Investing in
Uncertain times
Is gold the correct investment
avenue in these uncertain times?
With the uncertain times the world economy and the Indian economy is facing
in terms of Fed increasing interest rates, increase crude oil prices, Brexit
and locally with undoubtedly the best RBI governor India ever had calling it a
day, there is a lot of volatility and uncertainty the markets would facing in
the in the coming weeks, should this lead to buying more gold in one’s portfolio….
Gold has been billed as a “wonder investment” in portfolios, apparently
it can help protect against inflation or deflation, political, financial or
economic chaos and much more besides. So it is no wonder that we are seeing
interest in this commodity soar as investors find themselves in a moment of
political turbulence on both sides of the Atlantic.
However, some caution is warranted here, ideally the
simple suggestion would be that gold should occupy no more than low single
digits in percentage terms as a proportion of your total invest able assets, and
these uncertain times should not tempt you to increase the allocation in gold
as an asset class.
Perhaps the most alluring part of gold’s story right
now seems to be its role as a safe port in the storm. In a world seemingly
beset with more than usual levels of monetary, economic and political
uncertainty, gold, with its thousands of years of practice as a store of value,
seems to shine brightly as an investment prospect.
Most would agree that a safe asset should have a
relatively stable value during times of market stress. If we assume that such
times tend to see equity markets fall sharply, gold’s historical record over
the long term is far from perfect on this count.
Even without that blemished relative record, investors
should be wary of havens where the price has jumped around so dramatically even
when just viewed over the past five years. Nonetheless, if enough investors
believe gold to be a haven then it may well act as one.
Some argue that gold is not a commodity that is geared
towards providing protection against expected changes in inflation, but rather
it is there for the unexpected. This is more difficult to weigh, as the tricky
procedure of decomposing inflation into its expected and unexpected components is
more art than science.
However, based on some of the (admittedly crude)
empirical work that has been undertaken, the long-run relationship between gold
and unexpected inflation looks entirely unremarkable.
One area where there is an undeniably strong
relationship is between gold and real bond
yields. The basic argument here is that the relative attraction of gold wanes
as the real yield available on other, more plausible, havens rises.
Why would you buy gold, which
throws off no cash flows or coupons, when you can lend the US government money
with a yield above inflation? As real and nominal bond yields have plunged
lower this year, gold has prospered.
We see inflation picking up over
the course of the year, particularly in the US economy. Revolving credit is
picking up, wages are too and just as oil prices exerted significant downward
pressure on inflation indices over the past two years, they will exert upward
pressure as we continue to annualise those dramatic falls.
It is anticipated that as inflation
starts to return, a less historically remarkable term-premium for government
bonds may also follow, pushing real yields higher. would hesitate to suggest how quickly such a
risk premium would return, however, this sits behind the recommendation that
gold should not occupy large parts of a diversified investment portfolio.
There is perhaps some irony in
the fact that the recent recovery in oil prices has sown the seeds for gold’s
future under performance.
Nonetheless, the preferred route
in commodities is the diversified one. China’s property market bounce is likely
to help sentiment across the space even in the face of still unappealing
inventory statistics and supply-demand balances.
For
those looking for a port in the storm, cash and short-term bonds remain the
best option, nominal values will remain constant even if real values won’t. To
protect against the kind of inflation that we are currently envisaging,
equities have historically proved to be the most consistent bet.
-
Farzan Ghadially
