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International Journal of Applied Engineering Research

ISSN 0973-4562 Volume 9, Number 23 (2014) pp. 19083-19088

Research India Publications

A Study on Role of Gold Portfolio Allocation

Dr. N. Gopinathan and Nitin Ramakoti
Associate Professor in MBA, Sathyabama University, Chennai-119
Associate Analyst at JMN Investments Research, Chennai-40

The paper examines the key drivers of gold investment. Since 2000 the gold
price has risen drastically, making gold an interesting add-on to a portfolio. As
gold futures have negative roll returns, due to Contango, gold pool accounts
are characterized by high credit risk and physical possession of gold means
high transaction costs, Extra-Gold might be the most efficient way to enter the
market. Extra-Gold is a product created by the Deutsche Bourse in 2007, an
equivalent of which is a Gold ETF traded in India The most famous one
being GoldBees which is traded like a security but can be exchanged into
physical gold any time. In the portfolio context gold has had a positive impact
on portfolios between 2000 and 2006 due to considerable returns and low /
negative correlation to other assets.

Gold possesses three distinct attributes which make it unique in the commodities
Gold is fungible.
Gold is indestructible and storable.
Gold is characterized by massive above-ground stocks which are enormous
relative to the supply flow. This last attribute means that a sudden increase in
gold demand can be quickly and easily met through sales of existing holdings of
gold jewellery, increasing the amount of gold recovered from scrap. It can also
be met through the mechanism of the gold leasing market.
Golds high liquidity and high price elasticity is seen as its critical difference
that sets the yellow metal apart from other investable commodities. Another
crucial characteristic of the gold market is the fact that it is always in Contango,
a phenomenon in the futures market where the forward price of a commodity is
higher than that of the commoditys spot price. Contango results in negative
yield when the futures contracts are rolled forward into higher maturities.

Paper Code: 27723 - IJAER


Dr. N. Gopinathan and Nitin Ramakoti

Review of literature
Research by the World Gold Council, 10 Old Bailey, London EC4M 7NG, United
Kingdom. Copyright 2011, stating that within a simple benchmark portfolio (50%
equities, 40% fixed income, 10% commodities), an optimal strategic allocation to
gold can rise to as high as 9.5% for more risk-averse investors (with a 0.5% allocation
to other commodities) or a moderate 4.5% (5.5% to other commodities) for those
willing to take on more risk.

Objectives of the study

To explore the characteristics of gold as an investment.
To state that Gold is the most widely traded Commodity bullion.
To show that Gold has least correlation with other asset classes.
To prove that the Diversification objective is accomplished in a portfolio
consisting of other asset classes.

Findings of the Study

How to invest in gold:
A growing range of methods now allows investors to either buy gold, or simply gain
exposure to gold price movements. From gold coins, online accounts, exchange traded
funds (ETFs) and complex financial products, to mining stocks, the most appropriate
gold investments will depend upon the investors specific requirements and outlook.
Investment vehicles:
Bars: The most traditional way of investing in gold is by buying bullion gold bars.
There are bullion dealers that provide the same service. Bars are available in various
Coins: Gold coins are a common way of owning gold. Bullion coins are priced
according to their fine weight, plus a small premium based on supply and demand.
Exchange trade products: Gold ETPs represent an easy way to gain exposure to the
gold price, without the inconvenience of storing physical bars. However exchangetraded gold instruments, even those which hold physical gold for the benefit of the
investor, carry risks beyond those inherent in the precious metal itself. In other words
it is like investing in the stock exchange
Certificates: Gold certificates allow gold investors to avoid the risks and costs
associated with the transfer and storage of physical bullion (such as theft, large bidoffer spread, and metallurgical assay costs) by taking on a different set of risks and
costs associated with the certificate itself (such as commissions, storage fees, and
various types of credit risk).

