Has gold lost its Midas touch?

Despite returns from gold down over 5% in the past three months, it is a good idea to keep this asset class in your portfolio, say Joydeep Ghosh, Sanjay Kumar Singh and Tinesh Bhasin.
Illustration: Dominic Xavier/Rediff.com

Yash Singh, head of human resource at a leading corporate house, is more than a tad disappointed in gold.

He has been diligently buying one 10 gram gold coin every month for over five years. "It has become a habit now," says Singh.

But in the last few months, his faith in the yellow metal has been shaken. Nowadays, he is constantly seeking advice from his financial planner and other friends on whether he should continue this habit.

With returns from gold down over 5% in the past three months, and more importantly, down over 7% in the past five years, most die-hard fans of gold would be wondering if it is a good idea to keep this asset class in their portfolio.

Yes, things have been tepid in the past few years, but over long periods gold has given good competition to equities.

For example: Over a 10-year period, gold has returned 12.8% a year whereas the Sensex has returned 10.5% a year.

Over the past 20-year period, the Sensex has returned 11.9% annually whereas gold has returned 9.8% a year.

What has gone wrong?

What is interesting about the gold-dollar relationship, especially in the case of India, is this: When the dollar strengthens, gold prices fall.

So, clearly, there is an inverse relationship. But at the same time, a falling rupee offsets the fall in gold prices in India.

So, while the price of gold may fall 7% in dollar terms, it may drop only 5% in rupee terms.

"Gold prices in India at present (Rs 29,570 per 10 grams) are about 11% down from their all-time high (Rs 33,265 per 10 grams)," says Kishore Narne, associate director and head (commodity and currency), Motilal Oswal Financial Services.

Gold's weakness in the international market is primarily on account of the US Federal Reserve's hawkish stance.

The US Fed believes that the economy is strong enough to support further increases in interest rates.

It has hinted at four rate hikes this year and more next year. The US Fed is also shrinking its balance sheet.

"The US Fed is raising rates while other major central banks are not. This has led to a stronger dollar, and that is hurting gold," says Chirag Mehta, senior fund manager-alternative investments, Quantum Asset Management.

Under normal circumstances, gold would have benefited from the ongoing trade tensions between the US and China, but it has been completely overwhelmed by the dollar's strength.

Moreover, risky assets such as equities continue to do well in the US.

The threat of trade wars has only impacted currencies as of now. Analysts are expecting gold prices to start rising with a lag.

They say gold could revive if the ongoing trade dispute between the US and China flares up into a full-fledged trade war.

Moreover, tightening by the US Fed has reduced the spread between the US's two- and 10-year bond yields.

If there are a couple more rate hikes in the US, that could lead to an inverted yield curve, giving rise to the threat of recession. This could give a boost to gold.

All eyes are also on China, which is sitting on $1.2 trillion worth of US treasury bonds.

If China decides to dump some of them into the market as retaliatory tactics, it could cause yields to harden.

If the US economy suffers, gold would benefit from this.

Experts say at the current price levels the negatives seem to be more than factored into the price of gold.

Given the risks that exist today in the global economy, gold can prove to be a useful portfolio diversification tool and can help reduce overall portfolio risk.

"Equities have been running up while gold has not been doing well for the past several years, so investors' portfolios may have become underweight on gold. They should use the current price levels to build their allocation to the yellow metal," says Mehta.

Based on how things are panning out, investors should take significant exposure (up to 15% or more of their portfolio, depending on their comfort) to gold right now with at least a two-year horizon, according to Narne of Motilal Oswal.

Global inflation, rising interest rates, tightening of monetary policies by central banks, high crude prices are all positives for gold.

"Globally, if things worsen from here, gold can surpass its all-time high in India. Investors need to keep a long-term horizon as the price of gold will rise with a lagged effect. We can even see over 30% increase from the current prices," says Narne.

The most prominent cue for investors would be falling equity markets. The global markets are interconnected. Trade wars can impact growth and will then impact the stock market.

One way you may hold gold for the long term is via sovereign gold bonds. They pay an interest of 2.5% annually on the initial purchase price, but suffer from lack of liquidity.

The government will buy these bonds back from investors only after five years and they trade at a discount in the secondary market.

Gold mutual funds offer liquidity, but you will have to pay an annual expense ratio (0.4% to 1.2%). Avoid the gold deposit schemes run by jewellers.

"Investing in these schemes becomes a bet on the jeweller's financial position," says Deepesh Raghaw, founder, PersonalFinancePlan.in, a Sebi-registered investment advisor. "You could lose your entire money if he goes bankrupt."