In Indian culture as well as investment portfolios, gold has long been an integral part and rightly so, India is one of the largest gold buyers in the world. However, after rocketing in 2020 post the pandemic, gold seems to have lost its sheen and has underperformed since then. It soared about 18 percent between March and December 2020 but ended up giving negative 4 percent returns to its investors in 2021. This year, gold has been on a positive trajectory and returned about 4.5 percent till 30 April.
What can fuel gold to new highs?
Gold has served as a safe haven and risk-reduction tool for portfolios as it has a tendency to do well during uncertain times. Historical precedence suggests that gold has on average given double-digit returns in the year following a crisis, be it post the Soviet-Afghan war, global financial crisis, or the US-Libya attacks. As the Russia-Ukraine war is persisting, gold can continue to find price support.
Further, the metal has a low correlation with other assets which makes it appealing from a portfolio diversification standpoint. It has a lower drawdown when compared to equities, especially during times of crisis. There is also speculation of a probable recession in the United States as a result of yield curve inversion indications. In fact, this augurs well for gold, as gold prices have often climbed during recent yield curve inversions.
Gold is also touted to be a classic inflation hedge and currently, the way inflation is shaping up, it is here to stay. Investors associate high inflation with high risk and accordingly, high persistent inflation fuels gold prices. In fact, a study by the World Gold Council suggests that a one percent increase in inflation translates into a 2.6 percent rise in the metal’s demand.
One important factor that needs to be noted is that for a few years now, Russia has been shifting part of its reserves to Gold. There is also a belief that China will eventually follow suit. Also, following the Russia-Ukraine conflict, there is an increasing motive to peg reserves to gold, as these reserves cannot be sanctioned or frozen, unlike USD reserves. If China and other countries as well move to peg their reserves to gold, it can increase the demand for the metal substantially and trigger a strong upside.
Are there downside risks?
There are a few variables that can also limit gold’s rally. To begin with, gold has an inverse relationship with interest rates and the Fed is predicted to be hiking interest rates substantially this year. A 50 basis points hike is on the table in the Fed meeting this week itself. This can make investors shift to bonds as the opportunity cost of holding gold increases with higher interest rates. It seems that this is already being reflected in gold prices, as they have corrected in the last two weeks of April.
Finally, because Covid's resurgence has resulted in lockdowns, China's gold demand may be sluggish in the immediate term. Because China is one of the world's top gold consumers, this might limit gold's near-term potential.
The returns that gold has delivered since it began trading on the MCX in 2003 till February of 2020, i.e. just prior to the pandemic, are roughly in line with what Sensex has delivered. While there has been some variation in returns during specific event occurrences, the long-term returns of the two have been similar. However, the return differential widened sharply post-pandemic and the odds are now stacked against gold catching up.
Technically as well, the major trend in gold is bullish. Gold has been correcting lately due to the steep rally in the Dollar index apart from the interest rate hikes that are incoming. The Dollar index is negatively correlated with gold and the index is currently trading in overbought zones at multi-year resistance levels of 103-104. Should the dollar index reverse, gold can resume its upward move? Further, clusters of supports of gold are also forming around 50,500 to 50,000 levels. So it is likely that gold will bounce back in the short term after a successful retest of the said levels.
What should investors do?
The unique characteristics of gold as an inflation hedge, risk adjustment tool, and asset diversifier make it a compelling addition to one's portfolio. If you haven't started investing in gold yet, Akshaya Tritiya is a wonderful time to start. Investing in gold through exchange-traded funds (ETFs) or Sovereign Gold Bonds (SGBs) can be a more cost-effective choice than purchasing physical gold. In addition to price appreciation, SGBs also give additional interest income.
While the portfolio allocation to gold should primarily be determined by one's income and investing goals, an allocation of at least 5-10 percent is recommended. Investing in gold in the form of a systematic investment plan (SIP) is a smart approach to do it.
(The author is Head of Equity Research, Samco Securities)
Disclaimer: The views and recommendations made above are those of the author and not of MintGenie.