Investing in gold: When and how much should you invest in gold?

April 06, 2021 2:45 AM

Allocation to gold should be as per your profile, investment objectives and investment horizon, but the extent should be on the lower side and should not form a major part of your investment portfolio

Gold price,The rationale for allocation to gold being on the lower side is that gold per se does not produce any economic wealth.

By Joydeep Sen

For any investment, be it equity or gold or any other asset class, there is a tendency to buy when prices are on an upswing. In behavioural finance, this is called recency bias; when prices are moving up, that is fascinating and it seems prices will move up forever. Some people enter the asset class at this stage in an attempt to catch the price movement from that point to the peak. But nobody, not even experts, can predict the market bottom (the theoretical best price to buy) and the market peak (the theoretical best price to sell). It is theoretical because when the market is at that point, we do not know; only in hindsight we know it has bottomed out or peaked out.

A similar phenomenon happened in case of gold. Sometime earlier, when gold price was on an upswing, people were asking how much more can prices move up. The perspective is, that would be the basis for the investment decision: the percentage gain left from that point to the peak would give an estimate of expected returns. In this case, gold prices peaked in August 2020 but at that point, as per recency bias, it seemed further steam was left.

Investing in gold
The right perspective to an asset class is that of allocation in your portfolio. One of the reasons for allocation to various asset categories in your portfolio is that ideally there would be a negative correlation between the asset classes, to create a balance in your portfolio. In reality, negative correlation is not found, but a low positive correlation is desirable. This would make your portfolio less volatile as all the investments would not go up or down at the same time. The logic for investment in gold is the same; have some allocation to it so that the volatility in your portfolio is lower to that extent, i.e. , low positive correlation with other assets in your portfolio. The benefit will be that the risk-adjusted returns, i.e., returns adjusted for volatility will be that much better.

For allocation to gold in your portfolio, it should be as per your profile, investment objectives and investment horizon, but the extent should be on the lower side and should not form a major part of your portfolio. The staple asset classes are equity and debt; equity is meant for long-term wealth creation along with economic growth. Debt is meant for relatively stable returns as well as wealth creation. Some extent of gold in your portfolio would lead to overall less volatility than if it is equity and debt only.

The rationale for allocation to gold being on the lower side is that gold per se does not produce any economic wealth. It does not have much industrial application like steel or aluminium. Usage of gold for jewellery is prevalent in India only. Gold prices tend to move up when there is uncertainty, for example, geo-political, tensions about war, pandemic-induced slowdown, USD depreciation, etc.,— when global investors diversify away from their staple assets.

Conclusion
If you were bullish on gold at peak prices in August 2020, you should be bullish now that the prices have corrected and you are getting a better entry point. Over the past couple of months, USD has pulled back and theoretically that would be reason to not invest. But then you are getting into the guessing game, which may be futile. You have control only over your portfolio and not over the external environment.

The writer is a corporate trainer (debt markets) and an author

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