How to grow your money with gold

-- Source of Information : Economic times --

The perception about gold in India has come a long way from the days when its main function was to merely adorn and act as a status symbol. The emotional investment in the metal was so huge that parting with it seemed unthinkable. Consequently, it seldom yielded worth-while returns.

Now, however, it is becoming clear that an increasing number of Indians are realising that gold deserves a place not just in the cupboard at home or the bank locker, but also in their investment portfolio.

"Gold has been a traditional favourite for Indian investors. There is a shift in the mindset of investors. They are now looking beyond gold as merely a commodity for consumption and are realising its worth as an investment avenue too. It has given steady returns over a period of time," says Sutapa Banerjee, CEO, private wealth, Ambit Capital.

The trust in gold as a safe haven and a good hedge against inflation has only soared in the backdrop of the current global economic scenario. As a result, the yellow metal is red-hot at the moment, and the entire world wants to be part of the gold rush. Though prices have shot up and are hovering around the Rs 21,000-level, they have failed to eclipse its shine.

On the contrary, the already-humungous appetite of Indians to consume gold only seems to have been whetted further. According to a recent research report from the World Gold Council (WGC), Indian gold demand has grown 25% despite the 400% appreciation in the rupee in the past decade. The study expects the demand in the country to increase by over 30% in real terms.
Keen to capitalise on the growing reliance on gold as purely an investment avenue, the manufacturers and distributors of financial products are actively promoting instruments with exposure to the precious metal. Gold ETFs (exchange traded funds) and gold mining funds are becoming popular amongst retail investors. While these are relatively simpler to comprehend, the same cannot be said about other instruments like gold-based structured products.

The workings

The key to getting the best out of such complex products is to understand how they work. Their complicated nature means that they are usually targeted at high net worth individuals (HNIs) who are supposed to be conversant with the sophistication the products entail. However, in many cases, HNIs too rely on the expertise of wealth management arms of banks and boutique firms which usually act as the distributors for these products.

"Structured products come in various forms and the underlying security is commonly equity or an index. Now, we are customising structured products with the underlying security as gold. Hence, an investor can gain from the upside in gold even as the downside is protected," explains Banerjee. Despite the nomenclature of 'structured' products, this category does not exhibit uniform features.

Such instruments are typically customised for investors except in case of products like capital-protection oriented funds or equity-linked debentures/fixed maturity plans that are designed for retail investors' consumption. Structured products broadly refer to instruments that have exposure to equities and debt in varying, but prefixed, proportion, with derivatives also forming a part of the mix.

Capital protection is also one of the features of this category, although this comes with several riders. They track the underlying theme, say Nifty, while promising a participation in the upside (read returns) and protection on the downside (as they attempt to minimise losses). Therefore, in case of gold-linked structures, the instruments will attempt to replicate the performance of gold to an extent.

Why gold?

The simplest answer is that it is 'in' at the moment. "Product manufacturers will latch on to any underlying (asset), which is the flavour of the season. Usually, this particular underlying becomes the flavour after exhibiting good performance for an extended period of time, say three-five years. We had a profusion of Nifty-linked debentures in 2007 and now we are having gold-linked products," says Jayant Pai, vice-president, Parag Parikh Financial Advisory Services.

This is a big drawback of the structures. They come into the picture when the asset is rather popular. And what is popular need not offer the best-risk-adjusted returns in future. And then, there are other macro-economic factors too, including the ones mentioned earlier. "The trend usually is that gold weakens with a rising dollar. But there have been times when gold prices have continued to rise even as the dollar strengthened. Investors are currently bullish on gold and are keen to include gold as a part of their investment portfolio in view of the global turmoil," says Ambit's Banerjee.

Best of both the worlds?

Though the idea of gaining from market performance without taking the risk of your capital being eroded sounds exciting, the complexities involved call for a more cautious approach. "Reading the fine print is important. For example, one such product offered by a broking firm averages the initial entry price and the price on each cut-off date. Hence, it is obvious that the investor will not get the full benefit of the price rise. Of course, if there is a secular fall in prices your capital will be protected," explains Pai.

"Another product has a participation rate of 165%. Unfortunately, (or may be deliberately) the detailed break-up of the cost is not given." Understanding the participation rate becomes critical here. Participation rate is the exposure of a product to movements in the price of the underlying asset.

If the participation rate is 100%, the structured product would generate a return exactly equal to the rise in the underlying asset. For example, if a structure offers you a participation of 120% of underlying, say MCX gold futures, your returns will be 120% of the returns offered by MCX gold futures over the scheme period before charges. Also, don't trust the principal guarantee clause blindly.

If the structured products are in the form of debentures, ascertain who is issuing the debentures. The protection promise is contingent upon the issuer or the guarantor (of debentures, if the product is offered in this form) not defaulting. This apart, the commitment will hold good only if you stay invested till maturity. While verifying the estimated returns, factor in the charges levied as well as the taxability of gains or losses made to get the true picture.

"Also, check the price being used as the underlying. For instance, is it the London AM/PM fix, average of London prices over a particular period, MCX gold prices, etc. If London prices are used, check out the manner in which the price in pounds is converted into rupees," advises Pai of PPFAS. Finally, don't go for a product simply because it is popular. Making predictions is a tricky business and it's no different for gold. Therefore, the best strategy is to decide the allocation to the shimmering metal in your portfolio and stick to it.

Read more at : http://articles.economictimes.indiatimes.com/2011-04-05/news/29384334_1_gold-etfs-indian-gold-demand-gold-rush