Gold continues to shine brighter: 5 key reasons to add this precious metal to your portfolio
Investors can take exposure to gold via ETFs and Sovereign Gold Bonds. Gold should be viewed as a diversification tool in a portfolio, not for high returns. Central banks' strong demand for gold has surged prices, with majority purchases from emerging markets.
Gold's allure has captivated humans for millennia. The earliest recorded use dates back to 4000 BC, and by 1500 BC, it had become the standard medium of international trade. This association with money has continued, even though gold coins are no longer official currencies.
Central banks worldwide continue to hold a significant portion of their liquid reserves in gold. In fact, 2022 saw a 7-decade high of 1,081.9 tonnes purchased by central banks, with 2023 purchase only slightly lower at 1,037.4 tonnes. This strong demand is one reason why gold prices have surged recently, rising roughly 20% over the past year.
Also Read: Planning to invest in gold as an asset class? This is how the taxation works
Emerging markets drive gold demand
The vast majority of purchases during 2022 and 2023 have continued to come from emerging market central banks. A World Gold Council survey, amongst Central Banks from both advanced and emerging markets, regarding factors affecting the Central bank’s decision to hold gold, throws light on the possible reasons why Central Banks, especially from emerging markets, are buying so much gold.
Factors contributing to gold price rise
Interest rate policy: Traditionally, there has been an inverse relationship between gold prices and interest rates, meaning that when interest rates rise, gold prices tend to fall, and vice versa. In its recent policy meeting, the Fed had indicated for at least 3 rate cuts rate cuts in 2024. So easing monetary policy by the US Federal reserve is another contributing factor to the recent gold price rise.
Global uncertainty: 2024 is poised to see elections in more than 64 countries which brings in a lot of uncertainty in the markets. And during uncertain times, investors flock towards safety. Hence, gold becomes a natural option for them.
Geopolitical issues: Not to mention, the series of geopolitical issues in the middle East and Russia that we have been observing which again sends shock waves to the investor community and nudges them towards safety.
Also Read: 5 reasons why gold ETF is better than physical gold for uncertain times
The case for gold as an asset class
Gold is a safe haven asset class. When there is turmoil in the market due to macro events and equity markets are facing a lot of volatility, gold as an asset class tends to do well. Hence it is an effective hedge against equities. Hedging is a strategy employed to reduce the risk of adverse price movements in an asset. The approach helps mitigate the losses in an asset / instrument by gains in another investment. This helps navigate market correction.
The below table compares performance of gold against Nifty 500 performance during times of crisis.
Gold as a hedge against inflation
Inflation is the rate of increase or decrease in prices over a specific period of time. It indicates how much more expensive or cheaper a particular set of goods and services has become over a certain period, like a quarter or a year. Historically, inflation has impacted returns on equity and gold in different ways. High inflation has generally correlated with lower equity returns. On the other hand, over the long term, gold acts as an efficient hedge against inflation.
The below table illustrates the performance of Nifty 500 and gold during periods of increasing inflation. We have considered wholesale price inflation for the purpose of the below analysis.
Building a balanced portfolio with gold
A portfolio that includes both equity and gold is an efficient way to achieve capital protection and create wealth in a sustainable fashion. The performance of gold will offset the poor performance of equities during unfavourable macro events or persistently high inflation.
Also Read: Sovereign Gold Bonds: From advantages to eligibility; all you need to know
We have explored this idea in the below table. The table below explores the performance of equities and gold individually and as an equity weighted portfolio. As seen below, the portfolio does better than both standalone equity and gold when it comes to generating higher risk adjusted returns over the medium to long term.
There are different avenues through which one can take exposure to gold. Barring buying physical gold (which is not always a feasible option), investors can also invest in gold via ETFs and Sovereign Gold Bonds (SGBs).
Last but not the least, it is important to understand that in the context of portfolio building, gold should be viewed as a diversification tool and not an investment that will fetch high returns. Hence averaging the price will not work when prices are rising and allocation to the yellow metal should not exceed 10-15% of the portfolio.
Naveen KR, smallcase Manager and Senior Director at Windmill Capital
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First Published:16 May 2024, 11:45 AM IST
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