How much gold in my portfolio will protect against a market crash?

Each time gold prices start to move up, there is talk about how “gold is a hedge”, “gold is a safe haven”, about how every investor should have a small exposure to it, 5-10%. The question investors should really be asking is, how much gold in my portfolio will protect it against a market crash?

I have maintained several times before that investing in gold is not the same as buying gold and gold in small amounts will not really make a big difference. So let me reiterate this with a specific example: the 2008 market crash.

Also, check out:

• Gold vs Equity (Sensex) 40-year return and risk comparison
• Sovereign gold bonds: What you need to know before buying
• Gold Savings Account: Features, Benefits, How to use and When to use

How Sensex and Gold (INR) reacted to the 2008 (US) housing crisis

On 11th Jan 2008, the Sensex was 20827. It fell to 8325 on 6th March 2009. A 60% fall in 420 days!! During this period, Gold (INR per gram) moved up from Rs. 1235 to Rs. 1707 a 38% gain. Yes, yes that is big, but do not get carried away.

Let us assume an investor has Rs. 100 as the portfolio value in Jan 2008 (same dates as above) with Rs. 40 in fixed income and Rs. 60 in equity. We will assume a non-market linked fixed income as that is pretty common in India (even today and certainly then) with a 7% annual return.

During this period, the Rs. 40 in fixed income would have moved up to Rs. 43 (all numbers rounded off) and the Rs. 60 in equity would have dropped to 24. Thus Rs. 100 became Rs, 67. A fall of nearly 33% (imagine the carnage for some geniuses who want to hold higher exposure in equity because they are young and/or have a high-risk appetite).

The question we shall ask now is: Can I reduce this 33% fall by at least 40% by adding gold. That is, reduce the 33% fall to about 20% by adding gold. This reasonable IMO. So let us check out various possibilities.

1. Equity: 60% Fixed Income: 35% Gold 5% Loss:  31% Protection: 1.5%
   • This means the portfolio has 60% in equity, 35% in fixed income (debt) and 5% in gold and the loss during the above mentioned 420 day period is 31%. The protection offered by adding gold is 1.5%. That is, compared to a 60% equity: 40% debt portfolio without gold, this portfolio has lowered loss by 1.5%
2. Equity: 55% Fixed Income: 40% Gold 5% Loss:  28% Protection: 5%
3. Equity: 55% Fixed Income: 35% Gold 10% Loss:  26% Protection: 6%
4. Equity: 55% Fixed Income: 35% Gold 10% Loss:  26% Protection: 6%
5. Equity: 50% Fixed Income: 40% Gold 10% Loss:  23% Protection: 10%
6. Equity: 50% Fixed Income: 35% Gold 15% Loss:  21% Protection: 11%
7. Equity: 55% Fixed Income: 30% Gold 15% Loss:  25% Protection: 8%
8. Equity: 55% Fixed Income: 25% Gold 20% Loss:  23% Protection: 9%
9. Equity: 50% Fixed Income: 30% Gold 20% Loss:  20% Protection: 13%

Option number finally reduced the loss to about 20%. This is about 40% lower than the fall in a portfolio without gold. Even for this 20% exposure to gold is necessary. So that “small exposure” of 5-10% will not pad the wound much.

Now, now, we have just looked at 420 of some of the worst days in stock market history. When the markets do not crash (which is obviously a lot more common), gold is high maintenance.

• It is extremely volatile, much more than stocks!!
• It is highly dependent on INR USD movement: Gold Price Movement: USD vs INR
• Long term returns are comparable to fixed income and it is taxable like a debt fund (if you buy etfs of gold funds). Oh please do not think about Soverighn gold bonds!! They are for buying gold in a risk-free manner at a future date (see video below) and not for investing in gold. Stop confusing investing in gold and buying gold!!

So suppose you decide to hold 20% of gold in your portfolio, it will protect you to some extent when there is a global meltdown and fear in the stock markets but not too much. The price you need to pay for this is: rebalancing from time to time either annually or tactically and associated taxes.

Please do not say, “I will use a multi-asset fund”. It will work only if that is your only fund and you have the courage to pay taxes on it if has a debt fund-like portfolio when you withdraw.

There is no free lunch. It is not just important to choose your poison but also to choose it in the right measure! I would rather have no gold in my portfolio and fill it with safer instruments like fixed deposits. In India, the small savings schemes are the hedge and safe haven!

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