Financial year 2018-19 was a busy year for the Reserve Bank of India (RBI)—from increased questioning of its autonomy, a premature exit by governor Urijit Patel, the NBFC (non-banking finance company) liquidity crisis, the NPA (non-performing assets) problem in public sector banks, a slowing economy, sticky rate cut transmissions to a declining rupee.

The news is that in the midst of this mess, RBI has been doing some gold shopping. As per the World Gold Council, RBI raised its gold holdings by 52.3 tonnes in the year ended March 2019, its biggest purchase in nearly a decade since it bought 200 tonnes from the International Monetary Fund in 2009-10. This number should make you stop and think. Why gold, and why now?

Why is RBI buying gold?

In 2009, obviously, the global financial crisis of 2007-08 prompted the reappraisal of gold’s role as a portfolio diversifier and liquidity tool for the central bank. But what could have prompted this change in RBI’s attitude towards gold now? Possibly, the need to diversify its reserves away from the dollar. There are many who predict “peak dollar" but there are more critical reasons leading to this urgency to diversify reserves into an asset like gold.

Here are some reasons why it’s happening now. It seems like a clash for supremacy is at the core of the US-China trade wars, which can be expected to continue, taking a toll on economic growth. Weaponizing trade and instilling sanctions seems to be a tendency of the country whose currency is the world’s reserve currency and a norm of trade, giving the central bank more reason to diversify reserves. This irrational behaviour from the world leadership creates an uncertain economic policy environment, which will add to economic deceleration. Countries, in an effort to negate the slowdown effects of the trade war and to boost exports, could enter into a currency devaluation race. Central banks, with the agenda of supporting growth, will cut rates which will mean that real interest rates will be on a decline.

In a world where competing assets like currencies and government bonds are expected to underperform, gold seems like a good investment. Going forward, the overriding theme seems to be that with sluggish growth a continuing reality, a weaker currency will help, while a stronger one won’t. In a nutshell, there will be a situation of “competitive devaluation". Devaluation is the “beggar-thy-neighbour" policy that can aggregate uncertainties in global financial markets. The biggest beneficiary of the onset of currency trade wars will be gold, basking in the growing supply of freshly printed paper currency worldwide.

But is RBI the only one doing this? No. Central banks around the world have been stocking up on gold, with Russia, China, Turkey, Kazakhstan, Poland and Hungary taking the lead. India seems to be a late entrant in the camp of gold buyers. Countries like Russia and China have been accumulating gold over a few years, given that they are much more impacted due to trade uncertainty as compared to India due to our lesser external linkages. RBI, like other central banks, seems to think that it’s prudent to diversify some its dollar reserves to gold, given the uncertainty surrounding policy making; gold can be the asset that cannot be controlled by the whims and fancies of any policymaker. We expect that the central bank’s diversification of reserves will continue, given the uncertainty surrounding policy making vis-a-vis the US, which prompts it to reduce its reliance on the dollar.

Lessons for investors

When the central bank buys gold, you may also buy gold. To put it another way, just like RBI, you need to gauge the direction in which the world markets and economies are headed. Relook at your risk management practices and diversify your investments by parking 10-15% of your money in gold. Like it has helped central banks during times of stress, it has also helped common citizens during times of financial distress. Importantly, overall, gold aids in stability of returns of a portfolio and brings respite during bad times. The other ability of gold is to maintain value over long time periods.

So how do you go about it? Well, if you have bought enough gold, stay with it. If not, use any correction as an opportunity to add gold to your portfolio, or ideally keep allocating to gold in a systematic manner and build you allocation over the next six to 12 months.

Chirag Mehta is senior fund manager, alternative investments, Quantum Mutual Fund

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