gold price: Is gold’s utility as an asset allocation diversifier broken, will gold prices go up?


In the past one month, both equity and bond markets have suffered amid rising inflation and fallout of the prolonged Russia-Ukraine conflict. Surely gold would have put up a better show, given its safe-haven appeal? Not quite. Gold prices have also fallen in tandem with other asset classes, compounding investors’ misery. Domestic gold prices have fallen 7% to Rs.50,450 per 10 gram from April peak of Rs.54,380 per 10 gram. So does this mean gold is not doing its job? Is gold’s utility as an asset allocation diversifier broken? Let’s find out.

Gold is traditionally seen as a safe-haven asset during times of economic strife and uncertainty. The precious metal is also viewed as an inflation hedge to protect against the debasement of fiat currencies. It tends to have a loose correlation with other asset classes, particularly equities. That is why, financial advisers usually recommend having some allocation to gold as a diversifier to cushion the investor’s portfolio during bad times. However, the yellow metal has failed to live up to its billing in recent weeks even as financial markets have tumbled. This is despite a fall in real interest rates, which is usually conducive for gold.

The answer lies in a resurgent US dollar and buoyant US bond yields. The dollar has been surging as investors rush to the safety of the greenback amid concerns over

inflation. The dollar index rose for five straight weeks to a 20 year high as US treasury yields have climbed on expectations the Fed will be aggressive in attempting to tame inflation. After its 50 bps hike earlier this month, investors expect the Fed to follow up with two more front-loaded rate hikes. This is making investors nervous, and putting them in risk-off mode. “Market fear that inflation may remain high in the near term while tightening may slow down growth caused market players to shun all riskier assets like commodities and equities and stick to the most trusted asset which is the US dollar,” says Ravindra Rao, CMT, EPAT, VP- Head Commodity Research, Kotak Securities.

Gold and dollar tend to have an inverse relationship. When the dollar is on a strong footing, it makes gold less attractive for buyers holding other currencies. Rising short-term interest rates and yields in turn raise the opportunity cost of holding gold. While the Fed maintains its hawkish stance, real yields (adjusted for inflation) are expected to move higher. Positive real yield undermines demand for continue to remain in play. Central banks continue to value gold’s utility in these uncertain times and thus added 84 tonnes to global official gold reserves during the first quarter. Analysts expect central banks to continue to diversify away from dollar assets into gold. Global growth worries have only intensified in recent weeks amid mixed economic data from major economies, downbeat growth forecasts, continuing Russia-Ukraine fighting and anaemic activity in China owing to virus related restrictions.

With so many moving parts, the likelihood of the US Fed achieving a soft landing for the economy is low, reckons Mehta. “A growth slowdown, high debt levels, and financial market instability will ensure that the Fed’s tightening is short-lived, making conditions conducive for gold again,” argues Mehta. He believes the US and other global central banks are staring at a policy error. Inflation may not come down even if interest rates are hiked as supply-side inflation persists and contributes equally. It is possible aggressive policy actions may kill inflation at the expense of growth. If central banks realise this and take a U-turn, it will lead to repricing in gold.

The yellow metal has already seen some respite as the strength in US dollar and US bond yields has started to moderate. Rao reckons gold may see some recovery soon as growth and inflation concerns increase its safe haven appeal. Experts maintain that investors should be guided by their asset allocation and keep up to 10-15% of their portfolio in gold. This can be built in a staggered manner via investments in gold ETFs or fresh tranches of Sovereign Gold Bonds. gold because gold does not yield anything.

That is why gold has been declining despite the safe-haven demand from inflation and war concerns. “The Fed’s tightening cycle will continue to put downward pressure on gold for the next couple of months,” opines Chirag Mehta, CIO, Quantum AMC. As gold lost momentum near $2,000/oz level, some investors chose to exit. Gold holdings with SPDR ETF fell by 12.55 tonnes to 1,082 tonnes, lowest since mid- March. Gold ETF flows may become more price sensitive, Rao observes. “We may see fresh buying in gold only when market focus shifts from central banks to economic risks.” However, this does not mean that gold has lost its own safe haven allure, experts insist.

Factors supportive of gold prices continue to remain in play. Central banks continue to value gold’s utility in these uncertain times and thus added 84 tonnes to global official gold reserves during the first quarter. Analysts expect central banks to continue to diversify away from dollar assets into gold. Global growth worries have only intensified in recent weeks amid mixed economic data from major economies, downbeat growth forecasts, continuing Russia-Ukraine fighting and anaemic activity in China owing to virus related restrictions.

With so many moving parts, the likelihood of the US Fed achieving a soft landing for the economy is low, reckons Mehta. “A growth slowdown, high debt levels, and financial market instability will ensure that the Fed’s tightening is short-lived, making conditions conducive for gold again,” argues Mehta. He believes the US and other global central banks are staring at a policy error. Inflation may not come down even if interest rates are hiked as supply-side inflation persists and contributes equally. It is possible aggressive policy actions may kill inflation at the expense of growth. If central banks realise this and take a U-turn, it will lead to repricing in gold.

The yellow metal has already seen some respite as the strength in US dollar and US bond yields has started to moderate. Rao reckons gold may see some recovery soon as growth and inflation concerns increase its safe haven appeal. Experts maintain that investors should be guided by their asset allocation and keep up to 10-15% of their portfolio in gold. This can be built in a staggered manner via investments in gold ETFs or fresh tranches of Sovereign Gold Bonds.



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