Diversification into Yellow Metals
The Sensex has crossed the 17k mark, offering hope for investors. But is this the right time to bet on yellow metal? Gold is a monetary metal whose price is determined by inflation, fluctuations in the dollar, stocks, currency-related crises, interest rate volatility and the like. Gold is different from other precious metals such as platinum, palladium and silver because gold is produced primarily for accumulation; other commodities are produced primarily for consumption. Gold’s value arises from its use and worldwide acceptance as a store of value. Gold is money.
Let us have some basic reasons why one should diversify into yellow metal.
Gold is renowned as a hedge against inflation. The most consistent factor determining the price of gold has been inflation - as inflation goes up, the price of gold goes up along with it.
Gold has often been called the ‘crisis commodity’ because it tends to outperform other investments during periods of world tensions. As we have witnessed earlier, whenever a banking crises occur the public begins to distrust paper assets and turns to gold for a safe haven.
Gold production is declining; copper production is declining; the production of lead and other metals is declining. It is very difficult to open new mines when the whole process takes about seven years on average, making it hard to address the supply issue quickly. Gold output in South Africa, the world's largest gold producer, fell to its lowest level since 1931 this past year. India is the largest gold-consuming nation in the world.
One major reason why investors look to gold as an asset class is because it will always maintain an intrinsic value. Gold will not get lost in an accounting scandal or a market collapse. It is important to invest part of one's portfolio in an asset that will, at least, hold its value.
More than two thirds of gold’s total accumulated holdings account as “value for investment” with central bank reserves, private players and high-carat jewellery; Less than one third of gold's total accumulated holdings as a “commodity” for jewellery in Western markets and usage in industry.
The most effective way to diversify your portfolio and protect the wealth created in the stock and financial markets is to invest in assets that are negatively correlated with those markets. The key to diversification is finding investments that are not closely correlated to one another. Gold is the ideal diversifier for a stock portfolio, simply because it is among the most negatively correlated assets to stocks.
The sources of demand for gold are far more diverse - both geographically and sectorally - than those for many other assets, which helps to explain the independence of the gold price as well as why identifiable demand has remained robust in the face of a rally that has spanned several years. The value of gold demand increased by 79% between 2003 and 2007, and by 158% between 2001 and 2007. Moreover, most spending on gold is discretionary. 68% of total identifiable demand over the five years to December 2007 came from the jewellery sector, with a further 19% from investment and 13% from industrial demand. This is, in itself, unusual for commodities, where demand is typically driven by non-discretionary spending and is consequently more exposed to the vagaries of the economic cycle. Gold is unique in that it does not carry a credit risk. Gold is no one's liability. There is no risk that a coupon or a redemption payment will not be made, as for a bond, or that a company will go out of business, as for an equity. And unlike a currency, the value of gold cannot be affected by the economic policies of the issuing country or undermined by inflation in that country. At the same time, 24-hour trading, a wide range of buyers - from the jewellery sector to financial institutions to manufacturers of industrial products - and the wide range of investment channels available, including coins and bars, jewellery, futures and options, exchange-traded funds, certificates and structured products, make liquidity risk very low. The gold market is deep and liquid, as demonstrated by the fact that gold can be traded at narrower spreads and more rapidly than many competing diversifiers or even mainstream investments. rapidly than many competing diversifiers or even mainstream investments.
One of the most important aspects of investing is the control of risk in your portfolio, relative to the expected return. Tangible assets are an extremely useful tool for investors in that regard. Diversification is the allocation of investable funds to a variety of investments. The key to diversification is finding investments that are not closely correlated with one another. By diversifying, investors can reduce the risk that they would otherwise bear. Also, the risk reduction benefits of diversification can be achieved without reducing the overall return on one's portfolio. Gold offers enhanced diversification opportunities relative to many alternative assets. Independent studies have shown that while alternative assets and traditional diversifiers often fail during times of market stress or instability, even a small allocation to gold may significantly improve the consistency of portfolio performance during both stable and unstable financial periods