Use the current phase of correction to build your allocation to gold

It can act as hedge against high inflation or slowdown

Gold exchange-traded funds (ETFs) saw inflows worth Rs 446 crore in September. This was despite gold ETFs declining 7.7 per cent over the past year.

Opportunistic buying

Various factors were responsible for last month’s inflows. In the aftermath of the Covid-19 pandemic, people have increasingly realised that some allocation to a safe-haven asset like gold is essential.

With the equity markets wi­tnessing a steep run-up, many investors are booking profits.

"Since returns from fixed-income instruments are currently low, investors are allocating some of the profits booked in equities to gold," says Chirag Mehta, senior fund manager-alternative investments, Quantum Mutual Fund.

Most gold investors tend to have at least a five-seven-year investment horizon.

"Investors have taken advantage of the dip in gold’s price in September to build their allocation to it," says Pritam Kumar Patnaik, head-commodities, HNI and NRI acquisition, Axis Securities.

Lacklustre performance

Gold has disappointed investors over the past year. Central banks, which had been pursuing accommodative monetary policies, are now planning to normalise them. If all goes according to script, the US Federal Reserve will first reduce bond-buying between November 2021 and June 2022. It will then reduce the size of its balance sheet and hike interest rates.

"Such a scenario is negative for gold because it means the economy is doing well. Money will flow out of gold and into other riskier assets," says Mehta. He adds that both the dollar and real interest rates will also move up, which will again be a negative for the yellow metal.

According to Patnaik, in recent times, a lot of safe-haven flows have gone into dollar-backed assets. "This trend also doesn’t work in gold’s favour," he says.

Will normalisation happen?

The big question, however, is whether central banks will be able to pursue their planned course of normalisation.

"The last time they tried to do so, they were able to reduce asset purchases. But when they began to reduce the size of their balance sheets and increase interest rates, that took a toll on the economy, forcing them to backtrack," says Mehta.

While economies have rebounded strongly in the recent past, it remains to be seen whether they can grow at a sustainably high rate.

“In China, the crisis in the real estate sector seems to be deepening beyond Evergrande, with more players defaulting or delaying debt payments. Also, high energy prices are pushing up manufacturing costs, and having a negative impact on economic activity globally," says Patnaik.

Mehta sees the risk of rising wage costs driving up overall inflation in the US. Other expe­rts, too, expect high inflation.

“Commodities have seen a big run-up over the past 18 months. If inflation remains high, that will be a positive for gold,” says Kishore Narne, head–commodity and currency, Motilal Oswal Financial Services.

Maintain allocation to gold

To deal with either of these two scenarios – a slowdown in economic growth or high inflation – retail investors should have a 10-15 per cent allocation to gold. If your current allocation is lower, use price dips to build allocation. If you can make an allocation to gold for eight years, go with sovereign gold bonds, where you will get an annual interest rate of 2.5 per cent, over and above capital gains. However, these bonds are not liquid. If you have a medium-term horizon, go with gold ETFs.

Eleven fund houses offer gold ETFs at present.

"Look up three criteria when selecting a gold ETF – expense ratio, trading volume (or assets under management as a proxy), and tracking error," says Arun Kumar, head of research, FundsIndia.

Go with a fund that has a lower expense ratio, higher trading volume, and lower tracking error.