Why you must own gold.

Jul 18, 2022
Author: Ajit Dayal

In Review, Recap - and Invest (https://www.personalfn.com/the-honest-truth/review-recap-and-invest) the data suggests that those who stay invested in stock markets and don't get swayed by greed or fear will make sensible, impressive long-term returns.

Investing in equity mutual funds is very necessary as it allows your portfolio the opportunity to participate in the growth of the Indian - and global - economy. As economies grow, companies could make more profits. And as profits at companies grow, the share prices of the listed companies should grow to reflect these higher profits. This ends up as an increase in the Net Asset Value (NAV) of your mutual fund - and the returns on your investments that add to our wealth.

Table 1: Investing in equity should be core to your portfolio - it has been rewarding even when compared to the world markets.

Asset Class, avg annual returns June 30, 1991 / April 30, 2014 April 30, 2014 / July 1, 2022
Number of Trading Days of data 8,342 2,984
BSE-30 Index, INR +14.5% p.a. 12.6% p.a.
MSCI World, INR +12.7% p.a. 10.8% p.a.
BSE-30 Index, USD +9.4% +8.9%
MSCI World, USD +7.6% +7.2%
Loss of INR against USD - 5.2% p.a. - 3.7% p. a.
Source: Bloomberg
 

These are impressive returns from investments in the riskier asset class of stock markets and are 50% to 100% more than the base returns you may get from the risk-free government bond issued by the Government of India. However, these stunning returns from investing in the stock markets, encourage many investors to make the blunder of investing in only one asset class. The key to successful investing is to diversify your money across a few asset classes. For the non-vegetarians, this means not placing all your eggs in one basket. For the vegetarians, think of your savings as being a thali with a little bit in the many katoris from the salty to the sweet.

But what if the Indian economy stops growing and, correspondingly, companies stop making profits? Or global events send shock waves through financial markets? In the last 20 years we have experienced quite a few global events which were not caused by India and had nothing to do with India but which had a significant impact on India: the dot com bust; 9/11 - the first attack on the US Mainland by a foreign enemy in over 100 years; the fraudulent actions of the large financial firms which led to the Great Financial Collapse of 2008; the pandemic in 2020 caused by the China origin coronavirus that still lingers amongst us; or the more recent invasion of Ukraine by Putin. None of these were good for stock markets and, many a time, the financial system we have lived in since World War II nearly fell apart. At times, many felt that even the money deposited in the bank was not considered to be safe or 'risk-free'.

This is where gold comes in. Gold is a currency as much as the US Dollar, the Euro and the Indian Rupee are currencies. Gold - like the US Dollar and other currencies - is a medium of exchange, it is a store of value, is liquid and accepted globally. But, unlike the paper notes that you can carry in your pocket you cannot really carry paper gold in your pocket and tender it at a counter to pay for the samosa you just purchased.

Why is gold a 'precious metal'? Well, because it is rare - there is not enough of it to go around. There are an estimated 200,000 tonnes of gold owned by central banks, mining companies, jewellers and individuals. To put that in perspective, all the gold in the world could fit in a building which is 71 feet wide, 71 feet deep, and 71 feet high. If you live in a building with Ground + 6 floors which has 6 car park spaces on any 2 sides of the building, then all the gold ever mined can be stored within your building premises. According to Wikipedia, 75% of those 200,000 tonnes of gold were extracted since 1910 (112 years) and 67% since 1950 (72 years).

Gold continues to play its role as a 'store of value'

Paper currencies or Fiat currencies, in contrast, are not mined in limited quantities. They can be - and have been - printed at will for these currencies are backed by the 'guaranty' of the government and central bank that issues them. New currencies can be created in seconds, in paper form or in electronic form. For example, the amount of US Dollars in circulation has increased from less than USD 10 trillion in the year 2000 to over USD 80 trillion today. That is an 8x increase in 20 years, while the volume of gold grew by 2x in 52 years. The more you have of commodity A (paper currency) compared to commodity B (gold), then the price of A relative to B declines - one unit of B can buy more units of A over time. On August 15, 1971, when the price of gold was USD 35 for one troy ounce, President Nixon took the US Dollar off the gold standard which means that the US central bank no longer had to restrict the amount of US Dollars they created based on the amount of gold they had access to. Today the price of gold is USD 1,700 per troy ounce. This means that the US Dollar has lost 98% of its value against gold over the past 51 years. Even if you assume that gold carries no interest and the US government paid you a 3% tax-free rate of interest over the past 51 years, the US Dollar has still lost 75% against gold. On August 15, 1971, anyone in the world would have been far wealthier if they had surrendered their USD 35 to President Nixon and kept that one ounce of gold in their cupboard.

