The first tranche of Sovereign Gold Bonds (SGB) for the financial year 2023-24 is available from June 19 to June 23 this year. As gold prices have risen at an increasing rate in recent months, many investors want to know if they can invest in SGBs to diversify their investment portfolios. There is no doubt that gold is used to hedge against sudden market declines, but is it enough to buy gold bonds and hold them for eight long years?
You cannot lose gold investments
The idea behind investment diversification is to regularly change investments or adapt to market movements in order to reduce portfolio risk. However, this also means that investments must be inherently liquid so that investors can redeem them when necessary and reallocate the profits to a better investment option. However, you cannot do the same with these bonds, although some investors may consider selling them in the secondary market, albeit at a price lower than the prevailing market rate.
To achieve investment diversification, it is essential to sell non-performing or low-yielding assets at a fair market price. This helps rebalance the portfolio, thereby resetting or adjusting the asset allocation. You can never sell these SGBs halfway, which goes against the idea of diversification.
However, some investors argue for its decent, tax-free returns. Is this a good enough reason to include gold in your investment portfolio?
Basavaraj Tonagatti, Certified Financial Planner, SEBI Registered Investment Advisor and Financial Blogger at BasuNivesh explained: “Many assume that adding gold will create a well-diversified portfolio and a hedge against inflation. However, if you look at past data, even though there is a negative correlation between stocks and gold, it comes with just as much volatility risk as the stock market. If we consider gold as a hedge against inflation, the correlation between inflation and the movement in the price of gold is very weak. Therefore, I strongly suggest not considering gold in investment portfolios.
There is no set formula for determining when you can diversify your portfolio. You can insist on diversifying your portfolio once or diversify it persistently to protect your investments from market risks. However, this also means that you must abandon your non-gold investments due to the relatively illiquid nature of the latter.
When it comes to buying and holding SGBs to maturity to earn a return from gold, the potential range of returns is so vast that it bears a striking resemblance to gambling.
A look at the history of gold and the consistent returns of this metal over the past 30 years reveals that gold returns have always varied between 7 and 12 percent compared to stocks that have generated returns at double digits in the past. Although the risk of investing in gold is high, the quantum of returns generated from buying and selling this metal through bonds is not enough to justify its purchase and inclusion over an extended period. The reward does not match the risk taken.
Additionally, gold returns depend on a multitude of factors such as market position, monetary equations, and the economy. The price of gold stagnated for many years before reaching a new high. In some cases, it has also generated negative returns. Barring exceptional circumstances, gold prices do not increase exponentially as previously thought and do not match stock market returns.
Does gold really protect against inflation?
The effectiveness of gold as a hedge against inflation has been debated, with varying evidence and perspectives. Some studies suggest a positive relationship between gold prices and high inflation, while others find no correlation or even a negative correlation.
There are several reasons why gold is often considered a hedge against inflation. First, gold is a tangible asset with inherent value. Unlike fiat currencies, which can depreciate as inflation rises, gold retains its value.
Second, gold is relatively scarce and scarce, meaning its supply is not easily influenced by inflation. This characteristic makes it a reliable store of value in uncertain economic times.
However, there are also factors that call into question the reliability of gold as a hedge against inflation. The price of gold is influenced by various other factors, including interest rates and investor sentiment. Therefore, gold prices may rise or fall during periods of low inflation. Additionally, gold is not a very liquid asset, making it difficult to sell quickly when urgently needed.
In conclusion, the evidence regarding gold as a hedge against inflation is inconclusive. Different studies show different results, with some indicating a positive relationship between the price of gold and inflation, while others show no correlation or even a negative correlation. Ultimately, the decision to invest in gold as a hedge against inflation should be made after careful consideration of the risks and potential rewards, as it is a personal choice.
Inflation rates that are too high cause the Central Bank to tighten repo rates, which has a negative effect on stock prices. The stock market is falling and people are rushing to move their money into gold, claiming it will protect against inflation. But does gold really act as a hedge against inflation, as is commonly believed?
Viral Bhatt, founder, Money mantra said: “When the Central Bank tightens repo rates in response to high inflation, this move can cause stock prices to fall. This is because higher interest rates make it more expensive for businesses to borrow money, which can lead to lower profits and lower stock prices. In this environment, some investors may choose to move their money into gold in order to protect their wealth from inflation. However, it is important to remember that gold is not a risk-free investment and its price can also fluctuate.
Hiren Thakkar, chartered accountant owner, Hiren S Thakkar & Associates He added: “One should not invest in gold just because repo rates are higher and share prices are falling. In the Indian context, gold earns its return as the rupee depreciates against the US dollar and gold prices fluctuate due to other factors. The objective should be to obtain returns above inflation over a longer time horizon than through the equity portion. Gold is too volatile and experiences years of no returns.
You can not diversify your investments unless you can buy them back or replace them with another one. Additionally, every investor has a desire or expectation regarding a particular investment. With gold, you never know if it will float or sink depending on future conditions. With SGBs, diversification is a bit of a tough game, which is why some investors take the tactical approach of putting money into gold exchange traded funds (ETFs) which they can withdraw as they wish.
Gold shines and sparkles, but one cannot be sure of the sparkle it would bring to one’s portfolio, especially to those who plan their investments from a long-term perspective while adjusting it regularly to mitigate risks losses in time.
Indian stock market gave better returns than gold and debt