Gold: Safe haven asset or inflation hedge!

The bullion metal lost Rs 2,562, or 4.68 percent, for the week on MCX as investors booked profit (Image courtesy: Reuters)

Conventional wisdom says gold is a safe haven asset for investors during a time of crisis. But the world seems to challenge and not only ignore many of the conventional theories and practices lately.

Take for example the unconventional ways of central bankers now. No more austerity or any belt tightening measures please.  Aggressive cutting of interest rates and flooding the financial system with cheap money has become the usual response to all kind of macro woes and the global crisis now.

Even in the case of gold, the recent price movements reflect more of an inflation hedge theme rather than the typical behaviour of a safe haven asset. What it means is that gold prices are getting increasingly correlated with risk assets. For example, gold was unable to rally (or surge up) when the media was buzzing with US - China tension issues recently. Such a lacklustre response of gold to geopolitical issues has been a regular occurrence more often than not.

On the other hand, gold prices seem to move up on release of better than expected economic data from the US. Generally, in case of positive data released out of the US, the US Dollar falls and the equity market seems to rally. That’s because there is no rush of money to the US Dollar – a safe haven asset. In such a scenario, gold should also move down along with US Dollar on the back of better than expected US economic data.

However, on the contrary, gold seems to rally sharply even in the backdrop of weakness in the US Dollar. This counter intuitive move in gold prices is about investors viewing gold as an inflation hedge more than safe haven asset now.

Given the highly accommodative monetary policy globally and united policy efforts to boost consumer demand, the risk of a sharp increase in inflation is very real now and many experts have raised concerns about it.

Notwithstanding the changing price behaviour of gold, it continues to attract investor attention. In the near term, the global uncertainties are likely to persist and the policy makers are willing to experiment and take bold decisions now. Already, the mortgage rates have slipped below the 3percent mark in US lately. If inflation raises its ugly head, the real interest rates could turn negative thereby further fuelling the rally in gold.

In such a scenario, gold -- as safe haven or an inflation hedge – could continue to find favour among investors. Hence, even after the massive rally in gold lately, it might not be a bad idea to have some exposure to gold in your investment portfolio.

(Gaurav Dua is SVP, Head, Capital Market Strategy, Sharekhan Limited. Views are personal.)