Saurabh Jain and Aditya Sharma
Throughout history, gold has largely been considered as a ‘flock-to’ currency – a ‘safe haven’ in times of adversity, be it a geo-political crisis or a financial calamity. The last such episode can be traced back to the after-effects of global financial crisis of 2008, when international gold prices more than doubled between late 2008 and early 2012. Since then, gold has not been able to regain its lost glory. While we may have seen interim spurts in gold prices, gains have been much smaller and short-lived. Global terrorist threats, Brexit, Trump’s surprise win in the US elections and more recently, the uncertainty around North Korea have not been able to drive gold prices substantially higher for longer.
We believe ‘real’ yields (net of inflation) offered by benchmark government bonds, such as the US treasuries, possibly offer one of the best explanations for the recent pattern in international gold prices. Investors tend to favour government bonds which offer credible ‘real’ yields (or returns) than a non-interest yielding commodity like gold. A faster-than-expected Fed rate hiking cycle could drive real rates higher in the US and possible elsewhere, which would be negative for gold. We expect bond yields to continue creeping higher through the year on improved growth outlook and higher Fed rates. This could keep real yields elevated or push them incrementally higher through the year, which would limit the scope for gold to gain. However, we see some value in gold as a hedge against very specific risks such as an unexpectedly large surge in inflation, significant escalation of trade or geo-political conflict and late-economic-cycle dynamics which justifies a limited exposure to gold, typically 2%-5% of an investor’s total holdings.
For investors in India, gold faces its own set of local headwinds. Increased import costs, government crackdown on unaccounted money, restrained inflation, significant gains in Indian equities this year and continued elevated ‘real’ returns on local bonds are wooing away the traditional gold-buyers.
Another significant driver of local gold prices has been the rupee’s strength – a stronger rupee reduces the imported cost of gold and thereby the local price. The rupee had significantly weakened against the dollar over the past few years, supporting domestic gold prices all this while. However, local gold prices have been impacted adversely off late with the rupee turning into one of the strongest currencies against the US dollar this year. Another key emerging local trend is the shift away from ‘physical’ assets such as gold and real estate to ‘financial’ assets such as bonds and equities – Indian bonds gave stellar returns last year, with Indian equities kick-starting 2017 on positive note, outperforming the rest of Asia’s markets. This undermines investors’ preference for gold. More importantly, with the government’s clear intent to dissuade black money in the economy and deter cash transactions, the move from ‘physical’ to ‘financial’ assets is likely to endure for some time.
However, even in the Indian context, gold remains one of the most effective portfolio diversifiers available to local investors. Gold prices are largely unrelated to bonds and equities, providing an effective hedge in times of extreme volatility or crisis. Gold is also perceived as a store of value during periods of extreme inflation and is considered by many, including global central banks, as a reserve currency. Some of the world’s largest central banks, including China and Russia have been among active buyers of gold over the last few years.
Investors looking to ‘hedge’ their portfolio through gold need not buy gold bars or coins anymore. Simpler, more efficient and transparent offerings are available in the market which allow investors to hold gold electronically (just as they hold cash in bank accounts), without bearing the risk of storing gold. These gold funds are also liquid, allowing investors to divest should they need to raise cash or rebalance to other assets The Government of India’s Sovereign Bond Scheme is one such alternative, which additionally provides interest (coupon) to the investor while offering exposure to gold prices. While the scheme is less liquid than other funds, it effectively solves for the non-interest or non-dividend-paying drawback of holding gold.
Saurabh Jain is Executive Director, head of investment strategy and sales and Aditya Sharma is Director, investment strategy at Standard Chartered's Wealth Management unit.Views are personal