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All that glitters is not gold- Here’s why you should look beyond gold.

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Published: Monday, June 25, 2012, 11:38 [IST]
 
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All that glitters is not gold

Key Points:

  • Gold has delivered solid returns for the past 5 years, can it continue that trend?
  • Gold has already reached its peak. When will it cool off?
  • No one knows the fair value of the Gold, which leaves big scope of speculation
  • It is prudent to focus on the undervalued equity market, not on the metal

Unless you have been living under a rock, the buzzword nowadays is Gold.

Today, whenever you hear Gold, the first question that you tend to ask is how much more has the price of Gold increased? As Indians, Gold is a favoured investment over and above traditional Fixed Deposits and sometime even Real Estate. By now every one of us has either bought some gold or has made investments in Gold through Gold ETFs and Gold Funds.

The shiny yellow metal has always been used as a tool to hedge against inflation. During the current turbulent times, Gold is now seen as an asset which has the potential to outperform in the near term.

As Gold hits its epic high and with little scope for further upside, for investors with an appetite for Equities, gains made from Gold should be diverted to the equity space mainly through mutual funds route to advantage the attractive valuations in that space . Unfortunately, this thought process does not exist and investors with an appetite for risk choose to stay invested in the yellow metal, on hopes that the price of Gold will further rise in days to come. Few investors know that globally Gold has come off its highs since September 2011 when Gold almost breached the US$2000 levels.
Taking a different stance from others, I opine that the shine of the Gold is all set to fade out in coming days.

We Indians know the art of saving but when it comes to creating wealth, we are miles behind from others, thanks to our conservative approach towards investing.

Reason for the Outperformance

No one can deny the fact that Gold has outperformed equities in the last decade, but the question, why it has increased so much and whether this trend will continue in days to come or not.

The major outperformance of the gold was witnessed during the last 5-6 years. This outperformance of Gold is primarily attributed to the flight to safety on the backdrop of the global financial crisis which led to corrections in the valuations of other investment asset classes around the world.
It is loosely believed that gold prices and value of US dollar are weakly correlated with one another. In a layman's term a weak correlation means that when rises other fall and vice versa. In this case whenever the value of the US Dollar increased, the value of Gold fell and vice versa.

Chart 1: Showing returns of Gold in London Stock Exchange

The chart above reflects the trend line for returns of Gold from 1985. While Gold did not shine with returns between early 1990's to 2003-04, its value increased significantly after 2006-07 mainly on the back of widespread global economic slowdown following the collapse of Lehman Brothers and weak dollar. Fearing that the value of dollar will slid even more, there was a flight to safety as people started to accumulate Gold leading to the biggest rally in the history of Gold prices.
Adding fuel to fire, the US downgrade by the S&P along with the mounting worries over Eurozone economies furthered helped the Gold to carry on its winning momentum.

An opportunity missed to create wealth?

Although Gold has come off its highs last September, Gold prices in India continue to rally. Gold price is a reflection of Spot Gold on the London Metal Exchange (LME) and therefore price of Gold in India follows this market like any other country. Gold being largely an imported commodity in India, it needs to be paid off in US$ and therefore the price of procuring Gold has gone up since a greater sum in Rupees has to be paid. Sadly, investors continue to focus more on Gold and less on the equities, ignoring the fact that equities have the potential to generate the extra alpha in the portfolio of the investors.

Its investment prudence when an investor does not look at Gold as a wealth creator but purely as hedge over his portfolio. A good portfolio should consist of 60-70% equity, 20-30% in debt and the remaining in Gold related investments.
Equities are the growth enhancers of any portfolio and should form the core part of portfolio.

Chart 2: Showing the outperformance of Sensex

As evident from the chart above, the Sensex has outperformed both the Gold index and the world equity Index consistently.

A open Treasure Chest - Sensex

In the backdrop of a slowdown within the Indian economy and the Eurozone crises, stocks on the flagship Sensex are trading at attractive levels, based on FY13 earnings, making a case for markets to outperform in the near term. The informed investor should act to partially book their profits made from gold investments and should try to invest in Equities in such a scenario
Mirae Asset Mutual Fund in one of their recent reports reported that, "the forward P/E is close to 12.92 (12% discount to the 10 year average), while based on FY14 earnings the PE is 11.21. The 10 year average forward PE multiple for Sensex is 14.7 times earnings". "Based on current market levels of close to 16,000 the risk-reward ratio looks favorable".

It is expected that when the global economy will recover, there will be fresh demand for equities. While the FIIs and NRIs are investing in equity market, we Indians are parking our hard earned cash in bank accounts. For the informed long term investor, this is his opportunity to take advantage and get away from the herd mentality of parking funds in bank accounts.

In 1980, Gold prices fell around 70% from its peak, so before investing into Gold remind yourself that the yellow metal had a superb run and may be its just time, when the Gold prices will start to cool off.

Topics: gold, etf
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