Gold underperforming but make it part of your inflation-combating portfolio

It may underperform in the near term, but could bounce back if fears of a US recession gain ground

Gold exchange-traded funds (ETFs), which track the price of gold, have corrected between 1.7 per cent and 4.9 per cent (3.5 per cent on an average) over the past three months. Their year-to-date (YTD) returns, however, are positive. Experts say the yellow metal could continue to underperform in the near term.

Strengthening dollar, rising real rates

Three months ago, the conditions were favourable for gold. Inflation had flared up across the world, geopolitical risks had escalated with the Russia invasion of Ukraine, and Covid-19 remained a potent threat.

All this should have led to heavy inflows into gold. “A considerable portion of the safe-haven flows, however, went into United States (US) treasury bonds, causing the dollar index to strengthen. A strengthening of the dollar is negative for gold,” says Pritam Patnaik, head-commodities and HNI (high networth individual), NRI (non-resident Indian) acquisition, Axis Securities.

Central banks across the globe, including the US Federal Reserve (US Fed), began raising interest rates and withdrawing liquidity. And more rate hikes are on the cards as inflation appears not to be cooling down anytime soon. “The Fed fund futures rate suggests rate hikes of more than 200 basis points (bps) by December 2022 in the next five meetings. If this materialises, it will be a headwind for gold,” says Chirag Mehta, chief investment officer, Quantum Asset Management Company. 

The yield on the US 10-year Treasury Inflation-Protected Securities (TIPS) has also turned positive for the first time in two years, indicating positive inflation-adjusted returns for investors. “This has acted as a headwind for gold prices as, in such a scenario, investors take money out of this non-yielding asset to lock in positive real returns,” says Mehta.

Patnaik says gold tends to underperform during the initial part of a rate hike cycle.

Recession fears loom

Historically, several rate hike cycles in the US have been followed by recessions. Sometimes, central banks are forced to stop and revert to a more accommodative stance after a few rate hikes as economies begin to slow down. “By the end of May, both the dollar index and US TIPS retreated as fears of a recession overtook concerns about rising inflation,” says Mehta. A failure by the US central bank to achieve a soft landing for its economy will be positive for gold.
 

In May, India’s gold import jumped 667 per cent. A correction in the price of gold usually leads to heavy buying. More demand for the physical metal could emanate from China, a major consumer, as it reopens.

The 4.5 per cent YTD depreciation of the rupee against the dollar has supported gold’s price in the domestic market.

What should investors do?

Despite its recent underperformance, gold must be a part of your portfolio as it serves as a hedge against inflation. “It also does well whenever there are concerns about economic growth internationally,” says Ankur Kapur, managing partner, Plutus Capital, a Sebi-registered investment advisory firm.

Build an asset allocated portfolio comprising equity, debt, and gold. Maintain a 10-15 per cent allocation to gold. If your allocation is lower than that, build it by purchasing the yellow metal in a staggered manner whenever its price dips.

Investors may also link their gold purchases to an event that is several years away, and which requires gold, such as a child’s marriage. “Here, the idea would be not to benefit from movements in the price of gold but to lock in its price through regular purchases,” says Kapur.

If you need liquidity, then invest in gold ETFs. Opt for one that has a low tracking error and good liquidity on the exchanges.

Investors with an eight-year horizon may opt for sovereign gold bonds (SGBs). In addition to capital appreciation (or loss), you will receive an annual interest income of 2.5 per cent. However, exiting mid-tenure from these bonds is difficult. While they trade on the exchanges, liquidity tends to be low, and you could be forced to sell at a discount.