This dhanteras, strike gold

Written by Saikat Neogi | Updated: Oct 14 2014, 08:01am hrs
With Dhanteras the auspicious day when Indians buy gold just a week away, a sustained drop in the price of the precious metal to multi-year lows has brought a lot of cheer for households. The steep fall in price, by over 30% in two years, is driven by a stronger US dollar, lower demand of the metal from India and China and lower exchange-traded fund holdings by global institutional investors.

Investment in gold is a useful diversification tool and a good hedge against inflation. For many investors, the metal is an essential store of value for financial emergencies. Also, unlike real estate, investment in gold is highly liquid and one can sell it at any point to meet planned or unplanned needs.

Chirag Mehta, fund manager at Quantum Asset Management, says investment in gold is especially important during uncertain times: The main reason to own gold is the sheer fact that it is a good portfolio diversification tool as it helps reduce overall portfolio risk.

However, ideally, a retail investor should not allocate more than 10% of his investment portfolio to the metal since any steep and prolonged downturn in prices could reduce returns in the long run.

Historically, gold and US dollar have had an inverse relation, which means whenever the currency strengths the price of the precious metal slips.

A recent CARE Ratings report says gold is likely to soften in the near-to-medium term with the dollar expected to strengthen further on the back of better performance of the US economy and the expected interest rate hikes in the country. Increased buying from China and India could provide some cushion to prices. Gold markets could also get some support from higher physical buying at lower prices and from investors who seek portfolio diversification. Nevertheless, the metal is unlikely to see a significant resurgence in demand and price in the near term, says the note.

One can buy the metal in either the physical form (jewellery, bars and coins) or invest in gold exchange-traded funds of mutual fund companies.

One can also opt for lower karat gold, which is relatively cheaper than 22 or 24 karat. For example, 18 karat gold contains 18 parts gold and 6 parts other metal or metals, making it 75% gold. Similarly, 14 karat gold contains 14 parts gold and 10 parts other metal or metals, making it 58.3% gold. In the same way, 10 karat gold contains 10 parts gold and 14 parts other metal or metals, making it 41.7% gold. Indians, however, prefer to buy 18 and 22 karat gold. Analysts advise that if one buys lower karat gold, it should be purchased from a reputed jeweller and hallmarked.

Gold ETFs offered by mutual funds are a cost-effective option to buy the metal in the electronic form. Besides, this way, one gets to buy the metal at a price close to the one paid by wholesale buyers. By investing in the paper form, one can eliminate issues relating to purity and problems of insurance and storage. In order to invest in gold ETFs, one must have a demat and trading account with a broker.

One can also invest in gold funds through systematic investment plans (SIPs) and, in case of ETFs, one can buy each month. One does not even have to open a demat account to invest in gold SIPs, unlike gold exchange-traded funds, thereby saving on charges like annual maintenance of the demat account, delivery and brokerage and transaction charges. By investing through SIPs, an investor gains from rupee-cost averaging when gold prices go down, the fixed SIP amount will buy more units and vice-versa. Also, since payments are made at different points of time and at different net asset values, the purchase price of units averages out over the investment period. It makes sense to invest at different market levels rather than time the market and invest all the savings in one go.

Though analysts feel that gold is in a long bull run, they caution that the metal has seen spurts of volatility in the past. Such spurts give the investor an opportunity to invest at low levels, thus benefiting from rupee-cost averaging. Analysts advise staying invested in a gold SIP for a minimum of three years for better returns.

An investor should opt for multiple gold SIPs on different dates for better diversification and greater advantage from price movements. Returns from gold SIPs do not attract any wealth tax, unlike physical gold where 1% wealth tax is levied if the holding is over R30 lakh.