After a blistering rally over the past year, gold prices are starting to see sharp corrections. Since the record high on 28 January, global gold prices have fallen over 12%. But on Tuesday, it bounced back sharply.
Here is a guide to the global macroeconomic factors that are driving down prices of the precious metal, and how investors should think about gold in their portfolios in light of this correction.
1) How are gold prices behaving worldwide?
Historically, a weaker dollar has lifted gold prices while a stronger dollar has weighed on gold as it is a dollar-denominated asset class. Donald Trump’s nomination of Kevin Warsh to succeed Jerome Powell as head of Federal Reserve has reduced policy uncertainty and also increased expectations of a stronger dollar. Warsh is viewed as hawkish, easing rate-cut expectations and supporting the dollar, with the dollar index rising to 97.39 (as of 1.30 pm IST on 3 February).
However, experts say gold prices on Tuesday recovered sharply as investors looked to buy the dips.
2) What's likely to happen next?
Many experts still have a positive outlook on gold, though further gains will depend largely on continued buying by central banks. So far, demand for physical gold from central banks, along with inflows into gold exchange-traded funds, has been a key driver of the rally. Central banks worldwide have increased gold purchases to diversify their reserves away from the dollar, whose role as the dominant global reserve currency has come under scrutiny in recent years.
Rising global uncertainty has also led investors to increase their allocations to gold exchange traded funds (ETFs), which are backed by physical gold. However, if the dollar strengthens further, it could put some pressure back on the gold prices.
3) How does this affect your investments?
Gold ETFs on the domestic exchanges have corrected more than 14% since 29 January. However, this does not alter the role of gold in a portfolio. Gold is better viewed as a hedge than a return-generating asset. Its primary role is to provide protection during periods of uncertainty, when other asset classes may underperform.
4) What should the investors do?
Investors who have 10-12% exposure to gold to hedge their portfolios don’t need to do anything. However, those who became overexposed to gold in the chase for returns may consider re-balancing their portfolios.
Those who are yet to start investing in gold can start building up their exposure in a staggered manner, since analysts have said the possibility of a deeper short-term correction or consolidation cannot be ruled out.
5) What’s the best way to invest in gold?
For investors looking at gold purely as an investment, gold ETFs, gold fund of funds or multi-asset funds are more efficient options than holding physical gold. Physical gold involves storage and safety concerns, and investments through jewellery also come with additional costs such as making charges.
Investing directly in gold ETFs requires a demat account, as ETFs are traded on stock exchanges. However, investors can gain exposure to gold ETFs through gold fund of funds or multi-asset funds, which do not require a demat account. Multi-asset funds offer diversification across asset classes, with equities typically forming the core allocation, alongside exposure to debt, gold, silver and real estate investment trusts.