Gold prices in India are up sharply in the last year. Given the perceived high risk and uncertainty in other assets, there is an expectation that gold prices could continue moving up. This may well be the case, however, is it prudent to buy gold in an attempt to ride this current uptrend?
Inconsistent long-term trend
Most individual investors look to buy and hold gold for long term gains. Unlike the earlier requirement of buying physical gold, you can now invest in gold via mutual funds and even Gold bonds. However, if you are thinking of taking up your gold investment now just to ride on the price rise, you must consider that the trend which looks good in the last 1-2 years was not as inviting for several years before that.
If you look at the graph below, you’ll find that gold prices were stagnating for at least 6-7 years before they began moving up towards the end of 2018. After a rally of roughly 35% in the recent past, the probability of another year of double-digit return isn’t high. Moreover, this outcome depends on many other external factors; demand for gold, the performance of other risk assets like equity, US interest rate trends and so on.
The long term demand is not investment-led
The long-term demand in gold is not led by investors, rather the bulk of the demand comes from its use in the luxury industry. The World Gold Council estimates that at least 51% of global gold demand was thanks to Jewellery in the last 10 years. The trend in jewellery demand, however, has been declining over the last 2-3 years. Given that the world economy is staring at an expected long recession, there is a high probability that the luxury-based demand for gold will not continue at the same pace. The price of gold is influenced by its limited supply, however, if demand doesn’t hold up, price trend can change.
Gold price historically has also seen a negative relationship with the US dollar and with equity values. This means that when the US dollar depreciates or stock prices fall on a sustained basis, gold prices rise to an extent.
Unlike other assets and financial investments, owning gold does not pay investors additional income like interest or dividends. It is, however, considered a safe haven in times of risk, its why people flock to buying gold when things go wrong and why you are seeing gold prices rise now. Gold price historically has also seen a negative relationship with the US dollar and with equity values. This means that when the US dollar depreciates or stock prices fall on a sustained basis, gold prices rise to an extent.
However, this is not enough reason to ramp up your gold holdings. Long term investments are best addressed through a process of diversification and asset allocation, chasing returns can often backfire, no matter what the asset is.
Stick to your asset allocation, there are price cycles in every asset, but your future financial needs will rarely match these cycles. It's best to stick to a diversified portfolio which can address your long term expected return.