At a time when the world is going ga-ga over stocks and debt is too easy to borrow, do not forget gold, says Anil Rego.
On February 5, stock markets suffered one of their more precipitous falls in recent years. Events like this selloff are a good reminder that gold can deliver returns and reduce risk in portfolios.
Gold, in comparison to many assets, is a commodity that would go up or down depending purely on the demand for it. However, history is a testimony to the fact that gold has often acted as a portfolio hedge in market downturns and the recent pullback was no exception.
In fact, gold's effectiveness improves when market corrections are wider or sustained for longer. In years like 2008, 2011 and 2015, gold has shown that it is the only secure refuge for investors.
Gold as part of a larger portfolio
Depending on your risk profile, one may allocate 5 to 10 per cent of your portfolio to gold through a variety of instruments such as gold exchange-traded funds, gold equity funds, sovereign gold bonds etc.
The world continues to remain in a unique state of great disequilibrium. This is both with respect to the global economy and geopolitics. Things are always touch-and-go in some areas of the world.
The potential fallout of the geopolitics globally seems to now cap the downsides in gold, which as an asset has not performed that well. But given the macroeconomic picture, gold will be a useful portfolio diversification tool and thereby help you to reduce overall portfolio risk.
As a safe haven, gold typically benefits from the flight of quality flows.
This consequentially makes stocks and gold inversely correlated with sharp market downturns. This behaviour is the opposite to that of risk assets, such as oil.
Why gold
Gold serves four key roles in any investor portfolio.
So far, 2018 has been a good case in point of gold's role as a strategic asset.
Gold has gained over four per cent in less than three months (year to date), better than treasuries (government bonds), and stocks (Sensex or Nifty).
Clearly, gold has been one of the best-performing asset classes year-to-date.
Weakness in the US dollar continues to provide support to gold prices as the precious metal is denominated in that currency.
Its price movement both in India and globally is impacted by any actual or perceived risk build-up on economic, political or natural fronts.
In the absence of major concerns on the geopolitical front, gold price outlook is determined by Federal Reserve's movement on US interest rates.
There were three US Fed interest rate hikes penciled in for 2018 at the beginning of the year. However strong corporate earnings growth, low unemployment levels, and higher workers' wages growth had spiked fears that rebound in inflation would lead to an increase in the pace of outlined hikes.
Consequently, US bond yields hardened appreciably towards the 2.9 per cent mark in recent days.
How to buy gold?
Rising US bond yields are sentimentally negative for gold as it represents a higher opportunity cost of holding the metal, which bears no interest.
However, if investors buy Sovereign Gold Bonds (SGBs) they can actually enjoy fixed-interest rates and also price appreciation.
Investing in jewellery, gold bars, and coins comes at a 15 to 30 per cent transactional cost. However, the transaction cost for gold ETFs is comparatively low.
But unlike gold bonds, gold ETFs cannot be used as collateral for loans.
Gold equity funds are also an option to take exposure to gold as an asset class. These are mutual funds that invest in companies that mine gold.
So, in essence, your investment is in the stocks of gold mining companies.
It may happen that despite a boom in gold prices, the gold stocks do not do well due to other factors.
Another small category is the hybrid asset MFs, which combine equity, debt, and gold in one single portfolio.
For investors who want to take exposure to portfolios through mutual fund route, this is an option.
Asset classes do not move in tandem. From an investor perspective, gold deserves its rightful place in your portfolio.
Photograph: Beawiharta/Reuters
Anil Rego is the founder and CEO of Right Horizons, an investment advisory and wealth management firm that focuses on providing financial solutions that are specific to customer needs.
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