and gold ETFs both had a good year in 2008, and even now we advice investors to have 10-20% of their portfolio invested in gold.

The reason one may prefer gold ETFs over other forms of gold buying is as when compared, one finds, banks don?t buy back the gold they sell, gold coins and bars are harder to store and verify for authenticity, jewellery is more expensive due to the making charges, leaving gold ETFs as the preferred choice of investment.

Why gold?

Swati believes ?Gold as such does well when there is high risk aversion in the market and till that scenario exists, gold will remain attractive. While currently, gold may not be reacting to every asset class like it usually does, having a negative correlation to equities, debt and having a positive correlation to oil, in another two to three years it will normalise. Gold will then continue to act as a hedge against inflation, falling equities and currencies.

While the gold high maybe over, it still remains a powerful asset class and until the world economy stabilises and risk aversion settles down, it will not be bogged down.?

Most investors would be aware that gold is a good hedge against inflation and the best insurance against the markets. However, people may find it odd as to why are we discussing inflation when or falling equities when the markets are looking attractively priced right now. This is mainly due to the high risks that many nations are taking today, be it via offering huge stimulus packages as seen in the US or via increasing their fiscal deficit as seen in the case of India. If either of these scenarios play out, the governments will be left with little choice but to print more money, thereby creating inflation and destabalising the economy as well. In such circumstances, inflation is bound to kick back in and sooner or later, investors will once again have to turn to gold for solace.

On elaborating as to why is gold so essential during the present circumstances, Arvind goes on to explain, ?While the world economy is facing a major crisis, right now people need protection. So many countries these days are offering stimulus packages, which means these governments, in order to raise the money for the stimulus packages, will start printing more money. This will debase the currencies and in such times gold is the best protection one can have.

People will be looking to go towards gold to maintain their purchasing power and combat higher inflation, which maybe seen in the next year or so.?

Gold in your portfolio

As far as building a portfolio goes, Swati felt, ?If one does not have gold in their portfolio, then now is a good time to acquire it, especially since gold prices are currently down, from their all time high last year. However, from a three to five year perspective, equity will be a better class to invest in terms of returns.?

Gold over the last few years had again come into focus as an asset class, especially in India where it has been sought more in the form of jewellery. Most portfolio managers across the nation have been of the opinion that one should at least allocate 10-20% of their portfolio towards gold, and adjust it accordingly as the economic scenario becomes clearer.

When discussing if gold is an asset worth investing in, Arvind feels ?Gold is proving to be the safest asset in such times. This is believed as it is the only asset, which will protect your investment value. This is essential especially in such times. 20% allocation of ones portfolio, directed towards gold, especially via gold ETF?s, is the best way to invest in gold.?

Another reason for investing in gold now is due to the lower prices currently offered in the market. Also, if one looks at the various mutual funds performance across the country over the past 12-14 months, one will see that the top four funds are all gold exchange traded funds.

After giving average returns of 25% or more last year, they continue to grow at a steady rate in comparison to the other funds. However, when gold prices dipped after their all time high, these funds too took a hit in their NAVs. However, if one looks at the last one week of mutual fund performances, then too gold ETFs seem the best, having returns of 7-9% in the last 7 days.

Skeptics of the gold ETF boom have felt that the ETF?s net asset values often move at way higher rates than the gold price movement. Explaining the same, Arvind felt, ?Sometimes due to trading of gold ETF units, the gold ETF movement is higher or lower than the gold price movement. However, I feel this is only an intra-day phenomena. Technically, gold ETFs and gold should move in tandem, especially since at the end of the day, the NAV is based on the gold price.?

Some of the ratios that gold is often compared to is the Dow-gold ratio, oil-gold ratio and dollar-gold ratio. The Dow-gold ratio has a curious historical relevance, for it shows the ratio at its highest point once every 35 years. After this, the ratio steadily drops till it is below one. Currently, the ratio is at 7:1, almost with the Dow in the 7,000?s and gold at a $1,000 level. If this is to now move towards below one, the gold price is bound to rise, accompanied by the falling Dow. Oil on the other hand is usually closely related to gold in terms of movements.

However, now the ratio between them is the highest and this too is an anomaly of sorts. As far as the Dow-gold ratio goes, Arvind felt, ?The Dow-gold ratio is today at a critical phase. Historically, the ration reaches its peak once every 30-35 years, after which the ration will fall to below one levels. This has happened from the 1920?s onwards and given that the ratio had peaked last year, this phase becomes important. For it could mean that the Dow will drop drastically from its current 7,000 levels and gold will rise drastically from its current $1,000 levels, if the ratio is to be below one.?

All in all, whatever be the case with gold, the fact that it is the best hedge we have against the times ahead is now a universal consensus. China has tripled its gold and so are other nations, who are now turning towards refilling their gold treasuries. In such a case, retail investors too should revisit their portfolio and insure it with a decent gold allocation.