And this is the relative value of gold against the world's strongest and most popular currency: the US Dollar. Do not even bother to calculate what gold has done against the Indian Rupee! Let me give you one hint to tell you how bad it gets: The Indian Rupee has lost about 92% of its value against the US Dollar since August 1971 and the USD Dollar has lost 98% of its value against gold. Yes, we should all have listened to our grandparents and kept those tolas of gold and those guinea coins hidden under our mattresses (our government banned us from owning gold under the draconian Gold Control Act of 1968).

Table 2: Gold is a great complement to your portfolio, with higher returns than an FD

Asset Class, average annualized returns June 30, 1991 / April 30, 2014 April 30, 2014 / July 1, 2022
BSE-30 Index, INR +14.5% p.a. 12.6% p.a.
MSCI World, INR +12.7% 10.8%
Gold, INR +10.6% 7.7%
BSE-30 Index, USD +9.4% +8.9%
MSCI World, USD +7.6% +7.2%
Gold, USD +5.6% +4.2%
Source: Bloomberg
 

The secret for Gold's success in a portfolio of someone living in India is not only the gains that gold has made against the US Dollar over the past 51 years but the fact that gold is priced in US Dollars. We then translate this US Dollar price into Indian Rupees by multiplying the current foreign exchange rate. So, even if the price of gold remains the same in US Dollars, the fact that the Indian Rupee may weaken makes the price of gold in Indian Rupees see an increase. An investor in gold must have one of the two engines working: the gold price in the international markets priced in US Dollars should increase or the INR must weaken for a good chance to see returns from gold. If both happen - as they have over the past 51 years, investors in gold in India have both the engines working in their favour!

As can be seen from the Table 2 above, over long periods of time, gold has given decent returns - better than the returns from a fixed deposit in a bank. And banks are not safe - theoretically banks can be and have been in trouble. Gold is, as the saying goes, 'as good as gold'. More importantly (Table 3) gold has increased in price when your equity mutual fund portfolio has declined: this is precisely what makes it a great diversification. It is a green for positive returns amongst the red ink of losses. Seeing something with a positive return in a decimated portfolio should - and will - give you comfort.

Table 3: Gold shines in bad times

Returns during stressful times, in INR Event Gold BSE 30 Index MSCI World Index
September 1, 2008 to
Dec 31, 2008
Global Financial Crisis +17.6% -33.6% -24.6%
February 1, 2020 to
June 30, 2020
China coronavirus +18.3% -13.9% +0.3%
January 1, 2022 to
June 30, 2022
US raises interest rates + Putin invades Ukraine +4.7% -8.3% -15.2%
Source: Bloomberg
 

My advice to those who have started their journey of investing in the recent pandemic-inspired craze is to step back and learn from the tried and tested lessons of generations before us. Ask your grandparents what they (and their grandparents) think (and thought) of gold - and what the price of gold was when they were students or when they were your age. It is great that many of you have started investing early - now invest correctly.

Gold should be an integral part of your portfolio. Here is a simple tool to help you invest across the main asset classes of equity and gold and the necessary allocation to money that you may need for regular living expenses irrespective of where the world is at any point in time - your rainy-day money! The simple tool is for building a long-term portfolio of mutual funds for your many evolving goals. The 12 20 80 (baaraa, bis, assi) will help you navigate the challenging times. The beauty is that it needs just 3 minutes of your time. Understanding the 12 20 80 (baaraa, bis, assi) formula will take less than the time you spend waiting for your latte - or your lassi. Do visit the Quantum Mutual Fund website (www.QuantumAMC.com) which will give you access to this simple and powerful tool to build your own investment solution.


Ajit Dayal is the Founder of the Quantum Group which includes Quantum Mutual Fund and PersonalFn. Ajit has over 35 years of research and investment experience. An avid writer and speaker, Ajit has been profiled and interviewed by many international and local newspapers, magazines, TV channels and radio shows and is never shy of speaking The Honest Truth. Sign up here to get The Honest Truth delivered every week into your mailbox. It will change the way you think about your investments.

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