US-China trade war: Move 10% of your portfolio to the yellow metal

The ongoing trade war between the US and China has created uncertainty, which is good for gold, the safe haven asset

The equity markets are under pressure, with the Nifty down 1.89 per cent and the Nifty Midcap 50 down 5.30 per cent year to date (YTD). The slowdown in real estate continues. The volatility in yields has caused the returns of debt funds to see-saw in recent months. One option that investors need to include in their portfolio to provide balance to it is gold, which is up 4.26 per cent YTD. 

The bull market in gold started in 2002 and continued till 2012. From 2013 to 2015, the yellow metal gave negative returns. Thereafter, there was a mild improvement in returns (11.23 per cent in 2016 and 5.34 per cent in 2017 in India). This year the yellow metal is up 4.26 per cent already. 

The primary reason for gold being up currently is the ongoing trade war between the US and China. With each side announcing tariffs on a widening list of goods, there are fears that this spat could affect global trade relations, hurt the global supply chains that have been set up over decades, and also impact economic growth, productivity, consumer inflation and employment. This environment of economic uncertainty has led to investors moving in to gold, the safe asset haven.  

A trade war will also have an impact on the dollar reserves held by central banks. Since the dollar is the currency primarily used in international trading, many central banks hold large dollar reserves. If the pattern of trade shifts due to the imposition of tariffs and other regulatory hurdles, many central banks could reduce their dollar holdings and start holding the currencies of those countries with which they trade more. It could also happen that central banks may not feel very confident holding the currencies of their trading partners. In that case, they could hold more gold. 

Currently, many central banks around the world, such as those of the US, UK, European Union, Japan, etc are speaking of aggressive rate hikes and reducing their quantitative easing programmes. All this could lead to reduced liquidity globally. In the aftermath of the global financial crisis, asset markets across the globe have become accustomed to a high level of liquidity support. "If central banks go overboard in tightening liquidity, there could be a backlash. Such a situation would be good for the yellow metal," says Chirag Mehta, senior fund manager-alternative investments, Quantum Asset Management Company.

 As growth improves, inflation too will rise in developed countries such as the US. If the central bank is too slow in tightening, inflation could gallop ahead. Gold tends to do well in a high-inflation environment. 

Thus, gold's fate is closely tied to whether central banks around the world are able to wind up their loose monetary policies without going overboard in one direction or the other. If they slip up, expect gold to do well. 

In the current environment, investors must have a 10-15 per cent allocation to gold in their portfolios. This is the level of allocation that augments return while reducing volatility in the portfolio. If you are going to hold for a long time, invest via sovereign gold bonds, which give an annual interest of 2.50 per cent. However, not much liquidity is available in sovereign gold bonds trading on the stock exchanges. If you have to sell, the discount on the face value can be as high as 6 per cent. If you are investing for a shorter tenure, invest via a low-cost gold exchange-traded fund.