Gold a strategic asset in times of economic crisis – Here’s why
November 13, 2020 11:43 AM
Currency depreciation improves a portfolio's risk-adjusted return over the long term even while providing the liquidity option in times of need.
Treating gold as a strategic asset in an investment portfolio has worked wonders with the portfolio, especially in times of an economic crisis
2020 started off just like any other year but as the COVID-19 pandemic spread across the globe, it turned the whole world topsy turvy. The global economy started to fade and growth went into reverse gear. The stock markets became volatile and stock prices crashed owing to high valuations. But, thanks to the US Federal Reserve and its monetary policy, the markets rebounded globally, including that of India. Still, one asset class that has remained unscathed and is on top of other assets such as equities, debt and real estate is gold. The year-till-date return of gold in India is nearly 29.5 per cent* and the growth looks promising in future too.
In times of economic crisis, the demand – and hence the value – of gold is expected to increase manifold. The fear of a global recession as being seen during the current pandemic may continue to be a driving force for the gold price to move higher. According to the World Bank, the massive shock of the coronavirus pandemic and shutdown measures across economies will have a major toll on the global economy pushing them into a severe contraction. The global economy will shrink by 5.2 per cent this year, advanced economies by 7 per cent and emerging economies by 2.5 per cent, as per estimates by the World Bank. With global uncertainties abound and widespread negative economic data arising from the COVID-19 crisis, the rush towards safe-haven assets such as gold is expected to remain robust.
Solace in gold
During economic stress, gold has often provided solace to investors globally. While equity, debt, real estate are the core components in the portfolio of most investors, gold remains an equally important asset-class that should not be ignored. Overall, gold represents wealth and is a hedge against inflation. Currency depreciation improves a portfolio’s risk-adjusted return over the long term even while providing the liquidity option in times of need.
As an investment
Exposure to gold enhances the value of an investment portfolio in the long run. It has also been seen that an optimum allocation to gold provides diversification to the portfolio and helps mitigate losses in times of a downturn in the equity market. In both good and bad economic conditions, gold as an asset class has generated long-term positive returns. According to the World Gold Council (WGC) data, as of 31 December 2019, the price of gold had increased by an average of 14.1 per cent per year since 1973. Even the returns over the last 10-year period have been positive in most of the years.
As an investor, one wants to keep the volatility low in the portfolio’s return. In a study by WGCcomparing the volatility of stocks, stocks indices and gold, it was found that gold’s volatility is below that of many individual stocks, including technology stocks, and indices such as BSE 200, BSE 500.
As a diversifier
As the adage goes – ‘One should not keep all the eggs in one basket’, diversifying a portfolio with allocation across gold, equities and bonds helps deliver a high risk-adjusted return. Diversification works best when different assets perform differently and the co-relation is minimal between them. In that sense, gold acts as a perfect diversifier in a portfolio. Between December 2007 and February 2009, when the BSE Sensex fell by nearly 56 per cent, gold was up by nearly 48 per cent over the same period. Gold’s correlation with stocks helps portfolio diversification in good and bad economic times and thus play a major role in the hedging portfolio returns.
The movement of interest rates in an economy happens in cycles. There are times when rates are on the way up and then there are periods of interest rates lying low. While other factors are also at play, inflation tends to shoot up when rates are high. And, during high inflation, gold prices go up. Thus, over longer periods, witnessing different interest rate cycles, gold acts as a hedge against inflation.
What gold essentially does is to help preserve the value of the currency even as inflation eats into the purchasing power of rupee. According to WGC data, the average annual return of 10 per cent in gold since 1981 has outpaced the Indian consumer price index. In its research, WGC found that in years when Indian inflation was higher than 6 per cent, gold prices increased 11.5 per cent on average. Over the long term, therefore, gold has not just preserved one’s capital but has also helped it grow.
A touch of gold in your portfolio
Indians are known to be a big consumer of gold. With an annual demand equivalent to about 25 per cent of the total physical demand worldwide, India is one of the largest consumers of gold. Historically, gold has remained a symbol of wealth and its value has largely been preserved over time. The growing demand for gold can be established from the fact that it is not only looked upon as a wearable piece of jewellery but also as an investment avenue.
Treating gold as a strategic asset in an investment portfolio has worked wonders with the portfolio, especially in times of an economic crisis. With geopolitical tension between different geographies or at a time when global economies face a downturn, the importance of gold as an asset class increases manifold. While most financial planners suggest investing 5 to 10 per cent of the portfolio in gold, you may even consider allocating a higher percentage, depending on your risk tolerance.
* For 10 gram gold; Prices as on November 11 on MCX India