Gold has a way of capturing people’s attention.
Last fiscal, India’s central bank, the Reserve Bank of India, went on a shopping spree to shore up its gold reserves. It bought around 52 tons of gold.
Indians have their own sentimental and emotional reasons for buying the yellow metal, but in the case of the RBI, it was geopolitical - trade tensions, sluggish growth, a low/negative interest rate environment, as well as a desire to reduce its dependence on the dollar.
According to Bloomberg, our country’s gold reserves stand at a record high of over 600 tons. It quotes Ross Strachan at Capital Economics Ltd saying that the RBI’s purchases are part of a wider picture across developing economies that are looking at de-dollarizing their forex reserves.
Here's what Morningstar experts have to say.
Dan Kemp, CIO - Morningstar Investment Management EMEA
Investing in gold remains one of the most controversial exposures for an investor, as it is arguably a greater fool investment that is said to be fueled by three persuasive themes:
- Fear of an economic crisis or inflation outbreak fueling public demand
- A change in the sovereign wealth funds asset composition, such as demand from China, to diversify their holdings
- Negative bond yields losing their appeal as an effective hedge against equities.
Whether as a hedge against rising tension in the Middle East, uncertainty about the direction of the global economy, or rising fears about escalating tensions between the U.S. and China, investors commonly turn to gold as a "safe haven" asset class.
(Morningstar classifies an asset as a safe haven if it holds, or even increases, its value during periods of market and economic uncertainty and downturns. The asset should preserve capital, withstand market volatility, and provide diversification across a portfolio. Gold is an asset which is virtually permanent, with no significant erosion of quality over time, could arguably be considered a safe haven.)
The price of gold often moves in the opposite direction to the U.S. dollar, reflecting the fact that many regard the yellow metal as an alternative currency. To assess gold's ability to hedge against the dollar, Inton looked at how gold prices have trended against the real trade-weighted U.S. dollar index.
During the massive drop in the value of the dollar from 2002 to 2011, real gold prices rose more than 600% from $250 per ounce to $1,500 per ounce. Similarly, a rise in the value of the dollar after 2011 saw real gold prices drop more than 30% to almost $1,000 per ounce. Given the apparent negative correlation, gold appears to be a decent hedge to the dollar.
Inton adds that the historical relationship between gold prices and the value of the dollar shows some evidence that gold provides a "decent" hedge to the dollar, but not definitive. During the past 20 years, lower dollar values have tended to correlate with higher gold prices.
While gold isn't a perfect hedge, there is some empirical evidence that it provides a hedge against the dollar. However, we are reluctant to declare any kind of direct or causal relationship.
We suspect that rather than the dollar affecting the gold price, the relationship is actually the result of being affected by similar macroeconomic factors, such as inflation and interest rates. For investors seeking income producing assets, gold isn't a viable investment choice as it pays no yield. Also, consider the additional costs.
Philip Straehl, Head of Capital Markets and Asset Allocation, North America, Morningstar Investment Management
We currently don’t invest in gold in our multi asset portfolios (apart from the portfolios we offer in India).
In general, we’d expect gold not to generate a return that is significantly above 0% in the long-run in USD terms as the gold price basically just keeps up with inflation in the long-run. As you say, gold has not cash flows and there is not carry associated with investing in gold so there is not really a benefit to owning gold in the long-run.
That said, gold does have some risk hedging properties an and may outperform in a risk off environment. However, analysis indicates that duration is generally a better hedge than gold in a risk off environment. In general, gold is likely to do best in a stagflation or dollar crisis type scenario.
While I can see us having opportunistic exposure to gold as part of a risk management/portfolio construction exercise, I don’t see us having meaningful long-run allocations to gold.
Dhaval Kapadia, Director, Portfolio Specialist, Morningstar Investment Adviser (India)
Traditionally, Indians are known to buy and hold investments in physical gold for years, even generations. Gold has been seen as a store of value and inflation hedge.
Gold has traditionally been viewed as a safe-haven asset. In other words, during periods of significant distress or uncertainty in financial markets, gold attracts investors and performs well. In recent history, gold outperformed other asset classes during the global financial crisis in 2008 and the subsequent recovery period up to 2011. In the aftermath of the Tech bubble burst in 1999-2000 and the subsequent global economic slowdown as well, gold outperformed equity.
In the Indian context, gold also acts as a currency hedge; appreciating in value when there is a fall in the rupee vis-à-vis the USD (the domestic price of gold is based on the international or USD gold price, excluding domestic taxes).
Over long time periods equity tends to outperform gold but it plays an important role in an investment portfolio due to its negative to low correlation (as illustrated above) with traditional asset classes like equity and debt, thereby reducing fluctuations or volatility in the portfolio particularly during periods of significant uncertainty in financial markets or the economy.
Allocation to gold can be maintained at 5% to 10% of an investment portfolio.
