The Investment Case For Gold

Gold could act as a better diversifier due to its low correlation to other asset classes. It thus helps in the risk reduction and management. The unconventional monetary policies pursued by the central banks has brought focus over gold which is least malleable to their shenanigans

The recent surge in prices has renewed higher interest among the investors to allocate gold to their portfolios. This is partly driven by the geopolitical and macroeconomic policies of the countries, adding to the Fear of Missing Out (FOMO) amongst the investors. While it’s true that the gold price has surged partly due to the geopolitical and macroeconomic factors, it’s still not an outright winner. Unlike other investment assets, gold needs to be looked in a different perspective. Gold could be considered as a safe-heaven asset and investment asset.

The safe heaven is more than psychological and deeply rooted in culture and history. The presence of gold as a continuity and contingency element in the household assets makes it safe heaven. Unlike other physical assets like real estate, there’s no deterioration in its physical nature over long periods (where an open land is subjected to weather conditions, a constructed house could be dilapidated, etc.). The tangible nature and preservation of wealth that passed over generations adds glow to this metal.

The investment case for gold however, is through financial assets with gold as an underlying - ETFs (Exchange Traded Funds), MFs (Mutual Funds), Equities of gold mining companies, etc. The outcome of this varies though primarily on the gold price, the macroeconomic factors also rule the prospects of mining companies. The investment case is also bolstered by the inflationary hedge tool (though conflicting evidence) and diversification.

While clamor for gold is gaining, one needs to be objective amid the rhetoric. Particularly, the rupee value of gold price seemed attractive, it has come a cropper in the medium- to long- term. The YTD returns favor gold with an outperformance of approx 2 per cent over equities (broader index of NIFTY 50) the one-, three-, five-, ten through twenty years favor the equities. And the outperformance of equities is by a stark difference, of course, these data vary from point-to-point depending upon the cycle. It could’ve turned in favor of gold, at least in the medium term had we compared the data about two months back.

While I’m not contesting the role of gold in the portfolio, the size of the allocation should be well thought through. Past data indicates the troughs in the equities were much better managed with an allocation to gold in the portfolio along with debt. A pure 60:40 equity-debt portfolio would’ve had much volatility than a small introduction of gold through the 70-25-5.

Gold could act as a better diversifier due to its low correlation to other asset classes. It thus helps in the risk reduction and management. The unconventional monetary policies pursued by the central banks has brought focus over gold which is least malleable to their shenanigans. The fiscal imprudence, particularly by the developed economies has created a strong case for currency debasement where gold possibly could arrest the loss of value, making a strong rationale for allocation in the portfolios.

So, before jumping into the bandwagon of adding up more gold, one must re-evaluate their understanding and requirement for such an allocation. The strategy to hedge against the geopolitical risks might favor gold in the short-term but it then needs a realignment as things start to settle. A larger proportion or overweight on gold could backfire as history shows lumpiness and inconsistent returns while equities have certainly delivered superior returns. A strategic allocation of up to 10 per cent of the portfolio depending on the investor risk profile, could help for better stability and diversification.

Overall investors should re-look at why the allocation is being made at the first place and accordingly the sizing should be done. Exhibiting herd mentality would only lead to repenting later.

(The author is a partner at “Wealocity Analytics”, a SEBI registered Research Analyst firm and could be reached at info@wealocityanalytics.com)