Sep 17, 2011

Gold as part of your portfolio

If you do want gold as part of your portfolio, choose 'investment modes' like coins, bars or paper gold like egold, ETFs. They have zero or very little loads and fees. The next question obviously is about how much gold you should hold in your portfolio. After the huge rally in gold prices in the past few years, it might be tempting to allocate a large part of your portfolio in gold. But that, experts say, is detrimental to long term wealth creation. Why do they say that?

Gold as part of your portfolio

The reason: Gold has no intrinsic value. That is, the value or price of gold is just what people perceive to be the value (or crudely put, prices are driven by speculation and ironically demand from India and China plays a large part in that speculation). The price is not based on future cash flows or earnings potential. In the recent past, the perceived value of the dollar is dropping; hence the value of gold is rising. Secondly, gold has no utility value or intermediate cash flows either; it is just kept idly in lockers with no inflows like dividend or rent. That is not the case in assets like bank deposits or equities. In the case of bank deposits, the deposits are deployed in business by way of loans and the loans are used to generate income. In the case of equities too, the funds raised from primary market are used in a business and the business generates real profits and cash flows in the long term. Long term valuations of share prices are based on these fundamentals. Finally, money needs to be deployed to create more money. Money locked up in gold, cannot in itself, generate more money for extended periods of time.

Why are people currently buying gold and driving up prices then? For countries with global reserves, there is no real alternative to the dollar, hence the shift to gold as safe haven. Institutional investors are probably holding gold till there is clarity on where the world economy is headed. Once the clouds lift, they will get back to putting their money in core businesses and economies. After that, the price of gold might just plateau for a long time, like it did for the 20 years between 1982 to 2003. But how long that will take, nobody knows.

Having said that, it’s true, gold is indeed a safe haven; good to have in your portfolio. Gold has no credit risk and is highly liquid. In bad times, you can fall back on gold for sure. Just don’t go overboard; make sure your portfolio is well diversified for long term wealth creation. And make sure your gold is not in jewellery.Read More.