Investment Commentary

In this episode of our Strategic Edge series, Andrew McCollum, Head of Investment Management at Coalition Greenwich, discusses the findings of recent research on portfolio allocation trends with Matthew Mark, our Global Head of Institutional Sales.  

Watch below to see what market dynamics are influencing investment strategy and how the allocation mix is shifting. 

In the recently published 2021 Alternative Assets in Europe report, one thing is clear: alternative assets are en vogue amongst European investors. By the end of 2020, assets under management (AUM) in alternative funds rose above €2bn for the very first time. That’s a 14% increase y-o-y, and 59% growth since December 2016. And increasing allocations to alternative assets is not just a European phenomenon.

Private capital in Europe – at a glance

This trend of greater allocations to alternative assets comes as no surprise. In Europe, the ultra-low/negative interest rate environment has left investors hunting for yield among real assets, and investments in private equity, venture capital, hedge funds and infrastructure have long offered attractive returns compared to many competing asset classes. But higher returns come with higher risks – higher correlation to equities, lock-down clauses and high entry/exit fees.

Nonetheless, the report indicates that appetite for alternative assets shows little sign of abating. The deal value of private capital activity in H1 2021 hit €236bn, 83% of 2020’s full year total. The authors go on to mention that fundraising is on track to eclipse the previous record of €271bn from 2019.

Post-COVID, European investors will need to reshape their asset allocations. Bonds may no longer offer the returns or protection that they once did. The trend of greater allocations to alternative assets may therefore continue, potentially making portfolios riskier in the process. As a result, appropriate diversification strategies, which could include gold, may become even more necessary in the future.

China’s economy is facing challenges. Recently, many industries in major provinces have been impacted by power rationing and enforced cuts in a drive to meet targets for reducing energy and emission intensity.¹ And this could last for some time, placing further pressure on the supply side of the economy which is already showing signs of a slowdown.

Meanwhile, the demand side of China’s economy is weakening. The y-o-y growth in China’s retail sales fell to 2.5% in August, a sharp drop from previous months. Growth in real estate investment, sales and new constructions are also rapidly trending down. This could be due to a combination of the Delta variant’s resurgence and tighter regulations in the property market.²

Chart 1: Both supply and demand sides of China’s economy encountered challenges recently

This downward pressure on China’s economy has two major implications. First, a weakening economy could potentially increase equity market risks – which was partially reflected by recent increase in equity market volatility. Gold, with its unique relationship with the Chinese stock market and the independence from China’s economy, could be an effective tool for investors.

Chart 2: gold, an effective equity market risk diversifier

Conditional correlation between Au9999 and CSI stock index during the past decade*

Second, amid supply restrictions, commodity prices might continue to soar, leading to further inflationary pressure at factory gates. Consequently, retail price indices of many categories such as home appliance and transportation rose significantly. But at the same time, demand remains weak. This could signal a potential threat of stagflation. And our research shows that RMB gold tends to outperform other major RMB asset classes during stagflation-alike periods. This, we believe, could make gold a valuable addition to investors’ portfolios.

Table 1: gold has delivered superior returns during stagflation-alike periods in China

Conditional returns of assets under different periods*

Looking ahead, many economists are anticipating further stimulus packages to support domestic demand.³ We believe that China is likely to achieve economic stability after short-term shocks fade and stimulating policies are implemented. But for now, the ability to hedge against local stock market volatilities and outperform other assets during stagflation-alike periods in China could make gold shine in investors’ portfolios.

Listen as CIO of Lombard Odier, Stéphane Monier, discusses evolving macroeconomic trends, their impact on allocation and ESG strategy with World Gold Council’s Chief Market Strategist, John Reade.

Summary

• At the last monetary policy meeting held in October, the Reserve Bank of India (RBI) maintained its accommodative stance and kept its policy repo rate unchanged at 4%¹
• The RBI suspended its bond-buying program but cautioned against premature tightening of monetary policy
• India’s retail inflation (CPI) has declined but core inflation remains elevated
• Gold can play a role in downside protection, diversification and as a hedge against inflation amid India’s low-rate environment and the current upside risk to inflation.

