Gold is considered as a safe investment in times of economic or political turbulence. It is a symbol of wealth and it has emotional attachment, too. Most investors feel that gold is a safe haven to park funds until dust settles down. Let us discuss in detail why one should go for gold and what are the various forms of investment avenues available to investors.
If we track the history of gold prices, it provided better returns during times of economic shocks, falling equity markets and currency rates, higher inflation, geo-political uncertainties. An unexpected lockdown was implemented in many cities across the globe to prevent the spread of Covid-19. Its impact on the global economy affected all types of asset classes, especially capital markets and commodity markets. Thus, investors across the spectrum are looking for relatively stable assets and found gold as an appropriately placed asset class. The price of the yellow metal rose to Rs 48,420 per 10 grams on June 24, 2020.
Impact of interest rate
Owing to the ongoing pandemic, central banks across the world have cut interest rates aggressively. Gold and interest rates have historically, a strong negative correlation. Generally, gold price goes up when interest rates go down and vice versa. The logic is that when interest rates are higher, opportunity cost of holding non-interest bearing assets like gold is less attractive. Gold neither pays interest nor dividends. So, gold is relatively expensive to hold in our portfolio especially when interest rates are high and cheap when interest rates low.
There are different ways to buy and invest in gold. For instance, one can buy physical gold in the form of a coin, gold bar or bullion or even as jewels. While buying gold in the form of jewels, investors end up paying 6-20% as making charges. Gold coins of five or ten grams denominations are available. Gold bars and bullions can be bought in denomination up to one kilogram. Investment in physical gold requires storage of the same in a locker at a bank or home.
One can invest in paper gold in the form of gold exchange traded funds (ETFs) or Sovereign Gold Bonds (SGBs). Gold ETFs can be bought through demat accounts in both NSE and BSE platforms. Investors can go for either lumpsum or through SIP mode.
SGBs are issued by Reserve Bank of India. Recently, the central bank has announced an issue of six tranches from April 2020 to September 2020. Investors will get an interest rate of 2.5% per annum. Any capital gains arising on redemption of the bonds would be exempt from tax. If these bonds are sold in the secondary market before maturity, capital gains arising on such transactions will be taxed at 20% with indexation if sold after three years. If sold before three years, a marginal tax rate is applicable. The tenure of SGBs is eight years. One can buy a minimum of one gram of gold and a maximum of four kilograms of gold in a fiscal year.
To conclude, even in good times it is prudent to park up to 5% wealth in gold while maintaining a diversified portfolio. Given the oscillating equity markets, investing in gold reduces the risk of adverse price movement.
The write is a professor of finance & accounting, IIM Tiruchirappalli