Interviews

World Bank Estimates That Full Recovery Will Take 5 Years Chirag Mehta Sr Fund Manager Alternative Investments Quantum AMC

Broadly speaking, what’s your take on domestic Gold right now? We’ve already seen an impressive upswing since the yellow metal broke below 44,000 levels last month. What factors have contributed to it?

Post rally in mid-2020, gold prices shaved off some gains by the end of the year as a breakthrough in vaccine development occurred in November, and optimism of economic recovery led to markets focusing on risk assets.

Since the beginning of 2021, gold has been under further pressure on account of the dollar and US bond yields that have strengthened on the expectations that a quick US economic recovery will trigger inflation as the Federal Reserve insists on keeping interest rates near zero till 2023. But in recent weeks on account of a resurgence of the pandemic in several countries, global economic recovery has slowed down hurting risk sentiment and taking some pressure off gold as US yields and the US dollar cooled down. It seems that Chair Powell has finally managed to convince investors that despite a rosier economic outlook and surging inflation, the Federal Reserve has no plans of tapering any time soon and that any exit from the easy money policy stance will be gradual. Rising US debt levels as a result of the unprecedented spending and stimulus and the resulting dollar debasement seem to be finally reflecting in the currency, boosting gold prices.

And lastly, the Indian rupee is back to its depreciating trend after appreciating over the last few months with the second wave of Covid-19 and resulting restrictions raising concerns on the growth outlook and prompting foreign investors to trim their Indian investments. This too has been supporting domestic gold prices.

Do you think that the swift turnaround of the US economy and the global vaccine rollout will hurt Gold prices in the near term?

While some recovery is certain, the extraordinary economic damage caused over the last year cannot be undone overnight. The World Bank estimates that a full recovery will take 5 years. This reconciles well with the 2008 crisis which took six years of zero rates to recover and this crisis was much severe and widespread. Thus a return to “normalcy” is a long way to go and prone to setbacks. This along with a continued commitment to accommodative monetary and fiscal policies is capping gold’s decline.

US GDP growth for the first quarter of 2021 came in at an annualized rate of 6.4%, this is an encouraging figure but lower than expectations. It remains to be seen whether this stimulus-led rebound will sustain or will the US economy require yet another round of handouts to keep things going. But for now, the strength of this improving risk appetite has begun to fade. It is possible that confidence has peaked, making it difficult for markets to become even more euphoric given that there is still a long way for the majority of the population to get vaccinated and new waves and variants of Covid-19 continue to take a toll on the pace of the global economic recovery. Risk assets riding on easy money, however, continue to do well, raising concerns of frothiness and for now, are seen limiting a rally in gold prices.

Do you see the current liquidity fueled, risk on mood will taper off at some point? If that happens, do you expect Gold to scale the heights of August ’20 again?

The optimism surrounding the economic rebound and the cheap liquidity backdrop is expected to encourage further risk-taking in search of yield and continue to propel risk assets and commodities. However, the fact remains that the economic rebound has been losing steam. Take for example the US economy has seen a decline in jobless claims but is now adding jobs at a much slower pace. It’s in line with our earlier estimates that the initial rebound will seem V-shaped but will then slow down. When the liquidity-led momentum recedes and markets start reflecting ground reality, gold should reprice on the back of constructive fundamentals.  

You have recommended investors to step in and increase their allocation to 10-15% of their portfolio at these levels. What’s your rationale behind this?

Gold along with its dominant price drivers US dollar and US bond yields may remain choppy in the near term as investors weigh strong US economic data on the one hand with US policy maker’s commitment to monetary and fiscal accommodation on the other. But it’s possible that the yellow metal has bottomed out and is headed for recovery. The macroeconomic fundamentals point to higher gold prices over the near to medium term. Having seen a reasonable correction, Investors should step in and increase their allocation to 10-15% of their portfolio at these levels to benefit from the price appreciation and risk mitigation that gold would probably offer.

Based on internal research by Quantum which mapped the benefit that gold as an asset class brings when added to a portfolio, it has been observed that a 10 to 15% allocation to gold has effectively reduced risk without sacrificing returns over a 30-year period from 1990 to 2020. An allocation higher than that starts impacting overall portfolio returns without disproportionate reduction in risks.

At this point, do you see Gold as a growth opportunity, a risk hedge, or both?

Given current gold prices and the macroeconomic backdrop, we believe gold offers both growth opportunity and a risk hedge in a portfolio context.

Investing in gold makes good sense in this pandemic-stricken world where global policymakers are resorting to monetary inflation, credit expansion and government spending to tackle the economic fallout of Covid-19. This is because all these measures have set the stage for higher inflation and gold, a monetary asset has a long-standing positive correlation with inflation. Investing in gold can be a good way for investors to diversify their currency denominated wealth into assets that can preserve value over the long term and aren’t eroded by inflation. 

In addition to inflation protection, gold has the potential to optimize portfolio returns in the near to medium term. With many countries including India currently seeing a resurgence in Covid-19 cases, risk and uncertainty on the pandemic front are back. New waves and variants of the virus are taking a toll on the fragile economic recovery, which could trigger pullbacks in risk assets like equities. Gold could benefit from the resulting risk aversion, just like it did last year. Given the lingering health and economic crisis, central banks around the world, led by the Federal Reserve will continue to stay accommodative to support growth, which means interest rates will stay low for longer, making bonds less effective as portfolio diversifiers. Low nominal rates accompanied by higher inflation will keep real interest rates even lower and boost demand for gold. Gold’s competitor dollar will be under pressure going forward as all the pandemic relief measures debase the dollar and add up to the massive debt levels of the USA.

How should investors add Gold to their portfolio at these levels? All in as a lump sum or staggered over the next few months?

Investors yet to allocate 10-15% allocation of their portfolio to gold should invest 50% lump sum right now to take advantage of the lower prices and stagger and accumulate the remaining 50% over the next few months.

Any parting words of wisdom about Gold investing at this point, for retail investors?
When investing in gold, investors shouldn’t underestimate the importance of the instrument used to take exposure to gold, as it could make all the difference. Amateur investors prefer physical gold like gold coins, bars and jewelry which are marred with impurities, price inefficiencies and even illiquidity given the pandemic-induced lockdowns. Investors should first differentiate between consumption gold and Investment gold. For consumption, there is no choice other than to buy jewelry. Whereas for Investment, jewelry is considered to be quite inefficient. Investors should look at efficient forms of buying gold. Investors should thus opt for Gold ETFs that are backed by 24 karat physical gold with no concerns on purity and let us sit in the safety and comfort of our home while we buy and sell gold as and when we want. These instruments are traded on the exchange at the prevailing market price of physical gold with no making charges or high premiums eating into investor returns.




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