Through Russia-Ukraine conflict, US-China trade war and other crises, gold remains a useful asset to hold, says Chirag Mehta of Quantum

Chirag Mehta and Ghazal Jain

With the pandemic behind us, risk appetite and economic fundamentals were set to improve, spurring demand for riskier assets. Central banks, led by the Federal Reserve, would drop their accommodative stance and shrink money supply, strengthening gold’s rival - the US dollar. Higher interest rates would increase the opportunity cost of holding the non-yielding yellow metal.

The investment case for holding gold in the foreseeable future wasn’t relatively strong.

Unfortunately , just as investors were starting to discount gold, 2022 also brought with it the Russia-Ukraine war and the following global ramifications.

Widespread risk aversion and market pullbacks

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Chirag Mehta

Fund Manager|Quantum Mutual Fund

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We are in the second week of the biggest military action in Europe since 1945. Investors globally are spooked, not only because of the immediate effects of the war but also its long term implications. The Russia-Ukraine war marks a new era in international politics and threatens the US-led liberal world order. It kicks off a new superpower struggle among the US, Russia and China which could result in China following Russia and repeating Ukraine in Taiwan. We are thus seeing a sharp sell-off in risk assets like equities and cryptocurrencies as investors rush into gold, the US dollar and US Treasury bonds.

Soaring inflation and growth vulnerabilities

Economic sanctions against Russia, a major supplier and exporter of energy, metals and grains, could hit global supplies and fan the fire of already high inflation amid broken supply chains. Oil prices have touched 14 year highs and could go higher if the US puts into effect a complete ban on Russian energy imports.

Also, there is a limit to the sanctions that the West can put on Russia without hurting the global economy, given Russia’s critical role in global commodity markets. This possibly stagflationary environment will be supportive of gold prices.

Easier Central bank policy for longer

The geopolitical unrest has complicated things on the macroeconomic front for global policy makers just as they were putting Covid-19 behind and beginning to focus on slowing inflation by pivoting to tighter policies. The Ukraine invasion and its consequences for the global economy will weigh on the Fed’s March policy announcement. The Federal Reserve has in the past delayed major policy decisions in times of geopolitical uncertainty.

While high inflation suggests a need for faster tightening by the Fed, the chances of a 50-basis-point interest rate hike in March have lowered. The Fed has been behind the curve and further firming of commodity prices will lead to a more catching up on their part rather than real tightening.

The slowing growth will test the Fed’s resolve to tighten liquidity and hike rates. Any U-turn in their stance will be a big win for gold. In the event of the Russia-Ukraine conflict getting extended or escalated to involve other nations, we are looking at more borrowing and money printing to fund military actions which could be negative for fiat currencies and positive for gold.

Weaker rupee

Inflationary domestic monetary and fiscal policies combined with elevated global oil and commodity prices could cause a further spike in domestic inflation. This will be supportive of gold demand as investors strive to keep up with inflation. A flight of capital from India due to a widening current account and trade deficit and tightening global financial conditions could put downward pressure on the Indian rupee, which will be conducive for domestic gold prices.

All of the above, as we know, keep gold very relevant. Sure, as a source of returns, but mainly as a portfolio diversifier and source of liquidity during such testing times.

This mix of competing macroeconomic factors and its unpredictable impact on financial markets isn't special to 2022. It's the way things have always been and will continue to be. Yet we investors time and again rush to gold in times of stress or crisis only to discount the precious metal when the dust settles, unappreciative of the always-lingering risks and gold’s ability to thrive amid those.

Yes, no one could have seen the Russia-Ukraine war coming. Just like no one saw Covid-19, the US-China Trade war or the Global Financial Crisis coming. Yet, they did. They always do. And gold has been a useful asset through them all.

While the Russia-Ukraine conflict will be in the headlines for some time now, investors must keep in mind that gold is not a tactical play.

Even after the uncertainty on the geopolitical front eases, there are multiple risks on the sidelines which, if materialized, can help those with a strategic portfolio allocation to the metal to better navigate financial markets. One should thus stick to the fundamentals and allocate 10-15% of their portfolio to this asset class at all times in order to reap its return-enhancing and risk-reducing benefits. Those already invested should stay put. New investors should avoid lumpsum investment at current levels and wait for dips to build exposure or build it through averaging their costs by systematically investing.

Chirag Mehta is Senior Fund Manager - Alternative Investments at Quantum AMC and Ghazal Jain is Fund Manager - Alternative Investments at Quantum AMC.