An important tenet of portfolio construction is diversification. This is the need of the hour for a modern-day investor who is looking to build an all-weather portfolio.
Usually, investors while constructing portfolios tend to limit their diversification strategy to conventional asset classes like equity and debt, thereby ignoring gold.
Gold can be held for structural reasons i.e. generally for long term as part of strategic asset allocation or even for shorter term tactical asset allocations. Structural plays are generally longer term whereas tactical decisions are relatively more temporary and more often than not have something to do with valuation arbitrage or momentum-related factors.
Gold being cyclical requires investors to have an astute sense of the grander super-cycle at play. Gold offers significant diversification benefits and can be a part of clients’ hedging strategy especially in the current environment that presents uncertainties at regular as well as sporadic time intervals.
As an investment plan, an investor could project out her future cash flow requirements, discount them back to present value and shape up her strategic asset allocation. Gold has now, become globally accepted as a strategic asset given the high-risk, low-rate, uncertain global environment that stimulates liquidity flows into the safe-haven yellow metal.
Being a safe-haven, means it can demonstrate its importance during periods of economic concerns surrounding capital markets and Black Swan events such as the COVID-19. Such events bring to the fore the importance of portfolio hedges. Apart from crisis times as well though, gold should be considered.
Gold demand stems from investment demand, being a reserve asset as well as an adornment and even a component used in technology. It is liquid, no one’s liability, carries no credit risk and is scarce. Four key characteristics of gold as an asset: it provides return, is relative less correlated with other major assets in both expansions and recessions, has liquidity that is on par with other financial securities and, a proven track record of enhanced risk-adjusted returns.
Further, in periods of rising inflation gold is often seen as an inflation hedge and should the entire global economy reboot after the multiple COVID-19 waves, it would entail a resurgence of demand which would entail a possible spike in consumer-linked prices which could in turn, then also then drive up inflation.
Globally, governments have been trying to compensate for the damage done by COVID-19, trillions of dollars have been pumped into the global financial systemsthrough fiscal stimulus and quantitative easing. Based on the research from McKinsey, 2020’s stimulus has already exceeded the measures taken during the severe 2008-2009 global crisis. In such scenarios gold could be perceived in a favourable light.
Tactical allocation should also be considered above the strategic asset allocation. In recent years, digital gold, gold-based funds, and ETFs have caught the fancy of many investors. Perceptions of gold have changed materially over time, reflecting increased wealth in the East and a growing appreciation of gold in an institutional portfolio worldwide.
Looking ahead, investors’ confidence in the role of gold as a strategic and tactical asset could continue to strengthen. As the pandemic continues, its profound impact on social and economic activities globally has steered expectations for a V-shaped economic recovery towards slower paths. Against such a backdrop, economic uncertainties are likely to remain high, pushing up investor safe-haven demand.
Gold should be invested into keeping in mind cost efficiency viz. tax optimization and secondly, minimize transaction and investment costs. If an investor desires to trade (i.e. not invest) in gold without a long-term view, then Gold ETFs are apt. A buy-and-hold perspective though would mean that sovereign gold bonds might be a more suitable vehicle. Note that physical gold has additional costs of inventory costs, fair and transparent price discovery risk and liquidity constraints.
The author is CIO, Validus WealthDisclaimer: The views and investment tips expressed by investment experts on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.