This column was written by Ritesh Jain, CIO at Tata Mutual Fund, for the India Markets Observer.
The importance of holding equity has always been extolled, but investing in gold and debt is as crucial. At this juncture, both offer investors opportunities for growth through appreciation.
Gold was one of the most rewarding asset classes for the better part of the last decade as its price climbed more than six times during 2001-11. This period was followed by three years of a price correction when gold lost about 40% of its shine. The sharp price drop in the second quarter of 2013 led to fears of a prolonged trough, but 2014 saw the arrest of gold’s free fall albeit in a subdued price environment.
Gold neither pays dividend/interest (unless lent for ‘yield’ in return) nor does it carry a guarantee to repay principal over a period of time – as there is no maturity date. It has little productive use apart from a tiny fraction which is used because of its non-reactive properties.
Nevertheless, its financial importance stems from being an effective hedge against currency devaluation and a safeguard against inflation. The threat of default on gold investments is zero. Being virtually indestructible, it requires minimal upkeep.
During times of despair and runaway inflation, gold is a safe refuge. Steep declines in the value of equities or high volatility of other assets, lead to a demand for a stable store of value with a low correlation to other asset classes – Gold is the solution! It also provides liquidity during extreme economic environments where it may be difficult to realize the value of other assets. Gold has proved to be a hedge against flawed political and economic policy which has an adverse economic impact on most asset classes. The recent Ruble crisis is a testament to this fact.
Here’s why you should buy gold now.
Gold prices are nearing the cost of ‘mined gold’ after having come down to $1,200/ounce from highs of $1,900/ounce.
After having been through the Federal Reserve’s oft-referenced $85bn/month QE, QE failed to achieve its object of supporting inflation levels and led to an asset price boom instead. With every subsequent QE failing to achieve its objective, increasing amounts of ‘loose’ money entered the system and speculative forces came into play, thereby distorting asset prices. As things stand, the perception that central banks have been unable to induce inflation through expansionary monetary policy will reduce investors’ confidence in central banks and they will turn to gold.
The opportunity cost of holding gold is captured by the real interest rate. The prevalence of relatively high real interest rates in India for a while has translated into higher opportunity costs and this has put a downward pressure on gold prices. Against the backdrop of a softening real estate market and positive real rates, a higher allocation within incremental physical savings is likely to come to gold.
The returns from gold as an asset class for the rupee investor in dollar denominated gold is marked by two distinct phases – one leading to 2011 and 2011 onwards. The dollar denominated price of gold ensured healthy returns for the Indian investor till 2011.
The three years after that were characterized by a rapidly depreciating rupee against softening gold prices. Hence, the MCX gold spot lost only 5% during this period while the London Gold Market Fixing (PM) index lost 38% from its 2011 highs.
Here onwards, I believe global prices will be influenced by global factors – rising risk will drive investors (and central banks too) closer to gold. For rupee denominated gold, the steep depreciation of the rupee has partially offset the global gold price decline. RBI Governor Rajan wants to uphold the purchasing power of the domestic currency, which could keep the rupee in a relatively tighter band against the dollar compared to the recent past. For the Indian investor, the returns hereon will be increasingly determined by movements in dollar denominated gold prices rather than rupee exchange rate movement, which was the case in the recent past.
This is where we come to debt instruments.
During the past five years, household savings have been disproportionately skewed towards physical assets. As real interest rates have been positive after a fairly long time, households have been incentivized into parking a higher proportion of incremental savings in financial assets.
Debt as an asset class has given approximately 8% compounded return over the last decade. Fiscal prudence in the medium to long term will augur well for bonds as an asset class as it will pave the way for a sustainable reduction in interest rates.
The decision to cut rates between policies was triggered by a sharp fall in inflationary expectations by households. The RBI has stated its intention of keeping real rates in the 1.5-2% band that will pave the way for further loosening of monetary policy and lower rates in the medium term.
Lower bond market yields are here to stay. If we ensure fiscal discipline, we could emerge as an Asian tiger and portfolio flows will follow thereon. India is among the pockets of strong fundamentals in the global universe.
I recommend locking into a fixed income portfolio at current rates to earn higher coupons and capital gains resulting from a structural softening in interest rates. When compared to equity, debt instruments offer little secondary market liquidity. This will improve as more companies turn towards the capital markets to raise debt funds, which in turn, will increase the vibrancy of the debt capital markets and thereby, provide liquidity to bond holders. Investors can look at corporate and government securities and debt oriented schemes of mutual funds available across tenures and credit risk profiles.
As for gold, Gold ETFs are the most convenient.
The views expressed in this article are personal in nature and for information purpose only and do not construe to be any investment, legal or taxation advice.
To view the other contributors, click here.
