gold price: is the usefulness of gold as an asset allocation diversifier broken, will gold prices go up?

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Over the past month, equity and bond markets have suffered from rising inflation and the fallout from the protracted conflict between Russia and Ukraine. Surely gold would have done better, given its appeal as a safe haven? Not enough. Gold prices have also fallen along with other asset classes, adding to the misery for investors. Domestic gold prices fell 7% to 50,450 rupees per 10 grams from April’s peak of 54,380 rupees per 10 grams. Does this mean that gold is not doing its job? Is Gold’s Utility as an Asset Allocation Diversifier Shattered? Let’s find out.

Gold has traditionally been considered a safe haven asset in times of economic turmoil and uncertainty. The precious metal is also considered an inflation hedge to protect against the depreciation of fiat currencies. It tends to have a low correlation with other asset classes, especially stocks. Therefore, financial advisors generally recommend having an allocation to gold as a diversifier to cushion an investor’s portfolio during tough times. However, the yellow metal has failed to live up to its bill in recent weeks even as financial markets have fallen. This despite a decline in real interest rates, generally favorable to gold.

The answer lies in the resurgence of the US dollar and the strength of US bond yields. The dollar jumped as investors rush to safety in the greenback amid concerns over

inflation. The dollar index rose for five straight weeks to a 20-year high as US Treasury yields climbed on expectations that the Fed will be aggressive in trying to control inflation. After its 50 basis point hike earlier this month, investors expect the Fed to follow up with two more early rate hikes. This makes investors nervous and puts them in risk aversion mode. “Market fear that inflation could remain high in the near term while the tightening could slow growth has prompted market participants to avoid all riskier assets like commodities and equities and stick to the most reliable asset which is the U.S. dollar,” says Ravindra Rao, CMT, EPAT, Vice President of Commodities Research, Kotak Securities.

Gold and the dollar tend to have an inverse relationship. When the dollar is on a strong footing, it makes gold less attractive to buyers holding other currencies. Rising interest rates and short-term yields in turn increase the opportunity cost of holding gold. As the Fed maintains its hawkish stance, real (inflation-adjusted) yields are expected to rise. A positive real return undermines the demand to continue playing. Central banks continue to assess the usefulness of gold in these uncertain times and thus added 84 tons to the world’s official gold reserves during the first quarter. Analysts expect central banks to continue diversifying from dollar assets into gold. Concerns about global growth have only intensified in recent weeks amid mixed economic data from major economies, pessimistic growth forecasts, continued fighting between Russia and Ukraine and a anemic activity in China due to virus restrictions.

With so many moving parts, the likelihood of the US Fed achieving a soft landing for the economy is low, Mehta believes. “A slowdown in growth, high debt levels and financial market instability will ensure that Fed tightening will be short-lived, again making conditions favorable for gold,” Mehta argues. He thinks the US and other global central banks are looking at a policy mistake. Inflation may not come down even if interest rates are raised because supply-side inflation persists and also contributes to it. It is possible that aggressive policy measures will kill inflation at the expense of growth. If central banks realize this and turn around, it will lead to a revaluation of gold.

The yellow metal has already seen some respite as the strength of the US dollar and US bond yields have begun to moderate. Rao believes gold could see some recovery soon as growth and inflation concerns increase its appeal as a safe haven. Experts argue that investors should be guided by their asset allocation and keep up to 10-15% of their portfolio in gold. This can be built in a laddered fashion through investments in gold ETFs or new gold sovereign bond tranches. gold because gold is worth nothing.

This is why gold is down despite safe-haven demand due to inflation and war concerns. “The Fed tightening cycle will continue to put downward pressure on gold over the next two months,” said Chirag Mehta, CIO, Quantum AMC. As gold lost momentum near the $2,000 an ounce level, some investors opted out. Gold holdings with SPDR ETF fell 12.55 tonnes to 1,082 tonnes, the lowest since mid-March. Gold ETF flows could become more price sensitive, Rao observes. “We may only see further gold buying when the market focus shifts from central banks to economic risks.” However, this does not mean that gold has lost its appeal as a safe haven, experts insist.

The favorable factors for gold prices continue to play. Central banks continue to assess the usefulness of gold in these uncertain times and thus added 84 tons to the world’s official gold reserves during the first quarter. Analysts expect central banks to continue diversifying from dollar assets into gold. Concerns about global growth have only intensified in recent weeks amid mixed economic data from major economies, pessimistic growth forecasts, continued fighting between Russia and Ukraine and a anemic activity in China due to virus restrictions.

With so many moving parts, the likelihood of the US Fed achieving a soft landing for the economy is low, Mehta believes. “A slowdown in growth, high debt levels and financial market instability will ensure that Fed tightening will be short-lived, again making conditions favorable for gold,” Mehta argues. He thinks the US and other global central banks are looking at a policy mistake. Inflation may not come down even if interest rates are raised because supply-side inflation persists and also contributes to it. It is possible that aggressive policy measures will kill inflation at the expense of growth. If central banks realize this and turn around, it will lead to a revaluation of gold.

The yellow metal has already seen some respite as the strength of the US dollar and US bond yields have begun to moderate. Rao believes gold could see some recovery soon as growth and inflation concerns increase its appeal as a safe haven. Experts argue that investors should be guided by their asset allocation and keep up to 10-15% of their portfolio in gold. This can be built in a laddered fashion through investments in gold ETFs or new gold sovereign bond tranches.

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