Equity market dip, Federal Reserve signaling peak rate to boost gold

High oil prices would be detrimental; use any correction to build 5-15% allocation

Gold exchange-traded funds (ETFs) have witnessed a turnaround in flows. While flows were negative in the September and December quarters of 2022, as well as the March quarter of 2023, they turned positive (Rs 298 crore) in the June quarter of 2023. They rose further to Rs 456 crore in July and then in August, they touched a 16-month high of Rs 1,028 crore.

Fourteen gold ETFs, which have provided an average year-to-date return of 6.2 per cent, currently manage assets worth Rs 24,423 crore.

Safe-haven appeal driving flows

At a time when the equity market has touched a new peak, many investors are booking profits in equities and reallocating their gains to gold. “Investment advisors recommend allocating a portion of one’s portfolio to gold after investors have earned good returns in the stock market, as it can act as a safety net in uncertain times,” says Gnanasekar Thiagarajan, director, Commtrendz Research.

Interest rates in the US seem to be approaching their peak. “This alleviates concerns in the gold market that interest rates may continue to stay higher for longer because of persistently high inflation,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.

Gold prices have corrected about 5-6 per cent from peak levels. “This decline has resulted in increased attention from investors looking at gold from a long-term perspective,” says Navneet Damani, head of research, commodities & currencies, Motilal Oswal Financial Services.

Experts say that investor preference has shifted away from physical gold (jewellery and bars) and towards financial forms of gold, such as ETFs and Sovereign Gold Bonds, in recent months. “Instruments like ETFs offer smoother entry and exit, eliminate concerns over purity and maintenance, and bypass the Goods and Services Tax (GST) that applies to physical gold,” says Damani.

Key factors to watch  

Gold investors will take their cue from the outcome of the Federal Reserve (Fed) meeting. “While a 25-basis-point hike is priced in, the tone of the statement — dovish or hawkish — will impact the direction of gold prices,” says Thiagarajan.

A signal from the Fed that interest rates have plateaued could boost investor confidence in gold. “High yields deter investment in gold as investors can earn returns from fixed-income assets,” says Dhawan.

Gold’s inverse correlation with equities will also influence its trajectory. “If the equity market corrects significantly, money could flow into gold,” says Dhawan.

The rupee’s movement against the dollar should also be monitored. Strengthening of the dollar would have an adverse impact on gold’s price in the international market. But if the rupee depreciates against the dollar, that impact would get somewhat offset (depending on the extent of movement) in the domestic market.  

Seasonal demand during festivals like Dussehra, Diwali, Christmas, and New Year could provide a boost to gold prices. “These festivals trigger physical buying,” says Thiagarajan.

Geopolitical flare-ups could also provide momentum to gold. “An escalation in geopolitical tensions — Ukraine-Russia or China-Taiwan — or increased buying by central banks could serve as catalysts for higher gold prices,” he says.

Crude could play spoilsport  

Rising crude oil prices, due to production cuts by a few suppliers, could exert downward pressure on gold. “It could fuel inflationary fears, and potentially lead to the Fed adopting a hawkish stance. This could lead to increased interest rates and a stronger dollar, both of which would be negative for gold,” says Thiagarajan.  

According to Dhawan, if fears of a global recession recede, investors would make a beeline for riskier assets, which would affect gold negatively.
 

Allocate 5-15%  

Investors should allocate between 5 and 15 per cent of their portfolio to gold. “Aggressive investors should lean towards 5 per cent and conservative ones towards 15 per cent,” says Dhawan. He recommends an investment horizon of seven to 10 years.

Thiagarajan adds that while there are concerns about a stronger dollar suppressing gold prices, investors should use any downturn as an opportunity to build their long-term allocation to gold.

Lastly, opt for an ETF with a lower expense ratio to enhance your return. Also, opt for one with a lower tracking error.