Investors' Hangout: Is now the right time to invest in gold?

Can you please explain the surge in gold and why the central banks are acquiring more of it?
Historically, the US dollar has emerged as a global currency where global trade happens and gets settled in US dollars. Most central banks also hold it, and because they hold it, there's a natural demand from central bankers globally to keep holding the dollar. Anybody with a trade surplus holds a substantial part of it in dollars. The fallout of what happened in Ukraine was that the dollar assets of Russia were confiscated. As a result, we saw a big shift. Historically, investors and central bankers have been moving their money to gold besides the dollar, but that acted as a great catalyst. Many countries decided they needed larger gold reserves, creating a new demand for gold.

So far, gold in India has been substantially a store of value. It is held in the form of ornaments and as a valuable asset. People are comfortable holding it. Even if it does not beat inflation, that's fine.

The recent surge in demand from central bankers has been sustained. That is phenomenal and exceptional. India is among the biggest consumers of gold for domestic consumption. But of late, even the central bank, the Reserve Bank of India, has also begun to buy gold in large quantities. So, the net result of all this is that gold has been able to sustain.

If I go back into the history of gold, its financialisation actually happened in 2008 or a little before the 2008 crisis. That was when it became possible to have gold ETFs or funds, creating new demand. This was followed by the global financial crisis, which was unprecedented. For the first time, we witnessed debt and equity crashing, and gold was the only thing able to hold ground. That was one big demand trigger that drove gold prices around that time. Since then, gold has fluctuated but has been able to hold its value. It has guarded its worth but has not been an inflation beater.

Historically, we have viewed it as not a productive asset, but this new demand and the emergence of gold almost like a currency—which people hold and can realise or sell at any time while maintaining its value—have led to the surge in prices. This looks like it is sustainable because all the economies with trade surpluses, even if they store a part of it in gold, indicate that this trend is not ending.

What if this is a fundamental change? If this is how it's going to happen from now onwards, does that mean investors need to bring about a change in their investment strategy?
I sense that this is not a temporary thing. There are a lot of factors that are not very comforting about the US dollar. So, the surge in demand for gold and the money deployed in gold by central bankers is not a one-off thing. This trend might prevail if it remains a currency for central bankers. I understand that it has become significant due to current factors, and the demand can continue to rise steadily. If that happens, then I think investors need to fundamentally re-evaluate their strategies.

Historically, we have said that gold is not a productive asset, so you can do without it. I've always advised, even around Akshay Tritiya or similar occasions, to think of gold as consumption. Think of gold as a notional thing; keep it because it is part of our customs and beliefs. Have it to the extent that it fits cultural practices, for stylish jewellery, but don't consider it an investment.

Today, due to this new demand, which is likely to prevail, gold might be able to hold its value, guard its value, and even increase in value. Therefore, having some allocation to gold in your investment portfolio could be beneficial.

What is the best way to invest in gold?
The best form of gold ownership is to have sovereign gold bonds (SGBs). This allows you to benefit from gold price appreciation while also earning annual interest. Additionally, if you buy a sovereign gold bond issuance at the outset and hold it for eight years, all the appreciation is tax-free. This is a significant advantage. Moreover, you don't have the incidental risk of owning physical gold in your locker and don't need to worry about protecting it.

There are no management expenses with sovereign gold bonds, unlike gold funds or gold ETFs, which have an expense ratio. The return on a gold fund or ETF will be the appreciation of gold minus the expense. With sovereign gold bonds, you get the return on gold prices plus the interest you earn. So, this is the most beneficial form of gold investment.

What proportion of your investment should be in sovereign gold bonds?
There's no strict thumb rule, but if you need to de-risk yourself from equity and debt, you should consider allocating some portion to gold, say, around 3-8 per cent. However, I wouldn't recommend more than that because it remains an unproductive asset. Even if it functions as a currency, I wouldn't advise you to hold it in your locker since it is not working hard for you. Gold might appreciate a little better, so you can include it for various external reasons. But beyond that, it should not be a significant part of anyone's portfolio.

Viewer's query:

Vishal Kichloo asks, "How are arbitrage funds for parking a surplus amount for the short term (one year)? Is there any better alternative?"
Arbitrage funds could be a decent parking ground mainly due to their tax efficiency. They operate almost like a liquid fund. Tax-wise, they are considered equity funds. When you hold equity as a mutual fund for one year, your taxation rate is 10 per cent. For illustration, consider a 10 per cent appreciation in a liquid fund versus a 10 per cent appreciation in an arbitrage fund. The tax on the arbitrage fund will be 10 per cent, whereas, in a liquid fund, it will be added to your income and taxed accordingly. Thus, arbitrage funds are tax-efficient and you are not exposed to the equity market risk.

A better alternative depends on your timeframe. An arbitrage fund qualifies as a preferred mode for risk-averse investment. A liquid fund is suitable for short-term money (a few days to a few weeks). If you need the money but are unsure of the exact timing (one year, one and a half years, or two and a half years), consider an arbitrage fund if the period is less than three years.

If you intend to invest for three years or more and don't want to take significant risks but still want to optimise your return, a short-term debt fund or a conservative hybrid fund might be your best option.

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