Since the start of the year, gold has staged a stellar rally. In the years ahead, we believe it will continue to play a key role in an investor’s portfolio. Following are some of the factors that contribute to gold’s growing significance as an investment asset.
Real rates in the US and the allure of gold: Among the various investment avenues, gold stands apart due to its lack of credit risk and its intrinsic real value. This intrinsic value is best understood when considering inflation-adjusted rates. This is akin to the case of US Treasuries, which are often regarded as nearly ‘default-free.’ Investors have historically favoured US Treasuries when they offer high real rates (inflation-adjusted rates). This preference for US Treasuries has historically kept gold’s price range relatively narrow. However, as real rates approach their peak and are expected to cool-off going forward, the allure of gold is expected to shine brighter.
Heightened geopolitical tensions and the need for diversification: For nearly three decades, from the 1990s to the 2020s, the world experienced a period of de-escalation in terms of geopolitical tensions. However, the global landscape is currently undergoing a significant transformation, characterized by mounting geopolitical tensions and during such times, investors frequently seek safe-haven assets. Gold stands as a favoured choice for those looking to hedge against geopolitical risks and mitigate unpredictable outcomes. The need for diversification and allocation to assets like gold becomes evident as a prudent strategy for investors navigating an increasingly uncertain global environment.
Central banks’ pivot towards gold: In the present landscape, a growing number of central banks no longer view US Treasuries as the sole safe haven during turbulent times. Instead, global central banks are showing a growing inclination to gold as a means of hedging portfolio risk. This shift in sentiment toward gold as a reserve asset bodes well for the demand and value of gold. It underscores the evolving perception of gold as a reliable store of value and a hedge against economic and financial uncertainties.
Challenges in the US macroeconomic landscape: The US is currently grappling with several macroeconomic challenges. These include stretched fiscal and current account deficits, which have raised concerns about the sustainability of the dollar. Such imbalances in the US economy can weaken the value of the dollar, historically exhibiting an inverse relationship with the price of gold. As a result, gold prices may experience an upward trajectory, attracting investors seeking to protect their portfolios from currency devaluation.
Attractive relative valuation of gold: In terms of dollar valuation, the price of gold has remained relatively flat over the past three years. Notably, gold reached its peak in 2011, and since then, it has not witnessed a significant rally. This stands in stark contrast to US financial markets, where the S&P 500 has delivered impressive gains, posting a nearly 230% increase in absolute terms over the last 12 years. Even the Nifty 50 (or the S&P BSE Sensex) has yielded a 120% return in absolute terms in dollar terms, as of 1 November.
These stark differences in performance underscore the relative valuation of gold compared to other assets. In a landscape where financial instruments have experienced substantial gains, gold’s resilience and unique risk-return profile makes it an attractive option for those seeking opportunities for capital appreciation. The diverse range of factors, from real rates and geopolitical tensions to central bank actions and macroeconomic challenges, collectively underscore the growing importance of gold in an investor’s investment portfolio. Its distinctive characteristics of gold makes it a compelling asset for investors navigating an evolving and increasingly complex global financial landscape. And one of the easiest ways an investor can take or build exposure to gold is via Gold ETF, or exchange traded fund.
Chintan Haria is…