RBI kept its policy repo rate unchanged at the October meeting

Like many other central banks, the RBI lowered its policy repo rate during 2020 to mitigate the impact of COVID-19 on the Indian economy. In total, the rate was cut by 115bps last year to a record low of 4% in May 2020 (Chart 1).²

Chart 1: RBI has cut its policy rate to record low of 4%

At its latest monetary policy committee meeting the RBI kept the policy repo rate unchanged at 4% and stated that it would continue with its accommodative monetary stance to achieve a medium-term target of 4% Consumer Price Inflation (CPI) within a band of +/-2%.

The RBI suspended its bond-buying program but cautioned against premature tightening of monetary policy

To provide liquidity to the market during the second wave of the pandemic, in April the RBI launched a secondary market G-sec Acquisition Programme (G-SAP).³ Under G-SAP, the RBI made bond purchases of Rs1tn (US$14bn) and Rs1.2tn (US$17bn) in Q2 and Q3 2021 respectively. Signalling the start of tapering, this quantitative easing measure was discontinued at the recent monetary policy meeting, as the RBI aims to reduce surplus cash in the banking system (Chart 2). This huge liquidity, which has swelled to Rs7.7tn (US$100bn) could lead to further steepening of the yield curve and presents an upside risk to inflation (Chart 3).

Chart 2: Excess cash in the banking system remains elevated

Chart 3: Indian government bond yield curve has steepened after monetary easing

'10-year' minus '2-year' Indian government bond yield spread

But despite the removal of its bond-buying programme, the RBI cautioned against any premature tightening of monetary policy in its latest monthly bulletin. Tighter monetary policy could stall recovery in the economy and result in stagflation. Considering this, the RBI will continue to provide policy support until economic growth is sustained and broad.

India’s retail inflation has declined but core inflation remains elevated

India’s retail inflation (CPI) declined from a high of 6.3% in June to 4.35% in September due to a moderation in food prices. Core inflation (excluding food and fuel) remains elevated and sticky at 5.9% during August-September (Chart 4) due to the pass-through of higher input costs in key goods such as passenger vehicles, two-wheelers, washing soda, hair shampoo and stainless steel.

In the latest Monetary Policy Report the RBI highlighted the following factors as upside risks for inflation:

• 10% rise in crude oil prices to raise inflation by 30 bps
• 5% depreciation in INR exchange rate to raise inflation by 20 bps
• 1% higher global growth in global economy to raise inflation by 30 bps.

Chart 4: India's retail inflation has declined but core inflation remains sticky

India's CPI % change y-o-y vs core CPI % change y-o-y

Gold’s role in India’s low-rate environment

The low interest rate environment that has challenged investors over the past year is creating structural changes in asset allocations, pushing investors toward greater portfolio risk in search of return. Our analysis suggests that this will likely increase the need to hold assets such as gold for downside protection and diversification.

The huge liquidity in the banking system presents an upside risk to inflation. Over the last 40 years gold has delivered an average annual return of 10% in rupees, clearly outperforming CPI inflation, which grew by an average of 7.4% over the same period.⁴ Gold can provide an effective hedge against the expectation of an upside risk of inflation in India.

Conclusion

The RBI has started tapering its stimulus measures, but excess cash in the banking system poses an upside risk to inflation. Inflation may also stem from pass-through of higher input costs. The RBI is showing caution against premature tightening of its monetary policy in an effort to avoid stagflation.

In this episode of our Strategic Edge series, Joyce Chang, Chair of Global Research at J.P. Morgan, discusses market and allocation strategy trends with our Global Head of Research, Juan Carlos Artigas.

Topics they cover in this two-part video include...

• The outlook for tapering, inflation, and rates
• Redefining diversification with 'hybrid' instruments
• The 20/40/20 portfolio structure
• J.P. Morgan's ESG investment approach 

Watch below! 

