Business Today

Invest for Portfolio Stability

An investor is advised to allocate a proportion of his/her investments into gold. This is because gold has a largely inverse relationship with other financial assets.
Laxmi Iyer        Print Edition: April 26, 2015

Gold has been a natural global currency for a long time. Its scarcity, widespread acceptability and high demand make it a highly valued metal. Given the historical and current pervasiveness of gold as an asset, it continues to be seen as a store of value, and to a certain extent, as a last resort of exchange. Not surprising, then, that gold can also be "money by other means". Therefore, as is the case with cash, demand for gold tends to rise in adverse economic conditions, market volatility, rising inflation, weakening global currencies, or general socio-political instability. Thus, while "cash is king, gold is the crown on the king's head".

In the near term, however, the Gulf coalition's bombing in Yemen has led to a rise in the gold price. Moreover, while the US Federal Reserve is on the path of rate tightening, it has transitioned from making the policy action from being time-oriented to data-oriented. The market sees this as a reflection of continued benign stance in the US central bank's position. For that reason as well, the gold prices saw a marginal surge.

From the long-term standpoint, gold prices have remained largely muted for around a year now. The resurgence in the US economy and the expected rise in the country's interest rates would increase the clamour for dollar denominated assets. This reduces the susceptibility and risk perception, thus reducing the risk premium on gold.

Domestically, other than a possible deterioration in the rupee value, the price of gold may not rally. Moreover, the Reserve Bank of India's push to provide real interest rates by inflation-indexed bonds may also reduce the attractiveness of gold in the eyes of the investor. Additionally, the high returns by equities and debt assets over the last year, too, may take the investors away from the yellow metal. To add to that, the high price of gold and the subdued performance of the asset over the last two years have reduced the investment appetite amongst traditional investors. Besides, the financial sector is incentivising the monetisation of the retail gold holdings. This is also adding to the downward pressure on the metal.

An investor is advised to allocate a proportion of his/her investments into gold. This is because gold has a largely inverse relationship with other financial assets. The "low-to-almost-non-existent" correlation with other asset classes like equities and debt provides gold with a characteristic of an anchor even when the other two assets may not be performing well. Thus, gold helps stabilise the overall portfolio and provides a possibility of growth even in a recessionary environment. This ability of gold to help counter the business cycle continues to provide investment opportunity. For example, while gold has underperformed the equities and debt over the one- to three-year time frame, it has given competitive returns when debt and equity assets were volatile.

To sum things up, monetary expansion, geopolitical issues, institutional demand and prudent allocation requirements continue to ask for a marginal investment in gold. This investment logic is not driven by growth expectation, but rather by the need for portfolio stability.

However, from a retail investor point of view, the (physical) investment in gold has its inconveniences. Buying (physical) gold involves the risk of theft, misplacement and potential mispricing. Additionally, when an investor needs to sell his/her (physical) gold, he/she has to go through the inconvenient route of valuation, bargaining, transaction and delivery. Therefore, to circumscribe that, investors can choose gold exchange-traded fund as a medium to invest in the yellow metal.

(The author is Chief Investment Officer - Debt, & Head - Products, Kotak Mutual Fund.)

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