Lessons from the gold meltdown

Last Updated: Sun, May 05, 2013 06:11 hrs

The recent fall in gold prices was an eye opener for investors who encountered drop in asset prices of a 'safe haven' like gold for the first time. This leads to a question whether there is anything like a 'safe haven' in investments? Investment experts may claim that there is no such thing. All investments are subject to risk and risk varies according to the asset class. Traditional avenues such as bank Fixed Deposits (FDs) and post office deposits are less riskier as compared to other avenues such as equities and commodities, which are relatively more riskier. Then how should we plan our investment in a such an environment and should we really go for a less riskier avenue?

We all know that asset prices are determined by demand and supply factor. However, in reality there are many factors that determine the market price. It can be speculating on the future trend, change in business dynamics, government policy, global factors and so on. This can cause a wide fluctuation in prices. We are seeing the same in most of the asset classes other than gold and real estate.

Gold till recently was considered a safe haven especially since it had given more than 20 per cent to 25 per cent percent in the last few years. However, this perception was broken when it fell by more than 25 per cent in a span of less than 10 days. This led investors to think whether there is any safe haven to investment. The other relatively safer asset classes, namely bank FDs and post office deposits, are not giving any real return (that is, return net of inflation).

Asset classes and sectors - A comparison
Lets look at an analysis of the returns from gold, equities, some indices to look at the current trend. As can be seen from the table, GoldBEES(Gold ETF listed on the exchange) has been the worst performer looking at a year-to-date comparison of all asset classes. Nifty is more or less at the same level. However, FMCG sector index (CNX FMCG) has performed relatively better than other sectors. The returns from equity mutual funds (large cap) mirror more or less the trend in Nifty. Stocks like HDFC and TCS with a better governance and business model have performed better than Reliance and Infosys. It may be noted that once these stocks, Infosys and Reliance, were considered a safe bet and ones that gave sure shot returns. The changing market dynamics have led to relative underperformance of these stocks too.

Will real estate and bonds face the heat now?
With investors staring at negative returns in gold, the question now is which asset class will be the next to be affected. Real estate is one sector that has provided a double digit return in the last five-to-six year period. The market has been expecting price correction in this market. However, the same has not yet happened. Will real estate be next asset class to see price volatility? It is difficult to predict, but the same cannot be ruled out as it has not gone through a price correction for the last few years.

Another market that may see upheaval is the bond markets. Many gold loan companies and NBFCs have raised a huge amount from the public to finance gold loans. If the asset prices of gold drops further, these companies may face liquidity issues resulting in default. Investors need to assess these risks before investing in these assets.

Some tips to seek low risk returns
This leads to a question that in a world where many safe havens are not so safe, where can one invest money to earn respectable, relatively low risk returns? It will obviously depend a lot on the investor's preference, risk tolerance, liquidity needs and so on. Here are a few tips:

Traditional investment avenues like bank FDs and post office deposits provide a stable and secured investment avenue. However, they do not provide positive return after adjusting for inflation.

You can invest in deposits of reputed companies (that have high rating like 'AAA') for shorter term duration, that is, around one to two years with periodic interest payout. This can provide you better returns and liquidity too.

Stocks that are reasonably priced and have a high or medium dividend yield are a relatively safer bet. This will help you to earn some returns even in case there is no capital appreciation.

Having gold in your investment portfolio is advisable, however, the percentage of the same in your portfolio should not be more than 5 to 10 per cent. It's a hedge against extreme events and is a great diversifier in an asset portfolio, being totally unrelated to stocks and bonds. It provides a hedge against inflation.

Having liquid investments such as bank fixed deposits or liquid funds makes sense. Despite the lower returns, these investments gives you flexibility and the capacity to move when some of the current elevated asset prices drop to attractive level.

Do not have a very heavy exposure to real estate as they have low liquidity and involve high investment amount.

It is important to keep a diversified portfolio. The current volatility is likely to continue especially as the world is getting closer and domestic economy is affected by events in the external world. The recent drop in gold prices should not make you totally stay away from gold. Having a balanced and diversified portfolio can help protect your hard-earned money and grow it in a relatively low risk manner.

  • Investments are subject to market risk and fluctuation in prices is obvious
  • Asset prices are determined by demand and supply and also market speculation, government policy, relative pricing
  • Volatility will be the order of the day as the world economy becomes more integrated
  • A dynamic and diversified approach to investment is the best bet

More from Sify: