How bank deposits score over gold

Don't let the recent returns on gold bamboozle you into replacing your FDs and other investments with gold. It is not surprising that investors are seeking out gold after it has completed a nine-year run of positive returns.Second-guessing gold prices is even trickier than forecasting the Sensex, so it certainly isn't a predictable investment.

To anyone taking stock of his/her portfolio today, choices such as fixed deposits or bonds would seem positively foolish when compared with gold. For gold, in rupee terms, has delivered an eye-popping return of 25 per cent on a compounded annual basis over the last five years, while deposits have barely averaged 7 per cent. But don't be fooled because here are four ways in which fixed deposits score over gold.

GOLD LESS PREDICTABLE

Most people flock to gold for its ability to serve up a ‘predictable' return in turbulent times. But such investors tend to be taken in by gold's recent record. With two full-blown economic crises and worries about sovereign default haunting markets, it is no surprise that gold has delivered a 25 per cent return (in rupees) since 2007.

This, however, is a recent phenomenon. Historically, 20 per cent annual returns on gold have been the exception rather than the rule. In fact, a rolling return analysis for the past 20 years (measuring gold price returns at weekly intervals, for five years at a time) shows that gold has managed a 20 per cent return less than one-fifth of the time. What is more, gold didn't manage even an 8 per cent annual return about 45 per cent of the time in the last 20 years. Plus, there was a long stretch in 2001 when investors suffered losses on their gold holdings after a five-year wait.

These numbers suggest that gold price gains are as much a ‘paper' profit as returns from the stock market. They can change dramatically based on the point of entry and exit. Whether you make money on gold depends on how lucky you are in timing your purchases (and sales too). Second-guessing gold prices is even trickier than forecasting the Sensex, so it certainly isn't a predictable investment.

Contrast this with good old bank deposits. You will never make 25 per cent a year on them. But you can invest in them at any time, knowing exactly what you will receive every year by way of interest. One-year bank deposits have delivered a 5.5-9.5 per cent return in the last ten years, averaging 7 per cent a year.

WHAT IS IT WORTH?

Bank deposits also give you returns in the form of regular cash flows with complete safety of capital, while gold doesn't. The regular interest receipts from a bank deposit will continue to flow in, no matter what the state of the world economy, the Indian corporate sector or the rupee is. The same cannot be said of any other asset class, including gold.

Both stocks and bonds, in fact, have a greater claim to fundamentals than gold. Bonds represent the obligation of a company to pay back your money at the end of a certain period. The company's repaying ability is backed by its assets and an assessment of its prospects by a credit rating agency.

Stocks too are valued based on the earnings potential of the underlying company. If stock prices move too far away from the earnings potential or book value of the company, investors can decide to stay away.

However, gold, being a commodity, has no common measure of intrinsic worth. Its prices rise if demand at that point in time exceeds supply. That makes it impossible to say if gold, after trebling in the last five years, remains under-valued. Or even how much it could fall, if a correction takes shape.

NO HIDDEN EXTRAS

Then there is the liquidity aspect. Deposits or bonds have a definite maturity date when you can be sure of retrieving your capital. If you need to pre-close them, you can do that too, with a sacrifice on returns. Your capital remains intact. With gold, especially if bought in jewellery, coin or bar form, liquidation is not easy. If sold to the neighbourhood jeweller, it entails costs such as wastage and making charges, which cut into your returns.

Any fall in prices too can erode capital.

Moderating inflation further strengthens the case for deposits over gold. Inflation rates, after soaring through the roof in the past two years, have begun to moderate of late. If this continues over the next 3-5 years, gold as a hedge against inflation could lose sheen. But investors who are sitting pretty on five-year deposits at current rates of 9-10 per cent a year will stand to gain. Apart from securing safety of capital, they will take home a fixed return over and above inflation.

Overall, given its risk profile, gold is a better substitute for the equities in your portfolio than deposits or bonds. But even while replacing equities, it is best to stick to 5-10 per cent exposure to gold, strictly through the exchange traded fund route.