Use current prices to raise gold allocation to 10-15%, say analysts

Rising inflation, low real yield, and equity market volatility are positives for the yellow metal

The second wave of Covid-19 infections and the lockdowns being imposed across the country are adding to investors’ anxiety. Though these developments could delay economic recovery, they are likely to be positive for a safe-haven investment like gold. Already, the yellow metal has risen 6.2 per cent from its one-year low.

“The uncertainty on the pandemic front is back. New waves and variants of the virus, and the resulting lockdowns, could trigger pullbacks in risky assets like equities. Gold could benefit from the resulting risk aversion, as happened last year,” says Chirag Mehta, senior fund manager, alternative investments, Quantum Asset Management Company.

According to Hareesh V, head of commodity research, Geojit Financial Services, “Any signs of weakness in the global economy could lift sentiment in favour of the yellow metal higher”.

Physical demand is back

India imported 321 tonnes of gold in the March quarter, more than double the 124 tonnes imported a year ago. A couple more months of strong demand could support gold prices.

Inflation impact

India’s consumer price index-based inflation rose to 5.52 per cent in March, compared with 5.03 per cent the previous month. Even the Reserve Bank of India’s (RBI’s) estimate of inflation is pegged at 5 per cent for the next year. The massive liquidity infusion into financial markets the world over, including India, could trigger inflation.

“The ongoing stimulus measures by governments to support their economies have set the stage for higher inflation as money trickles down to the real economy. Gold tends to do well in times of higher inflation. Also, real interest rates, which are one of the biggest drivers for gold, will be under pressure due to higher inflation, supporting gold,” says Mehta.

Hedge against equity-market risk

Equities have enjoyed a great run over the past year. But stocks are richly priced now. Any possibility of a lockdown or an economic slowdown that could impact corporate earnings could derail this rally. A glimpse of this was seen on April 12, 2021, when the Sensex tanked 3.4 per cent. More such instances of volatility could make investors invest in gold as a hedge. Gold can also provide investors a hedge against the risk of the rupee depreciating against the US dollar over the long term.   

Negative real returns on bonds

With bond yields low and inflation rising, real yields — nominal yield minus rate of inflation — are under pressure. Investors in one-year fixed deposits offering 5 per cent interest earn virtually nothing. Taxation pushes their real return even further into negative territory. When real yields turn negative, investors turn to gold to protect their purchasing power.

Invest for the long term

Follow an asset-allocation approach while investing in gold. Over the past six months, rise in equities and fall in gold prices would have skewed your gold allocation, so review it. “Gold prices are down from their August 2020 highs. Bargain hunters and long-term investors should take advantage of the current low prices,” says Mehta.

Hareesh V advises against looking at gold as a short-term play. “Invest systematically in gold for the long term — five years or more — to enjoy good capital appreciation. Stay away from it if you can only invest for the short term,” he says.

A 10-15 per cent exposure to gold is generally regarded as ideal. Use gold exchange-traded funds (they offer liquidity) and sovereign gold bonds (for long-term exposure) to achieve this allocation.