How much gold should you have in portfolio in economic downturn?

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June 09, 2021 6:29 PM

Gold, as an asset class, is a hedge against inflation and provides diversification when equities are not doing well. It does not have cash flows like equity and debt assets. That said, historically, gold has proven to have a store of value.

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Natural calamities have the potential to cause massive economic and business losses, and short-term stock market corrections often follow. Hence, experts say a great approach to safeguard one’s investment portfolio against economic downturns could be to allocate a specific percentage of the portfolio to gold.

Anup Bansal, Chief Investment Officer, Scripbox, says, “Gold, as an asset class, is a hedge against inflation and provides diversification when equities are not doing well. It is not a consistent performer on a year-on-year basis. It also does not have cash flows like equity and debt assets. That said, historically, gold has proven to have a store of value.”

Markets may be impacted in the short term, but they will not remain negative for a very long time unless it is an extreme world-war like situation. In a downturn – whether due to economic cycles or natural calamities – equity markets tend to turn around in the latter half. Hence, it is not advisable to increase one’s allocation to gold beyond the prescribed limit simply due to natural calamities.

Experts say precious metals like gold have repeatedly proven to be a safe haven in times of economic downturns. Looking at natural calamities down the past, stocks and equity indices have reacted negatively which gave impetus to investor demand for gold. For instance, after the disastrous Sichuan earthquake of May 2008, gold prices had risen nearly 10.74 per cent by July 15th. On the other hand, the S&P 500 tanked 13.44 per cent during the same period.

Having said so, Arshad Fahoum, Chief Product Officer, Market Pulse Technologies, says, “Over longer time-horizons such as 15 years or higher, returns in gold investments have historically fallen short in comparison to equity benchmark indices. Thus, it would be best to increase one’s gold investments immediately after the occurrence of a natural calamity and eventually reduce his/her positions in the precious metal to reinvest in equities, once the economy shows signs of stability.”

While allocating, around 10—15 per cent of one’s overall investment portfolio to gold is a good practice as a safeguard against economic downturns.

Fahoum of Market Pulse says, “A better answer to this question can be sought by asking oneself two simple questions: what is the investor’s risk profile and, what is the state of the economy?” He further adds, “A risk-averse investor who prioritizes portfolio stability over portfolio appreciation can allocate a higher percentage to gold. Besides the probability of a natural calamity, if the economy is headed downwards or driven by stagnancy, adding to one’s gold positions could be a better alternative.”

However, industry experts say if the economy reflects a strong growth trajectory, investing in equity instruments could be more lucrative.

Ashraf Rizvi, Founder – CEO, Digital Swiss Gold and Gilded, says “For those fortunate enough to manage a larger portfolio, the investment in gold is subjective to the investors’ risk appetite and asset mix, not just purchasing power. While investing in gold, one should ensure that they weigh their investment in gold against all other assets in their portfolio and not just equities.”

He further adds, “Gold can diversify the market risk away, and the accompanying price benefit is a profitable by-product of the investment.”

Additionally, studies of investor behaviour have shown that people do not generally book profits in gold. Typically, experts say a consistent allocation of 5-10 per cent can provide adequate diversification and hedge against inflation risk.

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