“Gold is money. Everything else is credit”. – John Pierpont Morgan
Exter’s pyramid, which is now more relevant than ever before, exemplifies this. Exter’s debt pyramid contains the liabilities of all asset classes in the financial system. The riskiest debt securities – the numerous financial derivatives – are at the top of the pyramid followed by less risky asset classes as we move down the pyramid. At the lowest point of the pyramid is cash reserves and US Treasuries. Now, if we were to lose confidence even in a Central Bank backed asset, then the last haven would be Gold, outside the debt pyramid. Gold does not occupy a position within the pyramid simply because it is ‘nobody’s liability’. John Exter concluded that all debts become uncertain at some point in time, which is why people’s investment decisions will move down along the inverse pyramid to reduce the risk until they are holding government bonds and cash. If they lose confidence in these funds, then they will have to leave the debt pyramid and turn to the world’s only true money, Gold.
We saw this very recently when the world was first hit by COVID 19 pandemic, most investors liquidated both their equity and debt portfolio to either increase cash levels or turn to gold as a safe heaven. While gold has many uses beyond investments, it certainly adds a lot of value when blended with traditional assets like equity and fixed income. Gold can enhance a portfolio in two keyways:
Acts as an effective diversifier
The true value of a portfolio diversifier is recognized during market extremes. Most investors diversify between equity and fixed income basis their investment objectives which bodes well for them during normal market circumstances. But as we have seen in the past, during extreme market reactions the low correlation between them breaks when needed the most. This is when gold has stood out as a true diversifier. Let’s look at some data below.
Nifty 50 Index
MCX Gold Spot
Jan-08 to Oct-08
Jan-20 to Mar-20
Source – ACE MF. Nifty top and bottom dates in the above period is taken for the purpose of this calculation
As we can see that during the two largest market declines in the history of equity markets, gold has managed to deliver positive returns for the investor.
Generate long-term returns and enhance overall portfolio performance
While gold is construed as a hedge against inflation, gold as an asset class has outperformed Nifty 50 by 3.6% on a CAGR basis (14.1% vs 10.5%) in the past 15 years. This enhanced return has come at a substantially lower standard deviation vs equities (16% vs 23%). On a calendar year basis, gold has delivered positive returns in 11 out of 14 calendar years.
Over a long period of time gold has delivered superior returns with less risk and drawdowns.
Investing in Gold – A comparison between Sovereign Gold Bonds, Gold ETFs& Gold Funds
For investors, someof the common routes to investing in Gold are:
Sovereign Gold Bonds (SGBs)
Gold Mutual Funds and
Gold Exchange Traded Funds (ETFs). The key features of each investment vehicle (discussed below) can help you determine the vehicle that suits your requirements.
Gold Mutual Funds
Sovereign Gold Bonds have a tenor of 8 years and a lock-in of 5 years. Money can be withdrawn on the completion of the 5-year period, on the interest payment dates. Additionally, they can be traded on the exchange. However, the liquidity in the secondary market is fairly low.
Gold Funds provide daily liquidity and can be redeemed on a daily basis like other mutual funds
Gold ETFs are regularly traded on the stock exchange and thus have better liquidity than SGBs.
Each SGB represents one gram of gold of 999 purity. As an individual investor, the minimum investment is 1 gram while the maximum is 4 Kg for an individual.
Limits applicable to mutual funds apply
In the case of ETFs, each unit represents one gram of gold of 995 purity and the minimum investment is 1 unit.
The added advantage of SGBs is that they pay an interest of 2.50 percent per annum (taxable).
No additional interest
No additional interest
In the case of SGBs, there is minimal cost involved in subscribing/redeeming the bonds. There could be transaction costs involved if the buying/selling is done on the exchange.
Mutual Funds charge an expense ratio as fees. It ranges between 50 to 100 bps
Gold ETFs incur charges such as transaction charges and expense ratio. The expense ratio can generally range from 30 to 100 bps
SGBs held till maturity attract no capital gains tax. In case the SGBs are sold before the maturity date on the exchanges, the capital gains will be levied at the applicable rates. Interest earned from SGBs is taxable as per the investor’s tax slab.
Gold funds held for more than three years attract long-term capital gains tax while short-term gains are added to the individuals’ net taxable income.
Gold ETFs held for more than three years attract long-term capital gains tax while short-term gains are added to the individuals’ net taxable income.
All three whether Gold Bonds or Gold Funds or Gold ETFs are an optimal way to invest in Gold as all carry minimal risk and are fairly cost effective. Investors looking for the extra 2.5% income and those who would like to make a lump-sum investment for the long-term, SGBs would be ideal. On the other hand, investors who are looking to systematically increase their Gold exposure and value liquidity, Gold funds and ETFs would be the vehicle of choice.