We keep hearing conflicting theories about whether gold is good or bad as an investment option.
But what is the reality, is it worth investing in gold?
No matter what critic say about gold, but the fact is, everyone loves having it in their kitty.
Central banks of all major developed and developing economies of the world try to hold as much gold as possible.
Even individuals who are financially well-off includes gold in their investment portfolio.
There is some spark in gold that makes it so likeable.
Gold price is perhaps the most discussed thing in the world of investment after stock market.
With the evolution of Fiat money, though gold has lost some of its sheen, but its utility as an investment option cannot be undermined.
It is a fact that all investment options that deals in paper currency (stocks, mutual funds etc), would not like gold to become dominant. Why?
Because they want more money to flow into debt/equity market, and less money should go to gold linked investments.
I am sure, people who say they dislike gold are not honest about their real feeling about gold as an investment option. Why I say so?
Because the global trend does not compliment their views.
Global Trends in Gold Demand…
Who are the main consumers of gold across the world?
- Central Banks.
- Common Men.
Over the last 3 decades, the gold consumption in the world has only increased.
This is the same period, where the developing nations like China, Russia, India, Brazil has become more dominant.
More dominant means, activity in Fiat Money has been more.
But still, there has been a parallel demand for gold.
If the world has investment options like stocks, mutual funds, real estate etc, why people still purchase this dead-metal?
Why I call it the dead metal? Because Warren Buffett thinks it like that.
Buffett is not fond of Gold at all, and he has been very vocal about this.
But still Gold demand in the world has only increased in last decades.
Lets break down the total gold demand and see some interesting numbers.
#1. Central Banks…
Central banks are the number one consumer of gold. They buy gold to build upon their existing gold reserves.
It is estimated that there is about 187,200 tonnes of gold in this world (2017)
Out of this, 18% (approx 33,800 tonnes) are held in lockers of various central banks & organisations across the world.
If you thought that 18% is a small percentage, think again.
Every time there is a financial crisis (related to fiat money), central banks increase their gold reserves.
We will see how central banks across the world has increased their reserves over the past decade.
The developing countries have been mainly purchasing gold since year 2001 (last 1.5 decades).
The developed nations, have kept their gold reserves almost stable since 2001 (except for France).
Why developing nations are buying gold? Because they are the one who are facing the following risks:
- Higher inflation.
- Higher trade deficit.
- Weaker currency.
Maintaining gold reserves works like an emergency fund for these banks.
In case of crisis, banks can liquidate gold, or use it as collateral.
So if we follow the footsteps of our central banks (In India, RBI), gold looks to be a reliable investment option.
But this is also true that, gold must not bee viewed as “investment option” alone.
It is better to consider gold as an “emergency fund” and then start accumulating.
#2. Common Men…
How common men consume gold? In form of Jewellery.
Following are the countries where sale of gold as a Jewellery is most common:
In the context of gold demand by common men, lets talk about India in specific. Why India specific?
The reason might give you a pleasant surprise.
How much gold is held in all central banks across the world? Approximately 33,800 tonnes.
Out of these, how much is held by major countries?
- USA (Federal Reserves System): 8,134 tonnes.
- India (RBI): 562 tonnes.
But can you guess how much gold is held by households in India?
The value is close to 24,000 tonnes, as reported by World Gold Council in January’2017.
Yes you heard me right.
This value is close to the total gold reserves held by all central banks of the world.
So what does these numbers suggest? Two things:
First, the thirst for gold is two folds. Along with central banks, household in India and China are the major consumers of gold.
It is speculated that, Chinese households also have close to 16,000 tonnes of gold in their holding.
Second, the gold demand will only go up with time. How?
What do you think, Indian and Chinese household is going to cut their gold purchase in years to come? No. Why?
Because these people buy gold more as part of their culture and tradition.
I assume, as people become more affluent in developing countries, they will buy more gold.
So in terms of global gold demand in households, it is only going to go up.
This possibility of gradual surge in demand, makes gold an even better investment option.
Why people invest in stocks and equity based mutual funds? Mainly for the capital appreciation over a period of time.
When the same people invest in gold, they get disappointed. Why?
Because it is necessary to view gold with a different perspective.
On one side we see that, central banks of the world holds huge reserves of gold.
But on other side, according to World Gold Council, only 1% of global investment portfolio is allocated to gold.
Why this gap? Because gold is not an asset which can give fast capital appreciation.
In fact in normal days, gold price remains almost stagnant. So what is the point in buying gold as an investment option?
Gold must be bought as a hedge against equity market.
What does it mean?
Equity market is very volatile. Gold can act as a protection against any potential falls in equity market.
Lets take example of 2008-09 stock market crash. See a comparison between how Sensex and gold price behaved in the same period.
Between the period 2007 and 2012, Indian stock market was extremely volatile and full of pessimism.
Please note how gold price behaved in this period.
No matter how volatile was the equity market, gradual up-trend in gold price was also very visible.
Lets take another example of 2014-18, where stock market was most buoyant. See a comparison between how Sensex and gold price behaved in the same period.
This period has two key phase. Between 2014-16, Sensex was almost flat. In this phase Gold price saw a brief dip (2015). But it eventually recovered in 2016.
Between 2016-18, Sensex climbed from 26,000 to 38,000 points. In this period, gold price again moved up.
What does the above 2 price charts suggest about gold as an investment option?
Gold price will continue to move relative to the stock market. But its ascent is slower than stocks.
In last 55 years, gold price has moves up from Rs.64/10gm (1964) to Rs.30,000/10gm (2018). This is a growth of 11.9% p.a (CAGR).
In 1986 Sensex was at 561 points. Today in 2018, Sensex is trading at 38,000 points. This is a growth of 14.2% p.a in 32 years.
These movements suggest that, both gold and stock market will only move up with time.
And as Gold and Equity are non-related assets, one must invest in both for the purpose of diversification.
According to me, keeping ones investment portfolio 10-20% loaded with gold is good.
Though gold’s industrial use is not as wide as silver, but it has its utility.
In the recent past, technological developments has resulted in more use of gold.
Solid State Electronic Devices has been using gold since long time now.
As gold is a very efficient conductor of electricity, its use here is well known.
Moreover, gold has tremendous resistance to corrosion. This makes it an even better material to used as a “low voltage” current conductor.
Other industrial items which contain at least traces of gold are as follows:
- Mobile phones,
- GPS units,
- Television sets,
- Glass making,
- Medical equipments etc.
It is believed that with further advent of technology, utility of gold will increase.
This way gold will become even more scarce. How?
Anyhow, the supply of gold is very limited. With more gold getting consumed for the industrial use, gold availability for investment holding will decrease.
This will push gold prices to new heights.
This makes gold investment very dear for those people who are accumulating gold with very-very long term horizon.
Example: Passing on the gold holdings as an asset to the next generation.
World Gold Council estimates that, in the next years, out of the total gold demand, only 6% will be consumed by the Central banks.
The main consumption of gold will be in the form of Jewellery (54%).
The second utility of gold will be as an investment vehicle (30%). Gold can be purchases as investment vehicle in the following forms:
- Bullion (Coins, Bars).
- Exchange Traded Funds.
At present industrial use of this precious metal will be limited to 10%. But I personally believe that, it is here that the gold demand will really rise in next 30-40 years.
So I can conclude that, irrespective of the fact that gold on its own cannot generate any cash flow, hence its intrinsic value is zero.
But as Gold is one of the rare metals, which will also be in demand for the next decades/century, makes it a good long term investment option.