Gold investing involves the buying and selling of gold mainly for the purpose of hedging against any economic, political, social or currency related crisis. Such crises may include a stock market crash, high inflation, war or any social unrest. Moreover, since gold is the most popular precious metal, gold investments are made for financial gains when the market is bullish.

India — Non-Resident Indians included — goes crazy when it comes to gold jewellery. With the World Gold Council (WGC) aggressively marketing social and religious functions as gold buying events, the demand has shot up in the recent years to record levels.

Research shows that over 16,000 tons of gold is there in Indian households predominantly in the form of jewellery. The value of this as per market price is a whooping Rs 27.2 lakh crores ($591 billion). That is close to twice the foreign exchange reserves held by the Reserve Bank of India.

How is Gold Investing Done?

The two main methods of gold investing are:

• Direct investment: One can directly invest in gold by owning bullion or coins.
• Indirect investment: This method of gold investing includes gold certificates, spread betting, accounts and derivatives.

Gold exchange traded funds (ETFs) and shares of companies that are engaged in the mining of gold are some of the other gold investment options.

The two main techniques of identifying good gold investments are:

• Fundamental analysis: Investment managers study macroeconomic conditions. This study includes international economic indicators, such as GDP growth rates, inflation, interest rates and productivity. An important aspect of gold fundamentals is the assessment of total gold supply and gold demand.
• Technical analysis: This includes the analysis of chart patterns, market trends and moving averages. Through such analysis, investors will be equipped to speculate in the gold futures market.

Forms of buying gold

Any investor has to be aware of the different forms of buying gold.

1. Jewellery: The most traditional and the dominant form of buying gold in India is in fact not an investment idea. The reason is that there are heavy losses in the form of wastage and making charges. This can vary from a minimum of 10 per cent to as high as 35 per cent for special and complex designs.
2. Bank coins: Again not an investment idea as the premium that banks charge for their coins is anywhere between 5 per cent and 10 per cent. Also the bank coins have lesser liquidity as they are not bought back by the banks.
3. World Gold Council coins: These are coins issued by jewelers who are part of the WGC network. They have lesser premium over the market price (1% to 2%) and are redeemed at the market price when one takes them for selling off.
4. Bullion bars: These are good modes for investment but the minimum investment here is much higher than a common investor can think of.
5. Gold Exchange Traded Funds: ETFs are a hot option these days. These are like mutual funds that invest only in gold. They are proving to be an easier and safer mode to buy gold. The charges are very less and the gold can be accessed electronically. The disadvantage is that one never gets to ‘see’ one’s holdings.

Benefits of Investing in Gold

One can benefit in the following ways by opting for gold investments:

• Gold price appreciation makes up for lost interest, especially in a bull market.
• Gold investing helps bullish investors leverage their position as they have the option to borrow money against their existing gold assets.
• Investors can preserve their assets during tough economic periods through gold investing. Investing in gold is generally considered to be a hedge against inflation and against the devaluing of paper-based currencies when national debt and deficit levels expand.
• All gold funds are in a long term uptrend with bullion, most recently setting new all-time highs.
• The trend of commodity prices to increase is relative to gold price increases.
• Worldwide gold production is not matching consumption. The price will go up with demand.

Dangers of Gold Investing

Gold investing can harm one’s portfolio in cases such as:

• Gold doesn’t pay income or interest.
• Your broker probably won’t recommend gold funds.
• Gold investing via leverage may increase the risk associated with the investment if there is a decline in gold prices. Investors may face a margin call.
• If the investment in gold does not match the investor’s investment objectives, it may prove counterproductive.
• Traditionally, gold investing was exclusively done by wealthy families. High net worth individuals would protect their position by maintaining a large percentage of their assets as gold. More recently, all classes of investors have been attracted to gold and its derivatives.

Current income

Gold in any form does not give any current income. The only exception is the dividend option in the gold ETFs. If held in the physical form, there is only outflow of cash for the maintenance of lockers.

Capital appreciation

Historically, gold has been the perfect hedge for inflation. This is based on data from the year 1800 AD. But in terms of absolute returns gold has fared rather poorly giving returns at only 0.8% above inflation.

Real estate and shares beat gold squarely on the capital appreciation front. Real estate and shares have given returns of about 11% over inflation since 1979 (1979 as that was the year the index called Sensex was formed).

In the short run, however, gold is a very strong bet, compared to shares which are highly volatile. The idea for gold investment will be to use it at times when the markets are falling and when the inflation is very high.

A 5 per cent of the overall investment portfolio can be considered for gold investments (bullion, WGC coins, gold ETFs). Jewellery is not an investment as far as personal finance goes. It is only an expense for pleasure, symbolising wealth.

Risk

Gold does not carry much risk at least in India, as we hardly see deflation in the real sense. Even when the official figures where showing negative inflation (deflation) during the last year, the actual prices of food items were increasing. This was reflected in the gold prices too.

The real risk with buying gold is in the opportunity cost of investing in other avenues that can actually give higher returns.

Liquidity

Gold scores the highest in terms of liquidity, compared to all other investments. At anytime of the day and any day gold could literally be converted to cash. Banks would give you a jewellery loan. (Remember though that many banks do not give loans on coins, including their own).

Gold jewelers would exchange your gold possessions for other gold jewels. But the problem here is that there is going to be making and wastage charges involved again. Here we lose the value (to the extent of 10% to 35%) of gold jewels.

An unfortunate social aspect in most families in India related to liquidity is that, gold has sentiments attached and is the last item to leave the house in case of financial difficulties. This negates the entire purpose of gold having liquidity.

Tax treatment

Gold suffers capital gains tax as per the IT act. So it is better to ask your jeweler for the bill. Close to 90% of the gold jewellery traded in India is unbilled. This is a serious problem for those who look at gold as an investment. Only the branded jewelers would automatically give you a bill. At other places ask for one.

We can make use of indexation benefits when calculating the capital gains of gold. So the tax payable will not be much.

Gold does not have any other tax benefits.

Convenience

Gold scores very high here. But with the per gram price rising, the smallest single investment is becoming higher. With the emergence of Gold ETFs the convenience to hold gold for the short term has increased many folds. Instead of holding cash for the short term, one can today make investments in Gold ETFs.

Conclusion

Gold has proved itself time and again to be the perfect hedge for inflation. But to look at it as a hedge avenue, Indians are yet to consider this market actively as the purchases continue to be dominated by jewellery.

Gold only beats inflation. It fares poorly when compared to real estate or shares when compared on the basis of real inflation adjusted returns.

Any serious investor, however, is advised to have a certain percentage of investment in gold to hedge inflation.