ET Wealth | Will the gold price rally last?

The year 2020 has shown how one good year can wipe out a history of poor returns. Just a year ago, the returns from gold looked anything but shiny. The five-year annualised return was 4% and seven-year returns was a measly 1.5%. But gold has made a dramatic comeback in the past few months. Gold prices have shot up 42% in the past one year, pushing up its five-year returns to nearly 12% and seven-year returns to 7.8% (see graphic).With this sharp turnaround, gold has comfortably beaten equities both in the short and long terms. While other asset classes are feeling the heat due to Covid-19, gold is the flavour of the season as investors seek a safe haven in a gloomy economic environment. Investors who had given up on gold after nearly a decade of muted returns, are coming back in droves. Gold ETFs are in high demand and sovereign gold bonds are witnessing record subscriptions.Gold has made a dramatic turnaroundWith sharp uptick in gold prices since last year, long-term returns now look good.766595233, 5 & 7 year returns are annualised. Data as on 18 June Compiled by ETIG DatabaseWhat’s fuelling the rally?Gold is in a sweet spot due to a series of events that began last year. A trade war between the US and China, geo-political tensions and dovish central bank actions initially sent gold prices soaring over 20% last year. This year, the uncertainty caused by Covid has spurred gold by another 22% as investors shunned riskier assets and flocked to what has traditionally been a safe haven.Gold does particularly well during periods of negative “real” interest rates—when the inflation rate is higher than the prevailing interest rate. With major central banks continuing to pump in more money into economies to avert recession, currencies are getting devalued and interest rates are heading lower. The real yields of sovereign debt of many countries are in negative so the confidence in fiat currencies is very low. For instance, the 10-year US Treasury bill currently yields 0.64%—lower than the expected inflation rate. A long-term investor in US treasuries is almost guaranteed to lose a small amount of purchasing power over the life of the bond. This makes gold a more lucrative option. “It is at times like these that gold reclaims its role as a store of wealth, which will keep pace with inflation to preserve the purchasing power of capital,” says an ICICI Securities note.The currency debasement is likely to keep gold prices high, asserts Chirag Mehta, Senior Fund Manager, Alternative Investments, Quantum MF. “The unprecedented liquidity being pumped by central banks is unlikely to wind up anytime soon. More accommodative policies will keep real interest rates low while driving up inflationary pressures, making gold attractive,” Mehta says.Further, central banks worldwide are adding gold reserves to diversify their holdings amid heightened geopolitical tensions and economic uncertainty. The past two years have in fact seen the highest level of net purchases of gold by central banks. These institutions now hold over 35,000 tonnes of gold, reports ICICI Securities. Besides, investors are also adding to their gold stockpile. Gold backed ETFs have seen increased inflows in recent months (see graphic). According to World Gold Council, year-to-date inflows into gold-backed ETFs of $ 33.7 billion have already exceeded the highest ever annual inflows of $24 billion in 2016. This investment demand is driving physical gold prices. Arun Kumar, Head of Research at FundsIndia, explains, “Large ETFs hold a significant amount of physical gold. Therefore, the inflows and outflows from such ETFs can affect the metal’s price, by altering the physical supply and demand in the market.”Investors are flocking to gold backed fundsNet inflows in gold backed ETF (tonnes).76659533Globally, the demand for gold backed ETFs has increased substantially in the three months since the Covid outbreak.Source: World Gold CouncilBoosted by fall in rupeeLocally, the rupee depreciation is a critical contributor to domestic investors’ returns. In India, the landed price of gold is calculated by converting international gold price into rupee terms using the prevailing dollar-rupee exchange rate, apart from the customs duty rate. The sharp depreciation in the rupee has given a leg up to gold returns. With the government borrowing heavily to fund its stimulus package, India’s credit profile has deteriorated further. This will contribute to rupee depreciation in the coming years, which in turn will support domestic gold prices.Finally, the basic safe haven appeal of gold will not go away as economic activity is not likely to revert to normal anytime soon. While gradual reopening of industries and the ensuing spurt in activity may suggest a quick recovery, this rebound is likely to be short-lived, asserts Mehta. With uncertainty around jobs and decline in household incomes, individuals will not go for spending in the way they did earlier.Despite the 22% rally in 2020, gold still has a lot of steam left, say experts. “With heightened uncertainty and growing expectations of a global recession, unprecedented levels of stimulus from central banks and historically low interest rates, we believe that gold will touch higher levels,” says Saida Litosh, Manager, Precious Metals, Refinitiv, a financial markets intelligence provider. “Investors seem to be buying gold to protect their portfolios (as insurance) from a further deterioration of the economic environment,” contends Unmesh Kulkarni, MD of global private banking advisory Julius Baer India.Rupee depreciation supported uptick in domestic goldDomestic prices are determined by converting global prices using the prevailing dollar rate.76659543Global and domestic prices normalised to a base of 100What should be your strategyClearly, gold is