Gold’s position in an asset allocation can be both structural i.e. strategic as well as seasonal i.e. tactical.
Gold’s position in an asset allocation can be both structural i.e. strategic as well as seasonal i.e. tactical. The rationale for holding both these allocations need not necessarily remain the same and can change with the passage of time as well.
Generally, strategic asset allocation calls are longer-term and rarely change unless and until there is a marked change in investor needs and/or general or specific investment conditions. Tactical calls are more temporary in nature and their investment drivers are more dependent on shorter-term factors such as but not limited to valuation arbitrage or momentum factors.
The recent Samvat 2077 was an auspicious occasion for dipping into investment vehicles with the hope of wealth multiplication in the years to ensue. Globally and domestically there has been a slew of events that have shifted the tide of investment decisions back and forth as fickly as a fig.
Nevertheless, buying gold in these turbulent yet festive times for us always remains a top priority in most minds of both consumers and investors.
Gold is typically a cyclical asset and taking exposure to it would entail a judgment of where one is within its super-cycles. As an investment plan, one should have by now set up the strategic asset allocation keeping in mind the cash requirements during the years and times to come. Gold would most certainly play a prominent part in the asset class exposures given the uncertain global environment sparking liquidity flows into the safe-haven yellow metal.
While several “uncertainties” are being successfully addressed such as:
1) multiple vaccines (Pfizer, AstraZeneca and Moderna to name only a few) likely countering the COVID-19 pandemic;
2) the U.S. Presidential race drawing to a certain close (though the orderly nature of the transition and the stimulus and tax plans of the new President remain to be seen);
3) economic recovery being underway with GDP contractions much lesser than anticipated among others, the glut of liquidity being pumped by Central
Banks world-over should in all probability lend credence to the belief that the Gold rally potentially still has more steam left. Further, while the cost curve of producing Gold is varied and dependent on many factors – local and global – one can reasonably assume that the marginal cost of production of gold should act as a safety net for the price of the yellow metal.
There have been recent murmurs going around of a possible asset class rotation out of gold and into the “once-more-hot” cryptocurrencies but that alone should not determine the fundamental as well as tactical path future gold prices could tread.
Gold’s traditional role as a safe-haven asset means it can demonstrate its qualities during times of high risk. This dynamic is likely to persist, reflecting tenacious political and economic uncertainty, unrelentingly low-interest rates and economic concerns surrounding capital markets. Black Swan events such as the Covid-19 pandemic bring to the fore the importance of building hedges to protect portfolio destruction. That does not mean that one should look at Gold only during periods of irrational fear and risk-off sentiments.
Gold’s dual appeal as an investment and a consumer good means it can generate positive returns in good times too. There are four attributes that make gold a valuable strategic asset, by providing investors with: a source of return, low correlation to major asset classes in both expansionary and recessionary periods, a mainstream asset that is as liquid as other financial securities and finally, a history of improved portfolio risk-adjusted returns.
Gold benefits from diverse sources of demand: as an investment, a reserve asset, an adornment and a technology component.
It is highly liquid, no one’s liability carries no credit risk, and is scarce, thus historically preserving its value over time. Perceptions for gold as an asset class for investment have changed substantially over the past two decades. Gold’s unique attributes as a scarce, highly liquid and un-correlated asset highlight that it can act as a genuine diversifier over the long term. Gold provides diversification in a portfolio and is often correlated with the stock market during risk-on periods, while it decouples and becomes inversely correlated during periods of stress.
This is unique amongst most hedges in the marketplace because it ensures investors get the best of both worlds. Further, in periods of rising inflation gold is often seen as an inflation hedge and should the entire global economy reboot after the COVID-19 pandemic, it would entail a resurgence of demand which would entail a possible spike in consumer-linked prices which could also then drive up inflation.
In such scenarios, Gold could be perceived in a favorable light.
Over and above the strategic asset allocation, one should be increasing tactical allocation to Gold as well.
During the current festive season, taking exposure to gold should be chosen on the basis of the most cost-efficient manner i.e. tax optimization and least transaction and investment costs. For instance, if an investor desires to trade in gold i.e. without a long-term view, then Gold ETFs are the best bet. On the other hand, from a buy-and-hold investment perspective, sovereign gold bonds offer attractive return potential. Note that physical gold has additional costs of inventory costs, fair and transparent price discovery risk and liquidity constraints.
Rajesh Cheruvu is CIO at Validus Wealth. Views expressed are personal