Readers have been very concerned about the price of crude rising which will fuel inflation. And they are wondering if this is the time to get into gold.
Let me break this up into a few parts.
The impact of the price of crude going above $100/barrel.
India imports over 70-80% of its crude oil requirement. Crude prices at the current high levels would weigh on India’s import bill widening the trade deficit which in turn would weigh on the rupee.
High crude oil prices could translate into an increase in fuel prices (petrol, diesel) along with the second order effect of increased raw material and transportation costs feeding into the price of most goods and services. This will lead to inflation.
Inflation could impact demand and hurt economic growth. Higher inflation would also lower the profit margins of India Inc. leading to depressed earnings, and result in higher valuations for equities which may correct to account for the same. Higher inflation may also warrant faster monetary tightening by the RBI and lead to increased bond yields, which would impact borrowing costs in the economy and thereby impact demand. Of course, the RBI would also consider the impact of higher inflation and global uncertainties on trade and broader economic growth prior to raising interest rates.
Gold in the portfolio.
Gold plays an important role as a diversifier in a portfolio due to its low correlation with other asset classes and is seen as a safe-haven asset in times of global risk-off sentiment. It is seen as a store of wealth and as a hedge against inflation and currency depreciation.
Gold’s importance as a diversifier has been re-instated during the COVID-19 pandemic led sell-off in markets in February-March 2020, as it witnessed a drawdown of only 11% in rupee terms (S&P GSCI Gold Spot index) compared to 38% drawdown by domestic equities (S&P BSE 500 TR Index).
From an asset-allocation standpoint, it is advisable to have some allocation to gold (~5-10%) for diversification benefits. Like in other volatile assets, it is advisable to build exposure to gold in a staggered manner to benefit from rupee cost averaging. This benefits investors in falling markets since they would be buying units at cheaper prices.
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Digital vs. Physical Gold.
Digital gold is a virtual method of investing in gold, without having to physically hold the gold and can be purchased for as low as Re 1. Digital gold purchased is 24k gold and the buyer is assured of purity as it is certified by licensed agencies. It is stored in insured vaults by the seller on behalf of the buyer. Digital gold can be sold online or buyers can even exchange it and take delivery of physical gold.
Physical gold, on the other hand, is usually mostly for jewellery and is typically not considered an investment It entails costs such as making charges, storage costs etc, adding to the investment cost. Moreover, holding gold in its physical form at home is fraught with risks. Physical gold is typically purchased in multiples of 1 gram, while digital gold can be accumulated in much lower denominations.
What is your relationship with gold?
Gold Exchange Traded Funds (ETFs)
Gold ETFs are not subject to any lock-in. They are traded in the secondary market and investors can buy and sell ETF units in the secondary market at any point in time, subject to available liquidity.
Sovereign Gold Bonds have a lock-in of 5 years (total tenor of 8 years) from the date of issue. Issued by the RBI, they are government securities denominated in grams of gold. SGBs offer an interest of 2.5% per annum (paid semi-annually) besides the potential to benefit from price appreciation. Also, capital gains on redemption are exempt from any tax for individuals. SGBs are listed on stock exchanges and can be traded among market participants.
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