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Business News/ Money / Personal Finance/  Navigating the current global uncertainty with gold

Navigating the current global uncertainty with gold

  • Gold consumption in China has increased by over 6% this year despite higher prices. There is a lesson for the rest of the world in this

The Chinese central bank has exchanged some of its dollars for gold as it ran down its US Treasury holdings at a brisk pace—around $350 billion in the past two-three years.

The Chinese gold rush is a stark reminder of investor behavior when market and economic cycles turn. Gold consumption in China has increased by over 6% this year despite higher prices. The Chinese central bank has exchanged some of its dollars for gold as it ran down its US Treasury holdings at a brisk pace—around $350 billion in the past two-three years. The protracted bear phase in the stock and real estate markets has dented investor sentiment, driving a cross-section of Chinese retail investors to gold. The Chinese central bank, too, has been a net buyer in each of the past 18 months.

The Chinese gold rush is a stark reminder of investor behavior when market and economic cycles turn. Gold consumption in China has increased by over 6% this year despite higher prices. The Chinese central bank has exchanged some of its dollars for gold as it ran down its US Treasury holdings at a brisk pace—around $350 billion in the past two-three years. The protracted bear phase in the stock and real estate markets has dented investor sentiment, driving a cross-section of Chinese retail investors to gold. The Chinese central bank, too, has been a net buyer in each of the past 18 months.

The rest of the world can learn a lesson from this: It is essential to have a diversified approach to investing. Waiting for the risk assets’ music to stop and then scampering for safe havens like gold can be an expensive strategy, as Chinese investors are now realizing as they are paying a high price for gold.

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The rest of the world can learn a lesson from this: It is essential to have a diversified approach to investing. Waiting for the risk assets’ music to stop and then scampering for safe havens like gold can be an expensive strategy, as Chinese investors are now realizing as they are paying a high price for gold.

This might be a sign of the times as fear and greed get amplified by social media and its unscrupulous influencers, which can be especially detrimental for inexperienced investors who have not weathered the vicious economic and market cycles of the past.

Regardless of the forecasts and views, gold alone checks most of the boxes as a portfolio diversifier. Those who diversify into gold are in good company, alongside central bankers worldwide. Central banks’ US dollar holdings have decreased by around 12% in the past 20 years. While this rebalancing may appear to occur at a glacial pace, it indicates an alarming trend for the dollar, especially if it continues into the next decade, given central banks’ extremely conservative approach and their public scrutiny.

Central banks: A dilemma

A few missteps by the US Federal Reserve, such as underestimating inflation post-covid and its tendency to be data-oriented rather than providing forward guidance, pose a challenge for central banks holding a large volume of US Treasuries. This issue is evident in the record central bank purchases of gold in the past couple of years.

There is also a strategic reason for the “Global South" to diversify away from the US dollar. Trade disputes, geopolitical events and re-globalization raise the specter of US sanctions, quickly backed by its allies from the “Global North", as seen with Russia in recent years.

Gold carries no credit risk and stands as one of the most liquid assets, making it an appealing diversifier or hedge for central banks and individuals alike. Based on historic data, gold tends to perform well at times of high volatility in risk assets like equities. It has been noted as the best-performing commodity during global recessions.

In the near term, Chinese and other Central Bank purchases are the key drivers of gold prices. Demand in India has remained resilient despite higher prices. These two countries together account for approximately half of the global physical demand. Global ETF (exchange-traded fund) holdings in gold are at a five-year low, and, despite rising prices, outflows continue and are unlikely to reverse until there is a considerable correction in risk assets like equities and credit, mirroring events in China. Hedge funds and momentum funds hold sizable positions in gold that may lead to near-term volatility due to profit taking.

Other global factors

In addition to volatile situations in the Gulf region and eastern Europe (Ukraine, specifically), the world is also bracing for two major events that will have global repercussions as the world’s largest and richest democracies go to the polls. India is no longer a “rounding-off" item in the global financial markets, and the election outcome could impact the overall sentiment towards emerging markets. A second term as US president for Donald Trump is not what the struggling Chinese economy needs, as it could increase the probability of a depreciation in the yuan. A widespread tariff war could lead to currency market volatility, which could be conducive to gold.

Gold ETFs

The good news is that, according to the United Nations, World Health Organization and Organisation for Economic Co-operation and Development, the world is becoming a better place to live in with each passing year. However, do ‘black swan’ economic and geopolitical events no longer matter? Has humankind conquered the ups and downs of economic and market cycles? If you’re unsure, you might not want to put all your eggs in one basket. Consider a multi-asset approach to investing with allocation to gold ETFs.

Gold ETFs are a safe, convenient, efficient and liquid solution for investing in gold.

Vikram Dhawan is head of commodities and fund manager at Nippon India Mutual Fund. The views expressed are personal.

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