Home / Money / Personal Finance /  Adding gold will help diversify your portfolio

In India, precious metals like gold and silver have traditionally been recognized as physical assets, predominantly in the form of jewellery, given their deep significance in our culture. Jewellery carries ethnic significance and is symbolic in rituals, especially during weddings. Globally, both these metals are also considered as financial assets for portfolio diversification.

Gold is commonly perceived as a safe haven investment. The key characteristics that are attributable to safe havens are its low volatility, low correlation and utility value.

Low volatility: An asset class with lower volatility as compared to equities is likely to mitigate downside risk.

Low correlation: The extent to which the performance of two or more investments fluctuates in relation to each other is called correlation. The fundamental essence of a well-diversified portfolio is that the underlying asset classes should exhibit low correlation to each other. Safe havens typically exhibit very low or negative correlation vis-à-vis risk assets such as equities.

Utility value: There is recurring demand for such assets due to an inherent value, which takes away the risk of such assets becoming worthless.

Gold exhibits very low to negative correlation to various asset classes as shown in the chart. It shows that in the event of a fall in the equity markets, the price of gold will likely rise and vice-versa.

For silver, demand has typically been driven by industrial usage, renewable energy, consumption in the form of jewellery and silverware, and as an investment avenue.

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An analysis of price movements of gold and silver along with Indian equities in the past three decades suggests the following. One, silver has exhibited a positive co-relation to Indian equities. This is in contrast to gold, which has negative correlation to Indian equities. Two, though the CAGR for silver and gold during this period has been 10%, volatility (measured by standard deviation) for silver has been much higher than gold. In fact, standard deviation for silver is at similar levels to Indian equities.

Similarly, the maximum drawdown (fall from peak to trough before recovery) for silver is almost double that of gold.

Gold and silver price movement is likely to remain range- bound in the near future. The US Fed has continued to maintain a hawkish stance. It will be important to see the impact of interest rate hikes on inflation numbers. Updates regarding geo-political tensions and China’s overall covid situation could be in focus. Very importantly, volatility in US yields and dollar will be an important indicator for further direction in bullions.

From a long-term perspective, in a portfolio which has allocation to both equity and fixed income, the addition of gold, as opposed to silver, could provide healthy diversification. Gold should be treated predominantly as insurance or hedge against heightened volatility. One can invest in gold either through Gold Mutual Funds or Sovereign Gold Bonds (SGBs).

Nitin Shanbhag is head- Investment Products, at Motilal Oswal Private Wealth

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