Upbeat growth prospects for the global and local Indian economy are cause for optimism in the financial markets…
…but stock market volatility and rising geopolitical risk, amid key global elections, present possible challenges.
Gold’s role as hedge and its positive contribution to risk-adjusted returns can make it a valuable tool to Indian investors.
There is much optimism within financial markets today as the prospect of stronger-than-expected growth increases across key global economies, viz. the US. But at the same time, the overhang of risk persists. With the recent surge in equities, many major stock markets have touched all-time highs.1 But one critical question for investors is whether the prolonged tight monetary conditions can indeed bring about a “soft landing” for the US economy which should positively affect the global economy. Past experience suggests that this will be difficult; monetary tightening in the US has often preceded downturns and soft-landing narrative has often gathered pace prior to recessions (Chart 1). An associated question is whether the economy and profits meet current elevated investor expectations, or whether asset prices need to correct. This is inherently hard to forecast given the challenging investment environment in the backdrop of heightened geopolitical instability and divergent economic environment and outlook across nations that have the potential to spill over.
In the Indian context, there are also market-specific risks to the outlook. The domestic economy has so far maintained robust growth momentum - fuelled largely by government investment. But there are concerns as to the durability of this momentum if private capital expenditure fails to pick up and fill the gap as the government exert fiscal prudence. There is also the potential market volatility in an election year. We believe it is therefore vital that investors consider ways to protect their portfolios.
Gold has a key role as a strategic long-term investment and as a mainstay allocation in a well-diversified portfolio.
Gold is a highly liquid asset, which is no one’s liability, carries no credit risk, and is scarce, historically preserving its value over time. It also benefits from diverse sources of demand: as an investment, a reserve asset, as gold jewellery, and as a technology component. These attributes mean gold can enhance a portfolio in three key ways. It can:
Beyond its strategic appeal and looking at the macro conditions in 2024, gold can function as an effective market hedge.
Our analysis shows gold is a clear complement to equities and broad-based growth portfolios. A store of wealth and a hedge against systemic risk, gold has historically improved portfolios’ risk-adjusted returns, delivered positive returns, and provided liquidity to meet short-term cash flow requirements in times of market stress.
Effective diversifiers are sometimes hard to find, especially as assets become increasingly correlated as market uncertainty rises. Gold is different, in that its negative correlation to equities and other risk assets increases as these assets sell off (Chart 2).
The uncertainty associated with geopolitical crisis makes it virtually impossible to position for in advance. For that reason, long-term strategic portfolio diversification is essential, and it is here that gold can play a key role as a safe-haven asset. Indeed, its price tends to increase after a geopolitical event (Chart 3).
Gold is not only a good strategic asset because it is beneficial during periods of uncertainty; it can also generate long-term positive returns in both good and bad economic times. In other words, gold can increase risk-adjusted returns while reducing portfolio volatility and maximum drawdowns (Chart 4).
Although the consensus opinion is for a soft landing in the US, the possibility of a recession there – either in 2024 or thereafter – and its negative impact on the global economy, cannot be ruled out. There are also the heightened geopolitical tensions, potential market volatility in an election year, and concerns over the durability of the domestic economic momentum that Indian investors would be faced with.
In consideration of these potential macroeconomic challenges, we believe investors should consider ways to protect their portfolios and narrow the range of potential outcomes. And as outlined, gold can help mitigate the key risks ahead by providing effective diversification and enhancing risk-adjusted returns.
1Dow Jones Industrial Average, S&P 500, Nasdaq, Nifty, SENSEX, Nikkei, Bovespa
