Several recent reports and a study by DSP Mutual have drawn attention to the fact that the returns from gold have beaten most other assets throughout the 21st century. A look at Emerging Markets returns shows India is the only EM where returns from equities have exceeded the returns from gold between January 2000 and September 2023. While this neglects dividends, it is nevertheless an eye-opener.
Even in India, gold has returned a handsome 10.9% compounded through this long period, while equities (ex-dividend) have returned 11.6% compounded. The return from gold comfortably beat the return from debt everywhere through the last 23 years.
This is not a surprise. Gold is merely living up to its reputation as a defensive haven during times of trouble. Consider the following events (in no particular order of importance) that have occurred during the past 23 years.
The 9/11 attack was followed by wars in Afghanistan and Iraq, the Ukraine War, and the Arab Spring. There was covid-19. There have been sanctions on Iran and Russia, and China-US trade wars. The global financial crisis occurred after the collapse of the US subprime mortgage market. Then there was Brexit, and China’s Evergrande real estate crisis. Indians suffered through demonetisation.
The continuous turmoil of the last 23 years has led to persistent fears of disruptions in global supply chains. The prices of fossil fuels, industrial metals, and other commodities have been very volatile as a result. The combination of covid and the Ukraine war has also contributed to pharmaceutical drug shortages, semi-conductor shortages, and lately, food shortages. This has contributed to high inflation. Plus there’s the looming threat of climate change and the multiple unusual weather events connected to that. Throughout all this, investors have continued to stand by gold. The precious metal has beaten inflation and retained value.
Asset allocation theory suggests investors should hold exposure to different types of assets with different characteristics to ensure that they balance off risks. Equities, for example, impart growth to portfolios (while also exposing investors to bear-market risks). Debt gives assured returns (which may not be enough to cope with inflation).
There’s a very strong case for holding exposure to gold through the foreseeable future purely as a defensive asset. The disruptive events mentioned above have not necessarily all played out. Given multiple geopolitical tensions, we can expect more disruptions. The Ukraine war isn’t over for instance, and neither is the inflation associated with it. China (the world’s second-largest economy) is still struggling to rebound from Covid-related lockdowns. There may be, God forbid, another global pandemic sometime.
Climate change will have deleterious effects for decades to come. Attempts to cope with global warming will also lead to disruptions in the global economy. Most if not all industries will have to rework their current business models to ensure sustainability and reduce carbon impact.
What makes gold especially attractive as a defensive hedge is that 21st-century instruments based on underlying gold help reduce or eliminate some of the drawbacks of holding the yellow metal. You don’t for instance, need to actually buy metal anymore. Instead, you can buy gold ETFs, or Sovereign Gold Bonds. The problems of storage of a bulky, heavy commodity disappear if you buy these “virtual instruments”. So do worries about purity and physical security.
An ETF is an entry in an electronic ledger, which can be bought or sold like any dematerialised stock on the stock exchange. At need, you can even take a loan against an ETF as against the physical metal. If the rupee falls versus US dollar, gold will automatically compensate since the international price is dollar-denominated.
The other big drawback to holding physical gold is that it isn’t an interest-bearing instrument. The only avenue of return is capital appreciation. While this point about being non-interest-bearing remains true for ETFs, the Sovereign Gold Bond Scheme addresses this.
The SGB pays interest and the capital appreciation is zero-tax if the instrument is held till maturity. The rate of interest isn’t much at 2.5% per annum but it is something – it’s better in fact than the dividend yield from many stocks.
Each bond is priced at the equivalent of the current price of 1 gram of gold. An individual can buy a maximum of 4 kg a year. Just like ETFs, bonds can be traded in demat format. Indeed, smart gold traders are always on the lookout for earlier series of SGBs, which are close to maturity and traded at some discount.
It’s paradoxical but it seems the best defensive hedge for 21st-century uncertainties might just be something that has been considered a traditional store of value for over 2000 years.
