The rally in the equity market has led to modest returns from gold so far this year. Global gold prices have gained barely one per cent year-to-date and corrected 10 per cent from their highs of last year.

This may be a good opportunity for Indian investors to add some gold exchange traded funds (ETFs) to their portfolios. Investors can park up to 10 per cent of their portfolio in gold to diversify against risks such as a stock market fall, rising inflation and a weak rupee. Gold prices rarely move in tandem with other assets such as stocks, bonds or even commodities.

Having said this, the argument for buying gold ETFs today is threefold.

One, fundamentals for gold remain strong at a time when most other commodities are facing weak demand due to slowing global economic growth.

Data from the World Gold Council show that in the last three years while world gold demand has expanded by 1,000 tonnes, new supplies have only expanded by half this quantity, leading to a tighter world market. In the nine months ended September, new mine output of gold was enough to meet only two-thirds of the global demand. The shortfall has mostly been met by consumers recycling scrap gold.

Two, while retail buyers of gold jewellery and bars have slowed purchases this year, central banks and exchange traded funds have sharply increased their buying. Reserve diversification by central banks has, in fact, been a driving force behind global gold prices in recent years. From selling 260 tonnes and adding to global supplies in 2008, central banks have today turned into major gold buyers, accumulating 373 tonnes in the first nine months of 2012. The buying interest from smart money, in the form of ETF investors and central banks, could support gold prices at higher levels. Continuing asset purchase programmes of central banks in the developed markets, by infusing liquidity into the markets and devaluing paper currencies, also supports gold prices.

Three, despite the eight-year rally in global gold prices, the metal continues to be under-owned by professional investors. One estimate suggests that less than one per cent of the global financial assets are today parked in gold.

For Indian investors, gold ETFs, which earn their returns from rupee-denominated gold prices, offer an additional benefit. They help hedge the portfolio against the risk of any long-term depreciation in the rupee against the dollar. The rupee has weakened, and a steady depreciation of the currency over the long term appears likely. The size of the assets managed and the volumes traded should be key criteria for investors choosing between gold ETFs in the secondary market. Today, Goldman Sachs Gold BEES and Reliance Mutual Fund’s R Shares Gold Fund manage the largest assets. Their current Net Asset Value (NAV) hovers at Rs 2,990-3,000 a unit. Investors should avoid paying market prices that are significantly out of sync with NAVs.

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