To answer these questions, you need to clarify your objectives first. Will gold be a long-term constituent of your portfolio (meaning 10-20 years)? Or are you buying it to profit from short-term fluctuations in its price?

Long-term buyers

If you are buying gold for the long term, remember that it should not exceed 4-8 per cent of your portfolio. As a long-term constituent of your portfolio, it will hedge your portfolio and provide good returns in times when the economy is in the doldrums and other asset classes such as equities are faring poorly. It will also provide protection to your portfolio in case of hyperinflation.

But over the long term don’t expect great returns: it is likely to be around 2 per cent above the inflation rate. That is why financial planners suggest it should form only a small part of your portfolio. When buying for investment, buy a gold ETF (exchange traded fund) and not jewellery. That way you will lose less in manufacturing charges when you go to sell, and you will also be rid of the fear of theft. When buying for the long-term (meaning decades), anytime is a good time. To optimise your buying cost, buy a little every month or on price dips.

Short-term buyers

If, on the other hand, you wish to trade in gold, and hence want to know which way gold prices are headed, the key variables to watch would be US inflation, value of the dollar, the world economic outlook, and sale of gold by major central banks.

Normally, the price of gold rises as inflation rises and the dollar weakens. A poor economic outlook also augurs well for gold. And a large sale of gold by a central bank increases supply and hence drives its price down.

Billy X Wang, gold analyst at India Infoline, portrays five scenarios to predict which way gold is headed.

Scenario J. J stands for Japan. What if, despite the Fed’s monetary expansion, a Japanese style deflation takes hold? In this case, since gold’s role as an inflation-fighter becomes redundant, its price is likely to decline.

Scenario W. W stands for Wonderland. In this scenario, the Fed manages to engineer a recovery (through monetary loosening), and is spot on in staving off inflation (through monetary tightening). In such a scenario, gold will again decline.

Scenario H. H stands for inflation hawk. The Fed decides that inflation is a graver threat than slowing growth. It moves decisively to kill incipient inflation and unwinds the recent monetary surge. Again, gold will decline.

Scenario L. L stands for lame. The Fed delays tightening of interest rates, fearing it will kill off an incipient recovery. Inflation reaches double digits. The Fed then makes a few half-hearted attempts to coax the inflation genie back into the bottle, but finds it difficult. In that case, gold soars.

Scenario Z. Z stands for Zimbabwe. What if the Fed fails to curb inflation and Zimbabwe-type hyperinflation takes hold? Unlikely, but that would be the gold aficionado’s dream-come-true scenario. Gold would once again soar.

Gold thrives in conditions of economic uncertainty and fear. It also does well when paper currency loses its value owing to inflation. For all those wishing to speculate in gold, changing inflationary and economic outlook are the key variables to watch. This, admittedly, is no mean task.

If you are a conservative investor, buy in dribbles till you reach the 4-8 per cent limit, and then hold gold in your portfolio till need or calamity (war, hyperinflation, economic or financial crisis) strikes. Then sell. u

sk.singh@expressindia.com