Gold on the Edge - Is your Portfolio ready for what's next?
- Sarvesh Kondejkar
- Oct 14, 2024
- 4 min read
Gold, a cherished asset, is currently hovering near its all-time highs. This raises the question: why is it rallying so strongly, especially when gold typically becomes less attractive in a high-interest-rate environment?
Let’s deep dive into these current trends affecting gold worldwide and why it’s crucial for investors to analyze these factors and their potential impact on your portfolio.
As of October 2024, I believe gold remains a vital asset for diversifying portfolios and reducing overall investment volatility. Its current and future performance will be influenced by several macroeconomic factors, including interest rate cycles, inflation, geopolitical uncertainties, and the performance of other asset classes.
History of Gold -
Year-to-date in 2024, gold returns have matched those of the Nifty Index.
Given the Nifty's strong rally and its low correlation with gold, it's noteworthy that gold is outpacing the Nifty50 in a high interest environment.
If gold maintains this growth rate, it could mark one of the best years for gold returns.
Gold is a crucial asset class for investors. Historically, it has performed well, preserving wealth during uncertain times and provided solid support during various market conditions. Its rarity and rich history contribute to its value for numerous investors.
Following are the historic CAGRs of Gold -
Gold is an essential component of a well-rounded balanced portfolio. After running some simulations with various allocations of equities, gold, and fixed income, an observation was made that a portfolio consisting of 60% equity + 25% debt + 15% gold, yielded a minimum CAGR of 2.9% and a maximum of 14.9% over five years.
Coming to 2024 -
Looking ahead to 2024, the first half of the year has seen a strong rally in equities, resulting in above-average returns in both India and the USA. Further as the uncertainty rises, gold will serve a crucial role in preserving wealth.
Gold also has a very unique correlation with interest rate cycles and bonds.
Typically, when the 10-year Treasury yield falls, gold prices rise. This is logical: as bond yields decrease, gold becomes a more attractive asset class.
However, since 2022, this trend seems to have shifted. Despite aggressive rise in real interest rates, gold prices continued to climb. One possible explanation is that investors are not sharing the same views and perspective of FED's central bankers understanding of soft landing of U.S. economy, leading to this discontinuity in the usual trend.
Rising Geopolitical Tensions
Over the past two years, geopolitical tensions have escalated between the U.S. and China, the Russia-Ukraine crisis, and conflicts in the Middle East and Bangladesh, among others.
These developments created significant uncertainty and potentially trigged a move towards de-dollarization worldwide. The chart on the right illustrates the increase in China’s gold reserves as a result of U.S.-China trade tensions. Following the Russia-Ukraine crisis, China has recognized the vulnerabilities of holding U.S. assets, prompting a shift toward gold and a reduction in its stake in U.S. Treasury bonds.
The accompanying charts clearly show that central banks are actively increasing their gold reserves. For instance, India has requested the re-allocation of some of its gold holdings from UK vaults to store them in Indian vaults. By accumulating gold, central banks have a better chance to reduce currency fluctuations.
I have a simple way of analyzing this, when Central Banks are doing something, they are doing it after careful considerations. Otherwise, they won't just pile up on Gold.
Thus, instead of over-analyzing these moves, it makes sense to conclude that there is a strategic purpose behind them.
Investors and Gold
Despite the strong momentum in the market, gold ETFs have experienced record inflows globally. Notably, this trend correlates with the gold and 10-year Treasury yield graphs.
Since mid 2022s, the Inflows in the Gold ETFs have surged significantly.
I want to emphasize a point I made earlier: markets are forward-looking, and investors may be concerned that the U.S. could face a more severe recession than what the Federal Reserve anticipates.
In 1994-1995, the Fed raised rates seven times (from 3% to 6%) with the goal of stabilizing inflation, which led to a relatively soft landing for the economy and flat gold prices. However, the current situation is quite different!
What lies ahead?
Starting with the Investor or Trader sentiment, we can see a large amount of Long (bullish) open positions in the market, with net average pointing upward. This shows that current prevailing sentiment is Bullish!
Typically, when a rate cut cycle begins, fixed-income options become less attractive, making gold a more appealing investment. This shift often leads to a rally in gold prices.
What am I doing?
This chart reveals an interesting trend: whenever the ratio falls within the range of 2.2 to 2.4, we often witness a downturn in the index, followed by a rally in gold prices.
(Instances - 2000 Dot-Com bubble, 2008 Financial Crisis, 2020 Covid Crisis)
Currently, the ratio is approaching these levels and appears to be gaining upward momentum. I personally don't find any fundamental reason for our index to go bust immediately (apart from Valuation concerns), but this can act as a potential warning sign.
As of now, I have only 2% allocation to gold in my portfolio through Sovereign Gold Bonds (SGBs). However, after extensive research, I am convinced of the need to increase my gold allocation—whether as a short-term hedge or a long-term asset.
Moving forward, I plan to gradually raise my allocation to gold to 5-7% of my portfolio, depending on economic developments and gold price movements. Even if gold prices stagnate or decline, I might average down and hold it for the long term, as gold is part and parcel of Indian Households. Moving forward, I will consider investing in gold through either ETFs or physical gold.
Disc. - All views are personal and for educational purposes only! Please think and act wisely.
Thank you for Reading!
Investment Comparisons - Gold
Gold ETFs -
Not an Investment Advice!
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