A Study on Role of Gold Portfolio Allocation


Mining companies:
Instead of buying gold itself, investors can buy the companies that produce the gold as
shares in gold mining companies. If the gold price rises, the profits of the gold mining
company could be expected to rise and the worth of the company will rise and
presumably the share price will also rise.
Benefits of Gold Investment:
Throughout the world gold is considered as safe investment as it does not impacted in
a large in conditions like economic conditions such as inflation, market uncertainty,
and political discontent. Return from gold had never been disappointed in long period
of time. In fact last decade return has been much better than any other traditional form
of investment like fixed deposit. In current market there is various type of instrument
available in the market to invest in gold by which investment c an be made in a very
small pieces .There are number of instruments available in the market to invest in
gold say 1) jeweler 2) gold coins 3) gold ETF. Gold can be pledged for loan. In fact it
is the easiest form of obtaining loan against security. There is no concept of losses in
terms of premium and discount, and the initial investment is very low.
Barriers to Investment in Gold:
Despite gold being an alluring investment opportunity, it comes with strings attached.
Physical Risks: Investing directly in metals, by purchasing bullions or
numismatic coins opens the door to a number of risks. First, physical gold can
be stolen, second you might lose it and third its simply a forgery. Not a risk, but
a burden, is the storage fees, if the gold coins should lay in a banks safe.
Political Risks: On the one hand, unstable regimes drive the gold price up as in
uncertain times people rather tend to invest in gold than trusting national
currencies. However, what if the gold mine, in which you have a stake in,
becomes nationalized, or the possession of gold is outlawed?
Market Risks: At the long-term, gold can only become more valuable, as it is a
finite material and demand for it rises. However, currently the gold price is at an
all-time high. It would be not surprising if a slump will be experienced. This is
bad news for short-time investors. This is not so improbable.
Technological Risk: The gold price is partly governed by demand in industry.
What if technological ingenuity explores substitutes for gold, so that demand
eases of? This would certainly lead to a lower gold price.
Implications of Golds Regional Price Discord in Portfolio Allocation
Decisions: Gold prices in certain markets tend to deviate from the global gold
benchmark price movements due to external influences like government
intervention. The most notable cases include Chinese and Indian markets for
investable and ornamental gold. Indias restrictions, like the recently imposed 80-20
rule, on import of gold has had an adverse effect on the price of the metal by inflating
the supply pool or containing the demand from the worlds second largest consumer.
As shown in Chart 2, gold prices in India, though were largely intact with the
global gold price movements until early 2012, began drifting away since then.


Dr. N. Gopinathan and Nitin Ramakoti

Possible reasons that could explain this drift are the Reserve Bank of Indias
varied restrictions on the import of gold in an attempt to stem the burgeoning
current account deficit. Prudent portfolio allocations must consider such
conditions that cause price discord as it may impact the assets appropriateness
in the portfolio or its diversification benefits.

Chart 2: Indexed Gold Price in Key Currencies

Golds Indispensability in Investors Portfolio: The Yellow Metals Correlation

with Asset Classes.
Many professional and retail investors view investments in gold as a hedge against
risks in the financial system. Two major recessions have occurred in the last decade:
first, the bursting of the new economy bubble and later the mortgage scandal followed
by a global financial and later an economic crisis. Recognizing this, many investors
now try to protect their wealth or parts of it by investing in assets which are less
dependent on the stability of the financial system. Portfolio diversification leads to
reduction in the risk of the portfolio. The probability of one asset class or a single
investment significantly dropping in value is far higher than the chances that a well
balanced portfolio of many different investments from various asset classes will
depreciate in value significantly. To illustrate this property, we conducted linear
regression of spot gold prices as an independent variable with S&P 500 Index, widely
considered as the proxy for equity performance and year over year consumer price
index increases to assess the commoditys movement in relation to inflation. The

A Study on Role of Gold Portfolio Allocation


study is based on monthly data for all the three variables mentioned above for the
period 1/7/1964 to 1/7/2014, consisting of 599 data points.

Chart 3: Gold Price Comparative Analysis

Regression Results Gold / S&P 500 Gold / CPI
Adjusted BETA
ALPHA (Intercept)
R (Correlation)
Std Dev of Error
Number of Points

The regression results indicate that gold price movements are share very low
correlation with equities (S&P 500) and inflation (CPI). Assets that are less correlated
with traditional asset classes like equities and fixed income improve the risk return
characteristics of the portfolio.
Over the last decade, gold investments were one of the best performing asset
classes. In nominal terms, the price of gold has risen from below 300 US-Dollars to
above 1,500 US-Dollars.
What amount to invest in gold?
Investors who decide to put a share of their savings or investments into gold face the


Dr. N. Gopinathan and Nitin Ramakoti

question of how much to invest in gold. Choosing the ideal portion of a portfolio to
allocate to gold is key factor for creating a well-diversified portfolio which minimizes
investment risks. Expert recommendations range from below 5% to well over 15%.

In this paper, we examined two topics the various roles gold can play in a long-term
investment program, and why some analysts consider gold unworthy of inclusion in
any investment portfolio. We conclude that gold possess three potential roles in
institutional investment programs. Firstly, as a component of a broader real assets
investment allocation to help hedge against ination, secondly, as a source of alpha
for trading-oriented strategies such as global asset allocation and lastly, in the context
of global macro, as a component of a tail-risk hedge against systemic failures.
Importantly, the magnitude or sizing of any investment in gold depends upon the
investment philosophy of the investor.

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