The Yellow fever

Gold as an asset class has shown its mettle in the last one year. Especially in the past six months when the equity markets have been on a downslide, this yellow metal has continued to move northwards. And the numbers are there for all to see.

Since January, when the equities market started tumbling on the back of a US recessionary fears, gold exchange-traded funds (ETFs) returned 20-30 per cent between January and March.

Though returns were subdued in May (6.5 per cent), it still performed better than equities. And on the sheer price front, in the last one year, gold prices have moved from Rs 8,745 per 10 gram to Rs 12,235, a rise by Rs 3,490 in twelve months (June 1, 2007 to June 6, 2008).

Yes, it does seem that gold is the instrument, where one should be in right now, but the big question is that is it the right time to enter? The experts are divided in this. While some feel that buying gold after a month would help enter at lower levels, others believe the northward journey will continue because of developments in the US and Europe in the last two days.

Shailendra Kumar, head, commodity research, Sharekhan, thinks that gold will continue to rise because of the European Central Bank's Thursday stance to combat inflation by not tinkering with interest rates. This could further fuel the rise in crude oil prices. On Friday, taking cue from the developments in US and Europe, crude oil prices rose by another $ 8 to $138.92 per barrel.

Jayant Manglik, head, commodities, Religare Securities, however, believes that gold prices may come down by about 7-8 per cent in a month's time. According to him, though the situation in US has deteriorated, (Friday, 6 June, job data from US showed that the jobless rate has increased by 5.5 per cent) investors expect that things may improve from here.

So if you want to invest in gold, there are a few things that you should look at. Historically, gold, dollar and crude prices have been correlated. Let's look at how this works.

Gold plays the role of being a good hedge against inflation. And given that inflation is driven to a great extent by crude oil prices, it is important to consider crude oil movements before taking a call on buying or selling gold as an investor.

Then, the movement in dollar is especially important for Indian investors as the dollar-rupee exchange rate decides the price they pay for gold. That is, an investor pays Rs 13, 986 or $333 for 10 gms of gold at the exchange rate of Rs 42 (42*333).

Now, if the gold prices stay static, but the rupee strengthens to Rs 39 per dollar, the value of the gold would slip to Rs 12,987. Of course, if the gold prices were to rise/fall, the cost would differ.

One would have to come to the gain/loss after taking both the dollar and gold prices into consideration, as both are dynamic in nature. Many experts also feel that the continuous depreciation of the rupee against the dollar is another reason why Indian investors can wait for some time.

"The dollar-rupee exchange rates are not the favour of the Indian investor right now. Though in the long-term gold is a good bet, one can wait for a month's time to see in which direction the dollar and oil prices are headed," says, V Shunmugam, chief economist, MCX.

As a general thumb rule, one can say that the correlation between the dollar and gold is negative because investors enter gold when the dollar slips and vice-versa. Currently, gold prices are northward bound as oil prices are soaring and dollar is weakening, as US economy is slowing down.

But there have been positive indications from the US Federal. "The US Federal has recently said that they are not inclined to cut interest rates any more. This has boosted confidence of investors globally, who now believe, interest rates will stabilise in the US," said a commodity analyst with an international brokerage firm. And if this happens, investors bullish on gold now could move to other instruments.

Of course, it is important that you choose the right route when investing in gold. Buying physical gold has its disadvantages as there is a short-term capital gains tax (depending upon your income), if you sell it before three years. After three years, there is a long-term capital gains tax, but after indexation benefits.

Also, there are gold mutual funds from DSP Merrill Lynch and Tata AIG that invest in gold mining companies. Then, there are gold exchange-traded funds.

The last two are treated as debt funds and taxed accordingly. That is, if you sell within a year of buying, there is a short-term capital gains(depending upon the income). Selling it after a year attracts long-term capital gains tax after indexation.