Gold an effective hedge in volatile markets
Continuing with the last week’s theme of diversification, we will talk about investments in gold as yet another means to diversify a predominantly equity oriented portfolio.
Continuing with the last week’s theme of diversification, we will talk about investments in gold as yet another means to diversify a predominantly equity oriented portfolio. 2007 saw the launch of the first gold exchange traded fund (ETF) in India.
For a country that hoards gold, ETF is a revolutionary concept. Essentially the asset management company takes care of the physical gold and the investor is free to liquidate his holdings and trade on a daily basis. The only hindrance to redeeming units is the possibility of meagre trading on a particular day.
Correlation between Sensex and gold price
The idea behind diversification is primarily to ensure that the different assets in one’s portfolio do not move in the identical direction at all times. If they were to move in the same direction then there would be no hedge against losses and investors would flock to assets that yield maximum returns.
A look at the historic data brings out the variation in the movement of the Sensex values and gold prices. We assessed the relationship between the two at the end of every year over a decade. We found clear periods of high and low, and between 2001 and 2002 an inverse relationship between equity and gold prices in India. Between 1999 and 2009 there were only four distinct phases where the correlation was significant.
In 2007 when the stock markets peaked, the co-relation between gold prices and Sensex was not insignificant which means that investors would have profited not only from their equity holdings, but the increase in gold prices would have also reaped high benefits.
However by 2008, the two assets were moving in opposite directions, displaying the ability of the yellow metal to protect one’s portfolios at the time of a dip. In fact, during each of the two prolonged bear phases (lasting at least a year) over the past decade, gold has provided an effective hedge.
Sensex vs gold
Gold prices have been on an uptick since 2000, while the stock market declined from 2000 to 2003 and then again in 2008. Through the recovery phase that commenced in 2003, gold prices kept rising.
However in 2008 when the market was suffering from bearish phase worldwide, gold prices spiked as panic spread across global markets. So far since March 2009 in India signs of recovery in the stock markets have emerged. At the same time gold continues to forge ahead, albeit at a slower pace.
In terms of returns there is clearly a concrete case for including gold in one’s portfolio. The returns over the long term have been high unlike the other safe debt instruments which are low yielding (compared with equity).
Over 10 years, gold has clearly done better than Sensex. While over the much shorter one-year period the equation changes drastically. Over the one-year period, the Sensex has delivered an impressive return of 25.5%, as against 16% returned by gold. The characteristic difference between equity and gold is that the pace at which one gains and loses money in case of equity is extremely heady. We looked at a well accepted measure of risk — standard deviation — to judge this headiness.
Not surprisingly we found that while volatility in both segments has been on the uptick, the movement in Sensex is significantly more volatile. The movement from an average value in case of gold is not as drastic as in the case of Sensex.
Gold ETF returns and volumes
Gold exchange traded fund is a relatively new concept for investors. These funds are listed and traded on the stock exchange. The first gold ETF was launched in March 2007 by Benchmark Mutual Fund. Initially, the single-digit returns did not attract investors, as
the equity markets were performing far better. However, the subprime crisis all but swallowed equity markets. As a result, investors took refuge in the safety of gold.
This re-orientation of the asset allocation meant that investors began to understand the true benefits of the gold ETF. As a result, the otherwise subdued activity in trading picked up with an impressive increase in volumes and assets under management of gold ETFs.
When these funds were launched many feared insignificant trading volumes would hinder correct price discovery. Two years later these fears continue to remain significant. There have been cases, albeit rare, such as on May 18, 2009 when trading volumes of all six operational ETFs put together was a mere Rs 11,000. Volumes continue to look rather erratic.
However, a look at the returns belies our fears. IN fact, over the one-year period the gold ETFs have managed to return better than the price of gold (adjusted for exchange rate). UTI Gold
ETF has emerged as the best performer. However, like all passive investments a large deviation from the underlying returns is worrisome. Ideally, the difference in tracking prices of gold by these ETFs should be low.
