Is Gold A ‘Perfect' Investment Choice?

Dalal Street Investment Journal|May 25, 2020

Is Gold A ‘Perfect' Investment Choice?
The current upsurge in the price of gold may tempt many an existing or potential investor to assume that gold, from among all the other asset classes, makes for the most secured and profitable investment option. However, that is not truth, as this article points out

Gold is an integral part of Indian society. It is ingrained into our culture in a way that it encourages us to keep buying gold periodically, especially during festive and auspicious occasions. And even though there are now several other financial schemes that one can invest in, gold continues to be the biggest attraction when it comes to security. This makes India the second-largest consumer of gold in the world, after China. This has been further vindicated by the superb returns generated by this yellow metal in the last one year. For the one-year period ending May 8, 2020 the price of the gold in the Indian market has increased by 44.4 per cent. Gold prices in India have increased from ₹32,850 per 10 gram at the end of May 8, 2019 to ₹47,435 per 10 gram at the end of May 7, 2020. This return has helped gold to be one of the best performing asset classes. In the same period, for instance, equity has generated negative return.

The ‘Shine’ Factors

Whether it is an exception that gold has generated superb returns in the last one year or it is actually a good asset class is a question overlooked by many investors due to different reasons.

To gain more insights, we analysed the price movement of gold in India since 1979. Our analysis shows that gold has generated better risk-adjusted returns than many other asset classes in this period. For the 41-year period ending May 14, 2020 the annualised return generated by gold is 10.55 per cent. This means that every ₹1 lakh invested in gold 41 years back is now worth ₹70.81 lakhs. But here is the flip side of the coin. The equity represented by Sensex in the same period generated returns one and half times better than gold. Hence, the return offered by gold may not look tempting for many equity investors who saw such returns generated by many stocks in less than one-fourth of that time.

The problem is identifying those stocks and sticking with them. For every such single stock you will find 4-5 stocks that actually eroded your investment value. The return generated should always be seen in conjunction with the risk taken to generate such returns. The annual volatility generated by equity is 25.3 per cent compared to 20.6 per cent generated by gold. Gold is less volatile than equity calculated on the basis of standard deviation of returns. Now, let us check the other measures through which we can calculate risk i.e. drawdown risk. In simple terms, it measures the value by which your investment goes below its previous peak.

The table clearly shows that the drawdown in gold is much shallower than equity. However, it takes a longer duration to reach its previous peak. The largest drawdown in case of equity is 60.91 per cent but for gold it is 57.81 per cent. Nonetheless, beyond that it has never lost more than 50 per cent in its value from the peak. In the case of equity there were other two incidences when their value dropped by more than 50 per cent from the recent peak.

Hedging Strategy

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May 25, 2020