Your money: Taking cues from central banks’ gold buys

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New Delhi | Published: April 24, 2019 1:07:26 AM

Preference for gold after decades of selling is indicative of central bank concerns about financial markets and geopolitics.

gold, gild burchase, central bankIllustration: Shyam Kumar Prasad

Are you a hands-on investor who is always striving to optimise your portfolio returns? If yes, then it will serve you well to gain insight on what the big and informed money of the world is up to.

What is informed money? It is the cash invested by those who have a better understanding of the market or with access to information channels that a regular investor doesn’t. As such, this money is considered to be invested more accurately or profitably, and tends to make broad allocation changes much before the herd tends to follow.

Central bank money, for example, is big, informed money, given its scale, influence on global economics and access to non-public information. Other examples are institutional investors such as hedge funds, commercial banks and market mavens like Warren Buffett.

Central banks buying gold

Knowing where this money is flowing can be of great benefit to retail investors. This is not to blindly follow it, but definitely to gauge the direction in which world markets and economics are headed, thus helping you take “smarter” investment decisions.

Central banks around the world have been doing a lot of gold shopping, with Russia, China, Turkey, Kazakhstan, and India taking the lead. Central banks have been consistently stocking up on the metal since 2009. The global financial crisis of 2007-2008 preceded this central bank policy shift. The crisis prompted the reappraisal of gold’s role and relevance in today’s times, not necessarily as a source of returns, but definitely as a portfolio diversifier and liquidity tool.

Preference for gold after decades of selling is indicative of central bank concerns about financial markets and geopolitics. Higher global risks due to radical monetary policies, decade-long quantitative easing, exploding world debt, deteriorating quality of reserve assets such as dollars and euros, and geopolitical tensions have fueled the need for central bank reserves diversification.

Clearly, central banks’ confidence in paper currencies/the dollar is dwindling and they see a role for gold in a future international monetary system. After all, for how long can the world trust a reserve currency which is based on unlimited debt creation and money printing? Despite it getting stronger, the share of the dollar in total central bank reserves has reduced from 72% in 2001 to 61% in 2018.

The usage of dollar in international payments has been declining in the last three years. From 45% share of global SWIFT payments in April 2015, the dollar’s share fell to 38% as of April 2018.This means trade has started shifting away from the dollar and countries are using other currencies / bilateral trades for payments. These could be the first signs of the end of dollar dominance.

Intrinsic value of gold

Gold retains its intrinsic value as its value is not dependent on the ability of others to honour their liabilities. Gold is thus a source of return, liquidity, diversification and credit risk reduction. As per World Gold Council, 76% of central banks view gold’s role as a safe haven asset as highly relevant, while 59% cited its effectiveness as a portfolio diversifier. And almost one fifth of central banks signaled their intention to increase gold purchases over the next 12 months.

Just like the global central banks, we need to relook at our risk management practices. Gold is a valuable strategic asset for our investments as it plays a stabilising and defending role, minimising downside risk in times of crisis. We can use gold to counterbalance our currency risk by investing 5-10% of our money in it. The shiny metal definitely has a clear role to play in a world dominated by radical uncertainty. The big, informed money thinks so and is lapping it up while it remains relatively cheap.

The writer is senior fund manager, Quantum Mutual Fund

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