Part 1:

Part 2:

On November 3rd, 2021, World Gold Council, in partnership with State Street Global Advisors SPDR, hosted the fourth annual EVOLVE Investment Summit Americas/EMEA virtually. Building on EVOLVE’s reputation for delivering differentiated, incisive content across key themes affecting asset management and then world at-large, this year’s agenda featured pre-eminent thinkers including:

Don’t miss this rare opportunity to hear from some of the best minds in the world on ESG, sustainable leadership, opportunities in tech and emerging markets, monetary policy and more!

On November 9th the World Gold Council held an EVOLVE Investment Summit in Singapore. Our series of EVOLVE conferences explore the trends and issues shaping the future of finance. What happens in Asia is hugely significant for the gold market. India and China are the largest gold consuming markets, and other markets in the region including Singapore, Hong Kong and Japan are major trading centres for gold. In a blog for Goldhub, Dr Parag Khanna, one of this year’s keynote speakers, writes about the shifting economic centre of gravity and Asia’s role in the global economy.

World trade and economic activity have centered around Asia for much of history. And as in the past, Asia’s current economic ascent isn’t solely a consequence of developments in China and India, but also of sustained growth in West and Southeast Asia. These latter regions -- which I term ‘Ascending Asia’ -- are making large contributions to Asia’s overall growth, which represents half the world’s total projected GDP growth through 2050. Already, Asia’s exports and imports account for two-thirds of global trade. Its middle class is projected to reach 3 billion by 2030, representing 60% of the world’s total. And by 2040, the Asian middle class is forecast to drive 40% of global consumption.

Underpinning Asia’s sanguine growth forecasts are its strong macroeconomic fundamentals, a growing youth population, as well as strengthening intra-regional trade and investment flows. 8 of the 10 biggest FX reserve holdings are in the GCC and Asia. The large foreign exchange buffers make sharp capital outflows less likely, and to the extent they do occur, less destabilizing. Asia’s major currencies have also been less volatile in recent years, a consequence of greater local currency borrowing. These large savings pools have helped keep debt-to-GDP ratios relatively low across most of Asia. To the extent that Asian governments have engaged in significant sovereign borrowing, it is often to finance developments in infrastructure, education and other sectors driving long-term growth.

In addition to strong FX reserves, and prudent borrowing, Ascending Asia is increasingly marked by stable and low inflation; a trend the IMF expects to continue, with consumer price inflation projected to stay below 5% through 2026. With strong macro fundamentals, large and mid-cap equities in Asia’s emerging markets continue to outperform their counterparts in emerging markets outside Asia, with the gap widening to nearly 300 points on the MSCI EM Index since the outbreak of Covid-19.

The median age in most Asian countries remains under 30. Notably, even as China ages, it retains a sizable population of young people, with 700 million Chinese below age 40. Additionally, the number of 15-24 year olds across MENA is forecast to increase by over 30% over the next decade, making it the region with the fastest growing youth population in the world. With over 820 million working age millennials, and approximately 2 billion under the age of 40, global growth will increasingly centre around Asia, especially as aging trends in Europe and America accelerate.

Asia’s economic rise is marked by a strengthening of intra-regional trade and investment flows. Nearly 60% of exports originating in Asian countries are destined for other markets in Asia. Notably, GCC’s trade with China, Japan, and India now totals over $550 billion; with India and China, seeing a 4x and 5x rise in GCC imports respectively between 2008-18. Over half of Asia’s FDI flows are also intra-regional, reflecting deepening ties between financial systems and corporate sectors. These trends are likely to accelerate post-pandemic, as more Asians stay in Asia for holidays and education, spending their money and starting businesses within the region.

Over the long-term, Asia-led frameworks including the Regional Comprehensive Economic Partnership (RCEP) will further strengthen intra-regional trade and investment flows. With 3.6 billion consumers, and 30% of global GDP, RCEP is fast emerging as the world’s largest free trade zone. For ASEAN, improved market access through RCEP could increase regional GDP by $19 billion annually by 2030.

East and West Asia’s deepening trade and investment networks indicate that capital, companies, and consumers will increasingly traverse the Indian Ocean and strengthen ties along the new Silk Roads, stitching the region into a whole greater than the sum of its parts. As we look to the future, it becomes increasingly difficult to imagine a global portfolio that doesn’t include strong exposure to Ascending Asia.