Here is conventional wisdom in which the investors have unquestioned faith, and biblical belief. Gold is a hedge against risks (read: stocks); whenever stocks are down, gold is up due to uncertainty and volatility, and vice versa. For decades after World War II, and even before it, the maxim stood its ground. It seemed like something embedded on the yellow metal, and not ephemeral like the paper valuations of stocks. But if you are still a believer in it, you need to get out of the investment theatre, and stick to fixed deposits and pension funds. There is no hope for you.
New studies tell us that over the past decade or so, especially after the Financial Crisis of 2008, gold’s trajectory is the same as that of stocks. ‘Safe’ gold and ‘risky’ stocks have risen at the same time. According to one of the participants in a new research which reaches this conclusion, this causes “gold’s safe-haven effect to fade.” In effect, traditionally opposing forces are converging, and the bullion can no longer be acceptable as a hedge against volatility. It too can fall when stocks do, or rise when shares do. There is no guarantee that it will act as a shield or protection against risks.
David McMillan, professor in finance, University of Stirling, who took part in the research, first analyses the reasons for the convergence of stocks and gold. In the former case, the “global economy is emerging from a period of high inflation and high interest rate.” Central banks, including the Reserve Bank of India, have reduced interest rates, and more cuts are expected in the future. This propels both spending and consumption, and business investments and sentiments. Growth figures are good. Artificial Intelligence and tech innovations will enhance future productivity. Obviously, investors are excited, and the stock markets are up globally.
Geopolitical risks abound, and have only increased in the past few years. Regular bilateral wars, including a prolonged one between Russia and Ukraine, and tensions in the Middle East have influenced the prices of energy, food, metals and other commodities. The US president Donald Trump’s trade tantrums, and threats of trade wars have hiked the levels of uncertainty and unpredictability. In such an environment, thanks to conventional wisdom and thinking, investors queue up to buy gold. So do the central banks, which are worried about the negative impacts on their economies. As do specific nations, which are either overtly concerned about national security like Poland, or wish to dominate the world like China.
Now, let us look at trends that are unconventional, even unthinkable, but true. Since 2009, although there remains a lure for physical gold, investors can now buy and sell virtual gold, or gold paper, in the form of Exchange-Traded Funds (ETFs). Although the first gold ETF was launched in 2004, the popularity grew in the past 15 years. ETFs allow investors to buy a share in gold that is stored in warehouses by the managers of the funds. It implies that gold can be traded like shares. In fact, it has become a financial and paper instrument. Hence, it can be included in an investment portfolio.
What happens when gold is bought and sold like stocks, bonds and other commodities (oil and metals)? The yellow metal becomes an investment asset, which is included as a part of a financial portfolio, and loses its sheen as a hedge and safe haven. Subconsciously, investors think about what proportion of the portfolio needs to be in the form of gold. Thanks to the popularity of ETFs, there is thus a higher demand for gold, not only from central banks, manufacturing sector, and jewellers but from retail investors like you and I. We may not think about it but we no longer buy gold only when stocks are down. We do it on a regular basis, all the time, to balance portfolios.
McMillan concludes: “Since the end of the global Financial Crisis in 2009, and especially for the past 10 years, gold has broadly followed the same path as stocks. While there will always be deviations, this effectively means an end of gold as a safe-haven hedge against stock price falls. But that is not to say that gold has lost its appeal. Its limited supply and desirability for both jewellery and manufacturing are rare and valuable attributes. And with its intrinsic worth recognised all over the world, gold is likely to be in demand.” This is true for India, where gold has traditional, cultural, religious and lifestyle connotations, rather than only investment-related ones. Hence, gold buying will continue, and Indians will never get tired of it.
The Mumbai-based author writes on stocks and personal finance, and has an experience of 15 years