Gold: a great investment or just a fashion statement?

Many analysts, financial advisers and mothers tell us we must invest part of our savings in gold. “Gold has given excellent returns and is a great hedge against inflation” they say.

Let’s see if it is true.

Gold from 1979 to 2014

Over a 35 year period, from 1979 to 2014, gold has appreciated at a rate of 10.36 % per annum (CAGR Compound Annual Growth Rate) in India. 

Does this seem good? 

The Sensex over the same period has gone from 100 to over 27866 appreciating at a rate of approximately 17.12% per annum (CAGR).

If you think the 6.76% difference is not that much, think again.  Rupees 1 million over 35 years @ 10.36% becomes 31.5 million and at 17.12% it becomes 252.4 million. 

Wait a minute; equity shares give dividends which are not adjusted in the Sensex. What if we add just 1% every year for dividends? The Sensex return becomes 18.12%. If you didn’t spend the dividends on beer and invested them back in the Sensex shares, your Rupees 1 million in 1979 invested in Sensex shares would have become Rupees 339.9 million in 2014 and you could have bought 10.75 times the amount of gold you bought in 1979. 

What does this mean in practical terms? 
It means that in spite of the excellent tax free returns the Sensex shares have given, if you still wanted to switch to Gold, you could have bought 10.75 times the Gold you would have if you had bought it in 1979. You would be richer by more than ten times.   

This clearly shows us that in the past investing in Sensex shares, has been much more lucrative than investing in Gold.

Can Gold beat the Sensex in the future?

Gold in the future

Can we expect Gold to rise even as much as it has in the past? I think not.

Since 1990, when gold imports were freed, the gold prices in India have been dependent on (a) international gold prices and (b) the USD to Rupee exchange rate. These are discussed below.

a)  International gold prices spiked between 2005 and 2011 from around $420 per ounce to $1800 per ounce. They have since fallen to below $1200 per ounce and appear to be in a downtrend. For a long period before the huge rise from 2005 to 2011, i.e.1990 to 2005 the annual increase was 1% to 1.5%, adjusted over the period. If that was the increase in a fifteen year period, can one assume that there will be a spurt in gold prices in the international markets once one invests in gold? Are there clear reasons for an increase in Gold Prices in the long term? No?  Then putting money on gold is speculation and not investment.

 b)  Another possible reason for gold to go up in India can be expected depreciation in the Rupee which should be in the range of 3% to 5% per annum. (This is because we have a higher inflation rate than the developed world in general and USA in particular.)  However, this will be offset by declining international prices.

Hence, Gold seems like a poor investment that may give negative returns or at best returns less than other asset classes. Even bank fixed deposits are likely to beat gold in the long run.        

Demand for Gold

Gold consumption has fallen a lot amongst the rich and even the upper middle classes who now want diamonds and precious stones.

Most jewellery in the developed world is also low on use of gold.

However the people moving from low income category to the middle class in China, India and other low income societies are buying gold as a status symbol. They could be the pillars of support for gold demand, but once they realise that the rich have given up on gold will they keep buying or will they too follow the rich. 

Thus gold is a fashion statement and if we invest in gold we are assuming that this fashion trend will continue for decades.

Huge hoards of this commodity, whose only use is that it looks pretty, are lying with central banks as well as speculators around the world. If they start releasing their hoards, gold could fall significantly.     

 Gold gives no dividends, bonus or interest and the only hope of a decent return is that someone else, who has no practical use for this commodity other than its pretty look, will buy it in the hope of finding another fool willing to pay an even higher price.

Think before you rush to buy Gold. Is it a great opportunity to buy because it is cheaper today? 
Should you put your money in Gold or in index linked mutual funds? 

I would suggest index linked mutual funds.  I think even Bank Fixed Deposits will fare better than Gold.

 Gold is not an investment, it is speculation or even consumption. Just like the pretty accessories ladies buy to impress other ladies, the way men buy cars or other gizmos to impress their buddies.

Please consult your financial adviser before making investment decisions. The author is not responsible for any losses you make for any reason whatsoever.

Note: (1)When you sell your gold jewellery you probably get back 80% at the prevailing gold rate so to that extent the value does not become zero like in other items of consumption but how many people really sell their jewellery to raise money. You plan your retirement on the basis of your stocks portfolio and money in the bank not on the basis of your gold  jewellery hence the recommendation to treat it as consumption.

Note (2) The comparison is from 1^st April 1979 because that is the base date for the Sensex with value of 100.

Note (3)The price of gold on 1^st April 1979 is taken as Rupees 791.22 which is the average price for 1978-79 as per the Reserve Bank of India website. This price has been assumed as I was unable to find the Gold price in India on the specific date. Considering that the average price of Gold for 1979-80 is Rupees 1158.75 it is probable that the price on 1^st April 1979 was higher than the assumed price and the appreciation in Gold price was even  less than that shown above. The current price is taken as on 1-11-14 as Rupees 26460 per 10 gm of Gold and the Sensex value is Rupees 27866. 

Note (4) I have suggested Index inked Mutual Funds because the economy is expected to improve and India is expected to better than the rest of the world. Accordingly the profits of the companies in the Sensex should continue to rise year on year making them more valuable. It should thus be safe to assume that the Sensex over the long term (more than ten years) should give good return.