Adding Gold Exchange Traded Funds (ETFs) may be a good way to diversify your portfolio today, if you hold sizeable stock or equity fund holdings. Given its ‘safe haven' status, gold is likely to perform well as an investment, if the stock market slides sharply from current levels. Though global prices of the precious metal are at new highs, the fundamentals continue to support a bullish view on gold. Even if a global correction sets in, the decline in gold prices is likely to be much smaller than that on a portfolio of stocks.
Gold fundamentals
Though global prices have recently edged past their earlier record high, three factors argue in favour of adding to your gold ETF holdings today. One, gold has displayed a low historic correlation with the stock markets. With valuations in the stock market looking stretched and corporate earnings in recent quarters not keeping pace, adding gold may help smooth out your portfolio returns if stock prices correct sharply from these levels.
Two, unlike many other commodities, gold's demand-supply equation is finely balanced, so its fundamentals are quite supportive of prices. After the slump last year, demand for gold has been picking up, with improving jewellery sales, more industrial use and very strong demand from Exchange Traded Funds, which capture investment demand for gold.
In contrast, gold supplies have actually shrunk on the back of an almost flat mine output and dwindling sales from the central banks of the world. In the first half of 2010, according to data from the World Gold Council, while gold demand expanded to 1857 tonnes (1818 tonnes same period last year), gold supply shrank by about 9 per cent.
Gold prices in recent times have received support both from safe haven demand and from consumption demand (jewellery and industrial uses) as the emerging economies post strong growth.
Three, as gold ETFs in India track global gold prices expressed in rupee terms, their NAVs actually benefit from a depreciating rupee. That makes gold ETFs even better diversifiers for a stock portfolio. Periods of sharp outflows from the stock market usually set off a depreciation in the rupee as well.
Investors looking to buy Gold ETFs on the stock exchange now have as many as nine products to choose from.
Choosing between ETFs
ETFs that have been in existence for three years have managed a 26 per cent compounded annual return for three years and about 18 per cent for one. While the three-year return is well ahead of diversified equity funds (average 9 per cent), the one-year return trails equity funds (27 per cent). Investors in ETFs at this juncture should moderate their expectations, after this run-up and budget for a high single-digit return.
One caveat for investors. Given their relatively low trading volumes, ETF market prices at times tend to diverge substantially from the underlying NAV of the fund. Investors should therefore take the following precautions while investing. One, it is best to go with the gold ETFs that have significant trading volumes and a larger asset size. Currently, Benchmark's Gold BEES seems to be the best bet on this score.
Two, given that ETF prices can go through wide swings intra-day, it is prudent to check the fund's latest NAV and place the buy order close to or at that price, so that you don't end up paying a premium to the fund's intrinsic value and losing out on a part of returns.
At present, Gold ETF NAVs, each unit representing 1 gram of gold, hover between Rs 1,880 and Rs 1,940 per unit. Given that gold ETFs do not yield any regular income, allocating up to 10 per cent of the portfolio to these funds is appropriate.
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