Gold shines as bond yields rise and inflation soars

The last few months have been tough for the Indian consumer. Food inflation that accounts for nearly half of the Consumer Price Index (CPI) surged to 8.6% in September this year as compared to 7.62% in August. Similarly, retail inflation jumped to 7.41%, the highest figure in five months. This figure is well above the Reserve Bank of India’s medium-term target band of 4-6%. Hence, the RBI’s monetary policy committee has raised interest rates four times this year by 190 basis points.

Over the years gold has rallied during periods of high inflation in India. For instance, in the first half of this year alone, demand for gold rose by 42% as compared to the same period last year.

More crucially, rising bond yields, too, can drive investors to invest in gold. The Indian 10-year government bond yield has been climbing for nearly a year since December 2021 (See the figure below).

Source: worldgovernmentbonds.com (link)

This unusual rise in bond yields is largely down to a variety of global concerns including rising inflation in the West. In America, the core inflation soared to a 40-year high in September. This forced the Federal Reserve to make yet another interest rate hike. Europe, too, is grappling from nearly 11% inflation compared to just 3.4% just a year ago. Crude prices continue to remain high after Russia’s war against Ukraine.

According to the World Gold Council, “Bonds are expected to generate poor returns going forward and with a positive correlation between equities and bonds, they could also lose much of their diversification and risk-hedging attributes”. The following figure indicates how globally, too, the tide is turning in favour of bonds and stocks being correlated.

Source: Bloomberg, World Gold Council (link)

In India, specifically, gold continues to score highly during times of high inflation. Various studies have shown that over the years a 1% rise in inflation leads to a 2.6% rise in short-term demand for gold. To quote the World Gold Council, “over the past 41 years, gold has delivered an average annual return of 10% in rupees, clearly outperforming CPI inflation, which grew by an average of 7.3% over the same period.”

With this background, gold continues to offer investors an excellent source for effective diversification. In the next article, we will explore various ways in which one can invest in gold in India. For those getting started, gold provides some attractive returns especially in times of high inflation or economic downturns.

Moneycontrol journalists were not involved in the creation of the article.