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Is Gold A Golden Investment?

Gold has given good returns of late, but is it good enough to be the core investment of a portfolio

Last week, I wrote about the impending launch of real estate mutual funds and how this will add a whole new class of assets to Indian mutual funds. While I expect real estate funds to take a few months to get off the ground, there is considerable action in the other non-financial fund category, namely, gold. There are two kinds of gold-related funds in India. One is the so-called gold ETFs, which act as proxies for holding gold in physical form. Fund companies that run gold ETFs invest all of the investors' money in gold. Thus, the money invested in such funds makes profits or losses exactly in line with the price of gold, after charging around 1 per cent per annum as expenses.

In the year or so since the first gold ETF was launched these funds' number has grown to five with few more in the pipeline. For a niche fund type, they've proven reasonably popular and hold assets of Rs 550 crore. However, when one compares these funds to the amount of gold that is traded in the commodity markets, this is a pittance. However, it's the other kind of gold fund that is having a more interesting time. These are funds that invest in the stocks of gold mining, refining and marketing companies abroad.

Currently, there's only one fund of this kind-DSP Merrill Lynch's World Gold Fund but another one from AIG is on offer right now and there's at least one from Tata Mutual Fund that is in the regulatory approval stage.

While gold prices have always had their ups and downs over the years and housewives in many Asian cultures have always liked to have their personal hoard of gold as hedge against bad times, it has been a long time since anyone has considered it as an alternatives to investments like stocks. This appears to have changed. Gold has had an amazing run over the last seven years, earning returns of about 300 per cent. Still, this can't disguise the fact that over the long term, gold hasn't been a great investment.

Even at the current prices, gold on international prices has gained at an average 4 per cent per year over the last hundred years. Adjusted for inflation, this is a mere 0.6 per cent a year. Does investing in gold or gold mining funds make sense now? According to those who are pitching for gold, we are in an unusual time when a combination of factors will probably make gold appreciate. Demand may stay and the supply will not really expand. After all, this is one of the scarcest materials on Earth. The total amount of gold ever mined in the world can fit into a box that is 64 feet by 64 feet by 64 feet.

What does all this mean? Looking beyond the merits of gold as an investment, the actual issue is the chasing of past performance that we all tend to do. Gold may do well or it may do badly. But the way to make money in gold in was to have realised back in 2001 that gold was at a historic low and then to have started buying it gradually.

To suddenly become a gold investor when the price has already run up more sharply than it has for a generation is folly indeed. Gold may have given returns of 40 per cent over two years, but the last time it did such a thing was perhaps in the mid to late 1970s. Do you really want to take a call on whether such a thing is sustainable? Whether it's gold or it's stocks or funds, what has already happened is generally not a great guide to what's going to happen. Gold won't be an exception to this rule. Gold as a small holding-perhaps five per cent of one's financial assets is fine, but it can't be anyone's main investment.