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Gold Digs up a Dilemma

The changing character of gold, as an investment opportunity, has added to investors' problems

For many of us who have been investing in financial instruments, the relentless rise of gold poses a problem because we have no easy framework in which to think of the commodity. Till as recently as a couple of years ago, gold lived in a completely different world from stocks, funds and debt products. There was no easy way of investing in gold except for buying it as jewelry or coins and bullion trading was a mysterious world that was inhabited by a different species altogether. Gold investing was very much an out-of-sight and out-of-mind phenomena.

Since then, the arrival of commodity exchanges, Gold Exchange Traded Funds (ETFs) and gold stock funds has made it trivially easy to invest in gold without having to worry about purity and physical security. Just as important is the fact that these have made gold easily comparable to other investments. When an investor looks at fund performance data on ValueResearchOnline.com, or any other mutual fund portal, he can’t help comparing the returns of gold-based investments with equity-based ones. Since about 2005, gold’s returns make it look like a great investment compared to anything else. And it’s not just the returns, but the stability, when compared to equity, that the investor notices. The steepest fall in gold since 2005 has been the 20 per cent it lost from March, 2008 to October, 2008.

When I talk to gold’s new-found fans, I find that there are two more factors that make them like gold, if only at a sub-conscious level. One is the simplicity of decision-making. Gold is gold and that’s all there is to it — all the ETFs deliver identical results. Unlike an investor in equity or equty-backed products, there aren’t hundreds of choices. Secondly, most Indians seem to come mentally pre-configured with a propensity to view gold as an ideal vehicle for safe long-term investing.

At an intellectual level, many of us have bought into the logic of why gold doesn’t make sense. However, we are a gold-coveting culture and have descended from generations who have lusted after gold. It takes very little to convince us that gold is a great investment, even though the long-term evidence is decidedly patchy. Today, the value of gold is increasingly driven by the demand and supply of paper gold in financial markets. It is a financial asset and is clearly subject to the same volatility as other financial assets as investor interest flows in or out. We could well be in a gold bubble which is just as ephemeral as the stock, oil, or real estate bubbles were.

However, it is undeniable that many investors have started buying gold-backed securities of one kind or another as short-term trading opportunities. In the mutual fund space, there are actually two distinct kinds of gold-related funds available. One is the straightforward Gold ETFs. These closely track the price of gold itself and deliver profits and losses that mirror investing in physical gold. The second one consists of a couple of equity funds (one from AIG and the other from DSP BlackRock) that actually invest, not in gold, but in foreign gold-related stocks, like those of gold mining and processing companies. Interestingly, these funds seem to act as a sort f high-beta versions of the gold price itself. Over the last one year, gold has gained 44 per cent, but these funds have gained more than twice that.

Will the gold run last? If you look around, you will see as many cheerleaders as sceptics. As for me, I’m almost certain that one of the two groups will turn out to be correct!