To quote Oscar Wilde, “Consistency is the last resort of the unimaginative”. However, the quote applies best when one seeks disruption actively. What the world is experiencing today is unprecedented disruption, creating chaos and anxiety.
The past two decades have been action packed for the financial services ecosystem globally – the 2008 financial crisis, the European Crisis, BREXIT, the pandemic, Ukraine – Russia conflict and the undercurrent of the Sino-American rivalry that runs in parallel to the above events.
One of the common responses by central banks prior to the pandemic and the Ukraine – Russian conflict, was yield curve control either through quantitative easing (which pertains primarily to long term securities) or purchase of short-term securities to keep the interest rates low.
The pandemic and the Ukraine – Russia conflict significantly upended the supply chain ecosystems, which had become too used to globalisation, causing supply chain bottlenecks to result in global inflation. At first, every central bank ignored it, considering it to transient in nature.
However, as the external factors remained persistent, central bankers began to realise that the inflation is here to stay and needs to be controlled. This is what kickstarted rate hikes globally amongst various central bankers. Rate hikes by the Federal Reserve, Bank of England, European Union, and the Reserve Bank of India, to name a few central banking regulators have been notable and substantial.
Financial assets not the best option in a high interest rate scenario
Interest Rate hikes by central bankers is the most common monetary policy instrument available to rein in inflation. Rate hikes usually reduce the aggregate demand in the economy thereby cooling the overheating in the economy.
They also tend to cool public financial markets, which is usually experienced on account of unwinding of leveraged trades, which further have knock-on effects on bond markets on account of large amounts of liquidity being generated from them.
Private markets, even though not marked to market, experience large unrealized losses on account of higher discount rates. Thus, rate hikes largely result in decline in the value of financial assets. Real Assets become more valuable as they serve as a good hedge against inflation. This is where gold as an asset class comes in.
Building the case for Gold ETF as an asset class
Since gold serves as an effective inflation hedge, investing in gold in times of high inflation and high interest rates, is an effective investment strategy. ETFs (Exchange Traded Funds) are an effective way to gain exposure to the asset class, without having to physically buy gold – though must add a rider here that in the southern part of India, buying physical gold still takes a lot of precedence over Gold ETFs.
ETFs offer the much-needed advantage of a real asset class exposure with the feature of liquidity that makes financial assets attractive. While the amount of investment in gold ETFs and the timing, are a function of where an investor is in their portfolio journey, it is a good asset class to evaluate during times of uncertainty such as today.
As the world moves to regionalization from globalisation and near-shoring from offshoring, efficiency will not be the topmost parameter of consideration and thus inflation is expected to remain elevated, though not to its current levels. With this background in mind, it would be feasible to evaluate gold ETFs as an asset class to consider in the portfolio allocation strategy, of-course subject to the overall return and risk objectives of the investor.
Conclusion - A word of caution
While we live in a high interest rate environment today, the reality may change in the next 18 months and hence its imperative that every investor have in place an effective portfolio rebalancing strategy, that would time the macroeconomic expectations in line with the investor specific risk and return objectives.
While gold ETFs serve as a good asset class during times of high inflation, it is imperative to understand when the external factors driving the value of gold change and take investment calls accordingly. It is always useful to consider financial advice from regulator registered financial advisors and make an informed decision.
Vivek Ramji Iyer, Partner and National Leader Financial Services - Risk Advisory at Grant Thornton Bharat LLP