There are signs that gold as an asset class will retain its importance. However, given its steady rise, the gestation period of reaping gains is higher and investors need to remain invested for the long haul to truly appreciate the benefits.
For a country that hoards gold, ETF is a revolutionary concept. Essentially the asset management company takes care of the physical gold and the investor is free to liquidate his holdings and trade on a daily basis. The only hindrance to redeeming units is the possibility of meagre trading on a particular day.
Correlation between Sensex and gold price
The idea behind diversification is primarily to ensure that the different assets in one’s portfolio do not move in the identical direction at all times. If they were to move in the same direction then there would be no hedge against losses and investors would flock to assets that yield maximum returns.
A look at the historic data brings out the variation in the movement of the Sensex values and gold prices. We assessed the relationship between the two at the end of every year over a decade. We found clear periods of high and low, and between 2001 and 2002 an inverse relationship between equity and gold prices in India. Between 1999 and 2009 there were only four distinct phases where the correlation was significant.
In 2007 when the stock markets peaked, the co-relation between gold prices and Sensex was not insignificant which means that investors would have profited not only from their equity holdings, but the increase in gold prices would have also reaped high benefits.
However by 2008, the two assets were moving in opposite directions, displaying the ability of the yellow metal to protect one’s portfolios at the time of a dip. In fact, during each of the two prolonged bear phases (lasting at least a year) over the past decade, gold has provided an effective hedge.
Sensex vs gold
Gold prices have been on an uptick since 2000, while the stock market declined from 2000 to 2003 and then again in 2008. Through the recovery phase that commenced in 2003, gold prices kept rising.
However in 2008 when the market was suffering from bearish phase worldwide, gold prices spiked as panic spread across global markets. So far since March 2009 in India signs of recovery in the stock markets have emerged. At the same time gold continues to forge ahead, albeit at a slower pace.
In terms of returns there is clearly a concrete case for including gold in one’s portfolio. The returns over the long term have been high unlike the other safe debt instruments which are low yielding (compared with equity).
Over 10 years, gold has clearly done better than Sensex. While over the much shorter one-year period the equation changes drastically. Over the one-year period, the Sensex has delivered an impressive return of 25.5%, as against 16% returned by gold. The characteristic difference between equity and gold is that the pace at which one gains and loses money in case of equity is extremely heady. We looked at a well accepted measure of risk — standard deviation — to judge this headiness.
Not surprisingly we found that while volatility in both segments has been on the uptick, the movement in Sensex is significantly more volatile. The movement from an average value in case of gold is not as drastic as in the case of Sensex.
Gold ETF returns and volumes
Gold exchange traded fund is a relatively new concept for investors. These funds are listed and traded on the stock exchange. The first gold ETF was launched in March 2007 by Benchmark Mutual Fund. Initially, the single-digit returns did not attract investors, as
the equity markets were performing far better. However, the subprime crisis all but swallowed equity markets. As a result, investors took refuge in the safety of gold.
This re-orientation of the asset allocation meant that investors began to understand the true benefits of the gold ETF. As a result, the otherwise subdued activity in trading picked up with an impressive increase in volumes and assets under management of gold ETFs.
When these funds were launched many feared insignificant trading volumes would hinder correct price discovery. Two years later these fears continue to remain significant. There have been cases, albeit rare, such as on May 18, 2009 when trading volumes of all six operational ETFs put together was a mere Rs 11,000. Volumes continue to look rather erratic.
However, a look at the returns belies our fears. IN fact, over the one-year period the gold ETFs have managed to return better than the price of gold (adjusted for exchange rate). UTI Gold
ETF has emerged as the best performer. However, like all passive investments a large deviation from the underlying returns is worrisome. Ideally, the difference in tracking prices of gold by these ETFs should be low.
There are signs that gold as an asset class will retain its importance. However, given its steady rise, the gestation period of reaping gains is higher and investors need to remain invested for the long haul to truly appreciate the benefits.