Make the most of uncertainty, learn about gold ETFs

The clear uptrend in gold prices in the last one year has been driven by global uncertainty predicating on a variety of factors.

Aug 08, 2019 10:08 IST India Infoline News Service

If you look back at the gold price movement since the collapse of the Bretton Woods system in 1971, you will find a clear positive correlation between uncertainty and gold prices. Between 1971 and 1979, gold prices moved from $35/oz to $850/oz post the Arab oil embargo. In 2008, after the collapse of Lehman, there was again a shift towards the yellow metal with gold prices almost doubling to $1900/oz in September 2011.
 
Gold makes the most of uncertainty
In the aftermath of the liquidity infusion and the big equity boom post 2011, gold went as low as $1050/oz. However, the last one year has seen a rapid rally in gold prices.
Chart Source: Bloomberg
 
The clear uptrend in gold prices in the last one year has been driven by global uncertainty predicating on a variety of factors. Firstly, the trade war that began in March 2018 shows no signs of relenting. China and the US are engaged in a battle of attrition with the larger world economy paying the price in the form of a global slowdown. Secondly, the tug-of-war between oil producers and oil consumers has been going on for over 4 years now. The US sanctions on Iran added to the oil uncertainty. Lastly, the biggest uncertainty in global markets has been the likelihood of a currency war. As the US has tried to tighten the screws on China, it has retaliated by letting the Yuan weaken beyond CNY7/$. Economists fear that this could be the beginning of a full-fledged currency war as each EMs try to devalue their way out of an economic slowdown.
 
Gold is doing great; but what is in it for the investor?
There are two ways to look at gold as an asset class. The first is gold as an alternative to currency that does not lose value. That is what a lot of central banks are doing. According to the World Gold Council, gold demand from central banks went up by 67% in the last one year. There is increasing demand for gold from gold funds and gold ETFs. These are nothing but gold securities where the investor can participate in gold price movement. The second way to look at gold is as part of your overall portfolio. The broad rule is to allocate 10-15% of your portfolio to gold. The current period of uncertainty warrants increasing allocation to gold closer to the upper end of 15%. But, how do you really hold gold; that remains the million dollar question.
 
Gold ETFs can be a great idea – Here is why?

Gold ETFs are essentially closed ended funds where physical gold is converted into securities and sold to investors. Here are some of the key advantages of opting for gold ETF so to play the current market uncertainty.
  • Gold ETFs are listed so you can buy and sell gold ETFs in your trading account like any other stock. You can also hold them in your demat account, which substantially reduces your cost of holding.
  • Gold ETFs track the price of gold almost on a 1:1 basis (as we shall see later). Hence, holding gold ETFs is a proxy for holding physical gold, but without the hassles.
  • Gold ETFs offer a low cost method of participating in gold price movements. The gold ETFs have total expense ratios (TER) of less than 0.50% and the brokerage and statutory costs are also quite small.
  • Investors worry about the liquidity and assurance of gold ETFs. On the liquidity front, most of the gold ETFs in India are fairly liquid. While the price risk does exist in gold ETFs, your investment is secured as mutual funds issuing gold ETFs keep equivalent amounts of physical gold with the gold custodian bank. But, do gold ETFs really track gold prices? Check out the chart.
Chart Source: Bloomberg

The chart above captures how the price of the Reliance Gold Bees ETF has virtually mirrored the international price of gold. That perhaps says it all!

Related Story

Open Free Demat Account (Rs699)