Suparna Goswami Bhattacharya   

October 10,2014:The yellow metal traditionally has caught the fancy of many — be it in the form of bars, or in the form of Exchange-Traded Fund (ETFs). Stocks and shares remain the best form of investment for many, but gold has been steadily making inroads in the minds of investors.

There is a growing consensus among academics, researchers and asset allocation experts that gold is a hedging instrument and a safe haven asset. Many finance professionals and trading companies, including GoldCore, The Royal Mint, DGCX, BullionVault among others, now believe that gold should form part of investment and savings portfolios. The reason could vary from portfolio diversification to financial insurance.

Historically, people’s interest towards gold investment is not entirely a new concept, though. There has been a steady rise in bullion trading, especially post 2008-09 Lehman Crisis. “The start of the world economic downturn in 2008 resulted in a significant increase in demand for gold from consumers on an international basis,” says a spokesperson from The Royal Mint.

During the financial crisis of 2008, the price of gold rose to $50 on one day, the largest one day move since 1980. This, according to experts, was mainly because people took refuge in gold and perceived it as something which has high credit quality.

According to research conducted by The World Gold Council, there is potentially £4billion latent demand for gold investment within the UK alone, but consumers have been deterred from taking the plunge because of the perceived barriers to purchasing precious metals.

Asian and Middle East markets have huge faith in gold. In Dubai, the value of gold traded stood at $75 billion last year, representing nearly 40% of the world’s physical gold trade.

Also, gold jewelry stores cater to different demand segments. Tourists, especially from India, account for the majority of gold consumption in Dubai.

By 2020, when Dubai is expected to attract 20 million visitors per year, the gold traded through Dubai is expected to increase further. Given the strong demand, more gold jewelry stores are opening across the emirate.

Mohammad Younis, Director of Sales and Business Development for Dubai-based Gold AE, says, “Every year, the awareness for bullion trading has been increasing. Recently, there has been a gold rush. Several new investors are being introduced to the bullion markets. We have been seeing the most number of first-time buyers in the past few years. It has proved to be one of the most popular investments for the past two years.”

Veteran investor Marc Faber, author of The Gloom, Boom and Doom Report, reiterates the need of gold for a diversified portfolio. And he is not alone. Other experts like Max Keisr, producer Keiser Report, a programme which give financial analysis, and Josh Arnold, independent trader of options and stocks and blog writer, feel that investing in gold is not a bad option at all and provides investors some respite from the volatile nature of markets.

It does not come as a surprise that gold is one of the few asset classes that is perceived by investors as a safe haven during times of economic turmoil. “It is also one of the few assets that can be easily liquidated to generate cash. As an investment instrument, we can also provide a tactical hedge against inflation,” says Ian Wright, chief business officer, Dubai Gold and Commodity Exchange (DGCX). Looking at the growing demand, the company plans to soon add a physically deliverable spot gold contract to its portfolio of products. “This will provide yet another tool to the bullion and jewelry industry, both in the region and abroad.”

However, despite the bullishness and steady interest in trading, progress has been slow and gold still has a long way to go before it can match the popularity of stocks.

The sceptics

And critics have good reasons to make you believe that as far as gold as an investment tool is concerned, it is best kept at a distance. For one, investments in gold do not really lead to an income rise. “What income does gold generate? It does not produce any cash flow as against equity,” says an investment expert in the UK who did not wish to be named for this story.

For many, gold acts only as a hedge against fluctuating currency. In fact, some investment analysts advise their clients against investing in gold. “If diversification is what you are looking for, invest in real estate or something. The returns are much higher. Gold is safe, but if one wants returns, then that is not the right thing to invest in,” says an investment analyst with India-based Kotak Securities.

Experts opine that the problem with gold is it does not produce profits and hence not fit to be classified as real investment like stocks.

For the past 34 years, the value of gold has not risen and has, in fact, just kept up with inflation. When adjusted with inflation, it has the same value it did 30-35 years ago.

However, according to Wright it should never be the case of equities or gold. “A balance between them is important. All asset classes expose investors to various types of risk. The important point is that in investment terms, a portfolio diversifies that risk,” he says.

Gold companies on their part are trying their best to build confidence among investors. “We are building awareness for gold in the market to teach people that gold should be your plan A and not plan B, and as we always say ‘don’t wait to buy gold, buy gold and wait’,” says Younis from Gold AE.

What the future holds, nobody can say with surety. For now, you can take a call — whether you want stocks, gold or a bit of both.

Top 10 nations stockpiling gold

1. United States
2. Germany
3. Italy
4. France
5. China
6. Switzerland
7. Russia
8. Japan
9. Netherlands
10. India

Related Story: Gold hits 15-month low

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23rd July 2013

Derivatives are financial instruments whose value is a function of the price of another asset, as the name implies derivative contracts derive their value from the performance of an underlying security. A derivative contract, in their most basic form, represents the right to buy or sell a security at a specified price; derivatives are generally used as a hedging tool to guard against market fluctuations. The features of derivative contracts, such as purchase or sale price, size and expiry date are all pre-determined. The value of these financial instruments is derived from an underlying asset (stocks, bonds, commodities etc). Traders can swap interest rates, take bets on whether a firm can go bankrupt and safeguard against future asset price increases.

