Gold has lost some of its sheen in recent months as Indian investors piled onto the equities, pushing the stock prices to a new high on Dalal Street. The benchmark equity index BSE Sensex is up nearly 10 percent since the start of 2023 beating the yellow metal whose prices are up by around 7 percent in the international market. The yellow metal is traded in US dollars in international commodity exchanges.
The relatively poor show by gold compared to equity is largely based on perception rather than hard data. The price of yellow metal in the Indian market has largely kept pace with the rally in the broader equity market.
Most importantly, adequate investment in gold is perhaps the only way for domestic investors to protect their savings and investments from the corrosive effect of macroeconomic volatility in the Indian economy.
This is evident in the historical movement of gold prices in the domestic market. According to data from the Indian Bullion and Jewellers Association (IBJA), the price of standard gold is up by around 18 percent in the last 12 months. It has moved up from Rs 50,101 per 10 gm at the end of September 2022 to Rs 59,079/10 gm on Wednesday. This is slightly better than the 16.3 percent rise in the Sensex during the period.
In the same period, gold prices are up 16.7 percent in the international market from US$1684.9 per troy ounce in September last year to US$ 1967/Oz on Wednesday.
Similarly, in the last two years, gold prices in India are up nearly 30 percent cumulatively compared to the 13 per cent rise in the BSE Sensex during the period. The Indian equity market has outperformed the yellow metal by a big margin in the last three years -- 18 percent against the 75 percent cumulative rise in the Sensex during the period. But this is a historical anomaly due to a sharp fall in the share price post the breakout of Covid19 pandemic rather than a secular rise in share prices.
In the longer term, domestic gold prices have either kept pace with the rise in equity price or exceeded it. For example, in the last five years, gold prices in India have nearly doubled against an 85 percent rise in the Sensex during this period.
The yellow metal has given annualised returns of around 12 percent since 2010, a tad below the 12.8 percent compounded annual rise in the Sensex during the period. This is a superior performance by the yellow metal considering the high degree of volatility and downside risk involved in equity investing. This is the right time for Indian investors to increase the allocation to gold and cut their exposure to equity.
Historically, rupee returns on gold have been much higher than the appreciation of gold prices in the international market. For example, in the last 10 years, gold prices have risen at a CAGR of 4 percent in the international market but they have appreciated at a CAGR of 7 per cent in the Indian market during the period. This additional return for rupee investors is due to the depreciation in the value of the rupee against the US dollar.
The rupee has lost nearly 46 percent of its value against the US dollar in the last decade and this has acted as a tailwind for gold prices in India.
This tailwind has only gotten stronger with time which is likely to keep gold prices higher in India even if they weaken in the international market. The depreciation in the Indian rupee is due to a growing wedge between the interest rate in India and that in the United States.
The interest rate in the US has risen much faster than in India in the last 10 years, leading to a sharp compression in the bond yield spread on India and US treasury bonds. The yield on 10-year Indian government bonds is now only 277 basis points higher than the 10-year US government bonds and is much lower than the 10-year average yield spread of around 600 basis points. One basis point is one-hundredth of a per cent.
This is negative for capital inflows into India leading to a steady depreciation in the rupee against the US dollar. The Reserve Bank of India (RBI) has no choice but to keep interest rates low in India given the country's high public debt - 84 percent of GDP -- the highest in the emerging markets. This provides a long-term tailwind for the price of gold in the domestic market. In contrast, high public debt and its associated cost translate into lower GDP and corporate sector growth translating into poor returns in the equity market.
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).