Did you know, you've been investing in the dollar?

Deepa Venkatraghvan  Thursday April 14, 2011, 11:03 PM , the Economic Times

A couple of readers have talked about gold being a better bet for long term investing. But in all my interactions with financial planners and advisors, they have insisted that gold (not jewellery but coins, bars or ETFs) be limited to 15-20% of one's portfolio, purely as a store of value, a hedge against difficult times. So I decided to explore. Here are some of my observations. 

First, a quick look at the pros and cons of gold. 

The pros: It is a precious metal that is high on liquidity. It is an asset that you can see, touch and feel. Gold has aesthetic value if worn as jewellery. Gold does not have credit risk. To explain what that means, a bank or corporate can be badly managed and go bankrupt or shut down whereas gold does not have that risk. 

The cons: Gold does not generate intermediate cash flows (just like real estate would generate rent or equity shares would generate dividends). Because of that, one cannot put a value to gold like one can put a value to an equity share. Gold also does not have high utility value.

Next, can gold give good returns?

For this, let us see how gold prices have moved globally in the past 31 years. I have taken the gold price as per the RBI website. In 1978-79, the price of gold (London) was USD 208 per troy ounce. In 2009-10, it rose to USD 1023. The average annualized return (or CAGR) works out to 5.27% per annum. We don't have the official average for 2010-2011 but assuming it is USD 1400 the CAGR works out to 6.14%.

Now, let's look at India. In 1978-79, the average price of gold (Mumbai) was Rs 791 per 10 gram. In 2009-10, it was Rs 15,756 per 10 gram. The average annualized return works out to 10.13%. Assuming average rate for 2010-11 is Rs 19,000, the CAGR is 10.44%. 

The difference: 4.3%. Where does that come from? It comes from the appreciation of the dollar against the rupee. So in effect, in the past 31 years, we Indians have been investing in the dollar, believing that we are investing in gold. We have earned 4.3% from the appreciation in the dollar along with 6.14% in gold. 

One may question: So what if I made 4.3% from the dollar and 6.14% from gold? So now we are talking about two issues: gold versus equity and dollar versus equity. Let us see both.

Gold versus equity

In 1979, the Sensex was 100. Today it is 19000 – a CAGR of 17.82%. Now those who have made better return from gold have probably made it in the last 5 years. Let us compare. In 2005-2006, the price of gold was USD 476 in London and Rs 6900 in Mumbai. In 2010-11, going with our assumption, the price of gold was USD 1400 and Rs 19,000. The CAGR works out to 24% in London and 22% in Mumbai. During this time, the dollar largely depreciated. The Sensex average for 2005-06 was 8278 and today it is 19000, a CAGR of 18%. 

Dollar versus equity

In the last 31 years, the dollar has appreciated only around 5% per annum (CAGR). Moreover, the dollar is influenced by many more global factors.

Whether the dollar will recover in the future, we don't know. Whether gold will continue its majestic rise, we don't know. But here, allow me to make one more observation. In 1980-81, gold had peaked to USD 513. That was because people had lost faith in the dollar (Vietnam war etc) and rushed to buy gold as a safe avenue. Thereafter, the dollar recovered and from 1982 to early 2000s, gold remained in a range of USD 350-400. The recent peaks in gold have also been on account of a weak dollar. 

Indian equity on the other hand hinges on the domestic growth story. Of course I have not talked about the cons of equity, the key limitation being the extent of research and effort required to invest and monitor an equity portfolio. But cannot that be tackled with some education and perhaps the use of professional service? 

Food for thought? 

Till next time, Money Happy Returns!