Two common types of Derivatives are:

Futures:  A future contract is an agreement to buy or sell an underlying asset in the future at a pre-determined price. The buyer in this transaction is obliged to take delivery of a specific quantity of an underlying asset at a specific date and price determined at the time of transaction. Conversely, the seller agrees to deliver a specific quantity of an underlying asset at a specific date and price determined at the time of transaction.

For example: When an investor gets into a futures contract, he agrees to buy or sell an asset at a predetermined price in the future. For example today is 18^th July and the spot price of gold is $1,000, a three month gold future (expiring on 18^th October) is trading at $ 1,010. As an investor I believe the price of gold is going to rise over the next three months, so i enter into a long futures contract at current future prices of $ 1,010. As on 18^th October, the gold spot price would increase to $ 1,100, so I make a profit of $ 90. Similarly if gold prices had fallen to below $1,010 as on 18^th October, i would have incurred a loss equal to the difference between the initial futures price and the final spot price.

Options: An option contract is an agreement between two parties for a specified time period which gives the holder the right, but not the obligation, to buy or sell a specified number of shares, at a pre-determined price. Options can be bought and sold like shares.

There are two types of options:

Call: A call option gives its holder the right, but not the obligation, to purchase a specific quantity of an underlying asset, at a given price for a specified time period. In order to obtain that right, the holder must pay a premium to the seller. The seller of the call option has the obligation to sell a specific quantity of an underlying asset at the strike price indicated, if the holder exercises his right. Against this obligation, the writer receives a premium paid by the buyer.

For Example: Today is 18^th July and as quoted in the earlier example, the spot price of gold is $ 1,000, a call option that gives the holder the right to purchase gold for $ 1,000 as on 18^th October is trading at $ 30. As an investor I believe the price of gold is going to rise over the next three months, so i spend $ 30 to and purchase the call option. As on 18^th October, the price of gold is $ 1,100, now i exercise the “call” option and purchase gold for $ 1,000 and make a profit of $ 100. My net profit after deducting the cost of option would be $ 70. If the market price at expiry was below $ 1,000, i would not have exercised this option (as the market price is cheaper than the option strike price) and my profit would have been zero, after factoring the cost of option my net loss would be $ 30. The major advantage of this form of derivate trading (as quoted in the example) is if the prices of gold were to fall, no matter how much it fell, my maximum loss would always be at $ 30, the price paid for the option, whereas my net profit from is infinite.

Put: A put option gives its holder the right, but not the obligation, to sell a specific quantity of an underlying asset, at a given price (strike price) by a specific date (the expiration date). In order to obtain this right, the holder must pay a premium to the buyer. The buyer has the obligation to purchase a specific quantity of the underlying asset at the strike price indicated, if the holder exercises his right. Against this obligation, the writer receives the premium paid by the buyer.

For Example: You bought a company’s shares for $ 31, but you are concerned the shares of the company may drop due to a weakening market. A good way to protect yourself from this situation is to buy a ‘put’ option. So you decide to buy an August 30^th put for a premium of $ 1, which costs you $ 100. Buy buying the put you are locking the value of your stock at $ 30 per share until the expiration date. If the stock price falls to $ 20 per share, you can still sell it someone at $ 30 per share, as long as the option has not expired. By using this option as portfolio insurance, it fixes your worst risk at $ 200, which is inclusive of the $ 100 premium and the loss of $ 1 per share you can lose after paying $ 31 per share for the stock.

Forward Contract: A forward contract is an agreement to sell a currency, commodity or other asset at a specified future date and at a predetermined price. This may be the current price or the exchange price, or an agreed forward price, which would be at a discount or premium to the spot rate. Fundamentally, forward and future contracts have the same function as both contracts allow the traders to buy to buy or sell a specific asset at a specified time and a given price, however, future contracts are exchange traded and hence standardized contracts. Forward contracts on the other hand are private agreements between two parties and are not rigid to the terms and conditions stated in the agreement. The chance of default in this contract is high due to the absence of an exchange or clearing houses. Future contracts have clearing houses that guarantee the transactions and lowering the probability of default drastically.

Swaps: Swaps are derivative contracts and trade over the counter. The most commonly traded and liquid interest rate swaps are known as “vanilla” swaps, which exchange fixed rate payments for floating rate payments based on LIBOR and FCA regulations. Swaps have been categorised into equity swaps, commodity swaps, currency swaps and interest swaps.

Who Bears the Risks ?

After reading the above paragraphs of the article, you may be puzzled to understand who will ultimately bear the risk of derivatives? And what is the purpose of investors and speculators in the derivative market? Assad Dossani, a financial analyst and columnist who also trades on derivatives says, Investors take on the risks that hedgers want to get rid of, hedgers pass on the risk to investors and investors as a result expect to earn a profit for taking on the risk.

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