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  • JUNE 22, 2012

What you should know to invest in gold

Gold is an asset that has dazzled investors in recent times. And investors have all the reasons to be happy about owning gold. Since the end of 1978, the yellow metal has delivered nearly 620% in terms of returns. The following graph is a testimony to the good times that gold has given to people who believed in it and held it for a long time.

Gold has delivered solid returns
Data Source: World Gold Council

Even since June 2011, the precious metal has delivered a return of nearly 6%. Obviously if you compare it to the peak yearly return of 52% that it delivered in September 2011, this return looks low. But nevertheless, there are still investors who swear by gold. And they have every reason for it.

Reasons to buy gold

Gold has long been considered as a natural hedge against inflation. This means that in terms of price of the essential items, gold has not lost any value over time. So if back in 1978, you could buy x number of loaves of bread with one ounce of gold, you can still buy the same x number of loaves with the same one ounce of gold. This is one of the biggest reasons why investors love gold. While inflation eats away returns on other asset classes, till now gold has managed to remain insulated from it.

Another major reason for buying gold is its safe haven status. At a time when uncertainty and volatility have become the words of the hour, gold's ability to preserve its value becomes invaluable to investors. The crisis in the Euro zone, slowdown in US and the seesawing US dollar, all combine to help direct the flow of money to gold. Since the supply of the metal remains restricted, the higher demand can only result in prices moving northwards. True, that in recent times, gold has seen some decline in prices, but most rational investors look at it as an opportunity to invest.

But does it mean that investing in gold comes without any risk? Not at all. Like any other investment option, gold too has an argument against it.

Reasons to not buy gold

The one big area of concern in investing in gold is its price. Like any other investment option, it is necessary to keep valuation in mind when it comes to putting money in gold. The prices of gold have run up quite a bit in recent times. If we look at the following 5 year price chart for gold, we can see that the prices of gold have only moved north.

Source: World Gold Council

But prices have corrected since their peak in September 2011. Since then, the price of gold has dropped by nearly 14%. But does that mean that gold looks good to invest in? Unfortunately, there is no clear answer to this question. The reason for this is that unlike other asset classes, it is not possible to pin point a definite intrinsic value on gold. Due to its aspirational value as well as its safe haven status, gold investment is largely driven by what investors expect the price movement to be. So if they expect prices to fall in the future, they sell gold and vice versa. It is more of an individual decision.

Another problem with investing in gold is the form in which it should be bought. Some investors prefer to own gold in its physical form but that has a problem of storage and insurance involved in it. Some prefer to invest in e-gold or gold ETFs (Exchange Traded Funds) but in that case there are transaction costs involved which could cut down the total returns.

Most important reason to not invest in gold is its 'hedge against inflation' status. In fact this is a reason that has been cited by even the legendary Warren Buffett. Though investing in gold can help to preserve the value of the investment. But if in time, it does not cover inflation rates or help earn returns higher that inflation, then what is the point of investing in it?

Though it has its own pros and cons, gold nevertheless has caught the fancy of nearly every investor. And particularly for Indians like us, gold will always remain an object of desire. So the next question that pops into mind is how to go about investing in gold. In the next article we will discuss the various ways in which you could invest in gold. And the pros and cons of each way.

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