Is gold a good portfolio hedge in volatile markets?

The ongoing correction in gold prices can be a good entry point for investors

Gold is generally considered to be a good hedge against inflation. It is also considered to be a safe haven when equity markets go into a tailspin. The prices of the yellow metal rose for most of last year and even in recent months. But gold prices have been knocked back a bit, as equities continue to face the rout. They fell six per cent during the week ended March 20, though prices are up a good 27 per cent for the year thus far.

Should you add gold to your portfolio now?

The need for cash

When the stock markets across the globe went into tailspin and leveraged investors were asked to pay up for the margins, the easy way out was to sell what they were holding. Many institutional as well as high networth individuals buy stocks and other risky assets by paying fraction of the market price. The rest is funded by brokers and financial institutions.

Chirag Mehta, senior fund manager, Quantum AMC says, “Whenever there is liquidity crunch, in order to raise cash, assets are sold which are liquid, profitable and incur minimal impact cost.”

Gold satisfied all these three conditions, and hence, in the current volatile times, it is sold to satisfy margin calls.

After the Coronavirus spread beyond China, stock markets globally started falling and gold was sold to pay for the losses witnessed in the stock markets. “A similar trend was seen in 2008 as well when the financial crisis got aggravated,” Mehta points out.

Nippon India ETF Gold BeES – the oldest and largest Indian exchange traded fund tracking gold prices –registered 25 per cent returns in 2008, but it was a very volatile journey, as it lost more than 15 per cent thrice in that year.  The Nifty fell 51 per cent in 2008.

For the time being, both stocks and gold prices are down from their respective peaks. Investors need some breathing space and hence there is a tendency to opt for cash for time being. Rajiv Shastri, former CEO of Essel Mutual Fund and debt market specialist says, “Investors’ preference for cash has gone up. In uncertain times, investors first choose to get into cash before they decide on their future investments.”

Will gold come back?

If you go by the past, gold has a good chance of bouncing back. Gold typically does well when there is high uncertainty and currencies lose their purchasing power. The coronavirus pandemic is yet to peak and is expected to slow down the global economy. A Global Economic Viewpoint released by BofA Securities on March 19 expects “global GDP growth to drop effectively to zero this year, matching the major recessions of 1982 and 2009.”

No wonder policy makers are back in action. The US Federal Reserve has announced a 50 basis point rate cut to bring the policy rates to zero, along with a massive $700 billion quantitative easing programme. Central bankers of Malaysia, Canada and England, among others, too have done their part.

“There is an expectation of a much larger fiscal stimulus and monetary stimulus compared to what was done after the Lehman crisis. This will lead to currency debasement and fall in real interest rates. That is a fundamentally conducive situation for gold prices to rally,” says Mehta. Debasement of currency means lowering its purchasing power.

“As the nominal rates of interest are near zero in many developed economies and the real interest rates are in the negative zone, investors will most likely turn to gold for preserving their purchasing power,” says Ritesh Jain, former CIO at BNP Paribas AMC and now a blogger at worldoutofwhack.com.

What should you do?

This is not the time to run away from gold. It is better to reassess your asset allocation and consider gold as an investment option. “If you believe that the purchasing power of your currency is going down, then you better invest in gold which is the only asset that does not depreciate like fiat currency,” says Jain. He expects gold to touch Rs 1 lakh per 10 gram in the next three years.

Shyam Sekhar, founder and chief ideator at Chennai-based iThought says, “The ongoing correction in gold prices can be a good entry point for investors.” He recommends investing 10-20 per cent of liquid wealth in sovereign gold bonds and gold exchange traded funds.

But do not go overboard with your investments in gold. Also, avoid buying jewellery.