Saturday, 11 July 2015

Should gold be part of your long-term investment portfolio?

Should gold be part of your long-term investment portfolio?

Should gold be part of your long-term portfolio? Does it help to have some exposure for the sake of diversification?
This is the second part of “asset allocation for long-term goals”. The first part which considered only equity and debt, can be found here
This post was made possible, thank to Balaji Swaminathan. He got me the source of monthly gold price from June 1995 onwards.
Link:
http://www.indexmundi.com/commodities/?commodity=gold&months=240&currency=inr
If google has got it, Balaji can find it. He is the most intelligent web searcher I know. Probably why he does not post questions at AIFW! Why ask, when you know what to look for!
Methodology
  • Franklin India Blue Chip is chosen as representative of equity
  • Franklin India Income fund as representative as debt.
  • These are among the oldest equity and debt funds in the market.
  • A monthly SIP from 6th July 1998 to 5th May 2014 was considered (too lazy to update)
  • The monthly gold price (per gram) was considered to be equal to the price on the NAV dates of the above funds. Have to make this approximation. Can’t be helped.
  • Two different asset allocations were considered: One with 60% equity and another with 70% equity.
  • The gold allocation in the above was varied from 0% to 40% or 30%. The rest is assumed to be in debt.
  • The variation in monthly XIRR  was calculated with the XIRR SIP tracker.
  • The standard deviation in the monthly XIRR variations was computed.
  • The final XIRR and the standard deviation are plotted for different gold exposures for 60% equity and 70% equity.

Equity exposure = 60%

The x-axis represents the exposure to gold.
gold-asset-allocation-2
Notice that with increase gold exposure, the XIRR increases (not by much, if you ask me) but the volatility (- standard deviation) also increases.  There is a minimum at 5% exposure.  It is worth the effort and stress especially when gold is riskier than stocks, is something for you to consider. No point in holding gold as far as I am concerned. Will just increase my stress.

Equity exposure = 70%

The x-axis represents the exposure to gold.
gold-asset-allocation-1
The case of holding gold is much worse here.
Conclusion
Stay away from gold funds or gold etfs. Do you see articles in the media now, suggesting you buy gold, when the prices are lower from the peak of the crash?
Think for a moment as to why.  AMCs were busy pushing these products when gold prices looked liked it could never fall.  Now when there is sideways movement, no one is saying buy them.
Gold is supposedly a hedge against inflation. Not exactly in terms of price movement. When the economy collapses, then physical gold will perhaps serve as currency. I don’t think it has much value (other social, religious, traditional etc.)  otherwise.
It is silly to stock up on physical gold and not focus on investing.  What kind of  physical gold should it be, is another question: jewels, gold bars etc.
Should I buy some physical gold each year to protect myself against economic collapse? Perhaps.  As long as it not part of my investment portfolio.

equity vs gold

Charts: Equity vs. Gold. Vs. Debt

Here are some charts from yesterday’s post: Should gold be part of your long-term investment portfolio?
  • Franklin Indian Blue Chip is chosen as representative of equity
  • Franklin Indian Income fund as representative as debt.
  • Per gram price data obtained from indexmudi is used to represent gold investment
  • Data range is June 1997 to June 2014 (quite small but not bad).
  • Results over a longer period can be found here:  gold is riskier than stocks

Normalized NAV movement (absolute)

gold-asset-allocation-3

Normalized NAV movement (logarithmic)

gold-asset-allocation-4

Rolling annual returns (all three)

gold-asset-allocation-5

Rolling annual returns (debt and gold)

gold-asset-allocation-6

Extent of Correlation

The extent of correlation between annual prices returns can be easily computed with Excel. If there are two asset classes in a portfolio, ideally they must be negatively correlated. That is if one gives +ve returns, the other gives -ve returns and vice versa. This will stabilize the portfolio regardless of market conditions.
Gold and Equity annual returns are correlated by -0.65%.  Negative, but too small to make a difference, in my opinion.
Debt and Equity: -3%. Better but not spectacular. The stability that debt offers in a folio makes it indispensible.
Debt and Gold: -21%. Now that is significant, but not very useful!