poised to extend its rally. Does this mean that your portfolio should have more of the metal? Here, a historical perspective on gold’s performance will prove helpful. While gold has done well over the long run, the precious metal has often gone through extended periods of tepid returns. A study of gold returns across time frames since 1980 shows it has averaged 9.3% CAGR over five-year time frames and 10% over a 10-year horizon. What is interesting is the distribution of these returns. In 25% of the five-year holding periods and 20% of the seven-year holding periods, gold fetched less than 4% return. Investors will also note that gold managed to touch its 2012 peak after seven years in 2019.In this backdrop, investors need to rein in their expectations and not go overboard with gold investments. It’s time to exercise caution and not chase the prices, says Kulkarni. Experts insist that investors take a holistic view of the asset class. Treat gold more as an asset diversification strategy rather than to earn higher returns. Mehta stresses on having a permanent role for gold in the portfolio. “It’s only after every crisis that investors realise the importance of having gold in the portfolio,” he observes. Most experts suggest investors maintain around 10-15% allocation to gold at all times as a simple diversification tool. As Kumar likes to point out, “Gold is an asset that you buy and pray it doesn’t do well because that would mean the rest of your portfolio will most likely do well.”Experts say investors should buy more gold only if they are currently underinvested in it as per their asset allocation. Looking in the rear-view mirror and investing in gold (or any asset class) would not be the right approach, stresses Rajesh Cheruvu, CIO, Validus Wealth. “Discipline in sticking to strategic asset allocation should be maintained since it would incorporate long-term investment goals and needs. Accordingly, gold would deserve some allocation in the portfolio, with tactical changes to be done on a periodic basis,” he adds. A tactical change may involve going slightly overweight on gold, depending on one’s risk profile. But do not extend tactical allocation beyond 5% of the desired long-term allocation.Further, it must be pointed out that volatility in gold prices has increased significantly since the turn of the year. Between January and June 2019, annualised daily volatility in gold prices was 13.5%. This has doubled to 27% this year, partly due to the heightened volatility in the dollar.Gold prices have been very volatile in 2020Annualised daily volatility in gold prices.Jan-June 2019: 13.5%July-Dec 2019: 17%Jan-June 2020: 25.9%Volatility in the dollar rate this year heightened the movement in gold prices.Note: Figures represent annualised standard deviationReturns from gold can be tepid for long stretches76659551In 26% of the five-year holding periods and 21% of the seven-year holding periods since 1980, gold has given less than 4% return.Best ways to invest in goldIf you want to add gold to your portfolio, avoid physical gold. It has multiple issues such as concerns over purity, very high making charges and storage costs etc. Experts say investments in the precious metal should be in the form of paper gold. Gold ETFs and sovereign gold bonds (SGBs) are two options for investors—both completely different from each other.SGBs are issued by the government at regular intervals at the prevailing gold price. They have a fixed tenure of eight years, but can be sold after a lock-in of five years. If held till maturity, there is no capital gain tax on the investment. This is unlike gold ETFs or gold funds where gains after three years are taxed at 20% after indexation. Further, unlike gold ETFs, gold bonds offer an interest of 2.5% annually, paid semi-annually. This interest is taxable, but SGBs do not levy any charges unlike the 0.5-1% expense ratio charged by gold ETFs and gold funds. Experts maintain that SGBs remain the best vehicle to participate in gold for the long term if the intent is to hold the bonds till maturity. This applies even if the bonds are purchased in the secondary market.“For a tenure exceeding five years, SGBs would be the best route, with the return a little higher compared to actual gold return due to zero charges, the additional interest and the taxation benefit,” points out Cheruvu. If sold before maturity, gains on bonds sold after three years are taxed like gold ETFs. Besides, traded volumes are very low in most SGBs so those selling before maturity may have to do so at a discount. You can even buy any of the existing bonds in the secondary market at a discount but make sure to hold till maturity. The government has already launched three tranches of SGBs so far this financial year. Another three tranches will be rolled out by the end of the year.But a small 5-10% exposure to gold is critical to diversify your portfolio76659559Gold returns are for spot gold prices (995 purity), equity returns are for Nifty50 index and bond returns are for Crisil Composite Bond indexGold ETFs have their benefits too. Unlike SGBs, gold ETFs or gold funds are available on tap. Since these can be bought and sold anytime, gold ETFs are suitable for taking advantage of any intermittent volatility in gold prices. Investors can even set up SIP in gold funds to allow regular investment in smaller denominations. There is no limit on the quantity or amount of gold ETFs that an investor can purchase. Aptly chosen ETFs are good for a shorter tenure as charges are minimal and exit mechanism is easy, Cheruvu says. “A combination of the two can be a good strategy for investors – SGBs for allocation towards one’s long-term strategic portfolio, and ETFs for liquidity and tactical investing, apart from making a larger allocation,” suggests Kulkarni.

from Economic Times https://ift.tt/2Vq0YsS