Gold, Silver & the Smart Way to Invest | The Index Investor | Value Research

Summary

Gold and silver have seen significant rallies recently, driven by central bank shifts in asset allocation and global economic concerns. Vikram Dhawan, head of commodities at Nepon India Mutual Fund, explains how these metals serve as important diversifiers in portfolios, especially amidst currency volatility and rising global debt. He highlights how both metals are crucial in managing risks such as inflation, currency devaluation, and climate change. While high prices might deter some investors, Vikram emphasizes the importance of minimum allocations for risk management, suggesting both metals are a hedge against uncertainty, with returns being a bonus.

Takeaways

• 😀 Central banks have significantly increased their gold holdings in recent years, moving from an average of 400 tons annually to between 1,000 and 1,100 tons per year in the last three years.
• 😀 The global reset in asset allocation, especially after the 2008 financial crisis and the COVID-19 pandemic, has led to increased exposure to gold by central banks, reducing reliance on US dollar assets.
• 😀 A 2024 study revealed that 70% of managed wealth portfolios either had little or no exposure to gold or silver, showing a significant shift towards including these metals in investment strategies.
• 😀 While prices of gold and silver are high, central banks and investors continue to buy as part of long-term diversification, managing risk, and reducing volatility in their portfolios.
• 😀 Investors should approach gold and silver with an asset allocation mindset, as having exposure, even at high prices, helps diversify portfolios and manage risk.
• 😀 The volatility and market behavior of gold and silver differ, with each offering different benefits during periods of market instability, requiring investors to balance their exposure.
• 😀 For Indian pension portfolios, the optimal allocation to gold is between 5% and 15%, according to studies by the World Gold Council, but individual analysis is crucial for determining exact percentages.
• 😀 While physical gold is preferred by some investors, for most, gold ETFs are more liquid and convenient, offering better portfolio diversification and easier access during market fluctuations.
• 😀 Liquidity is a critical factor when investing in gold and silver; being able to convert these assets into cash quickly is essential, especially during periods of volatility.
• 😀 Precious metals like gold act as a hedge against the risks of debt and currency depreciation. As sovereign debt continues to rise globally, these metals are seen as a safeguard against potential credit risks and economic instability.
• 😀 Over the long term, gold and silver are primarily seen as diversifiers or hedges in investment portfolios, protecting against risks such as global debt and climate-related disruptions, rather than purely for returns.

Q & A

What is the trend in central bank gold buying over the last few years?

Central banks have significantly increased their gold purchases in recent years. While the average annual gold purchase by central banks was around 400 tons per year, it has surged to between 1,000 to 1,100 tons per year over the last three years.

What factors are driving the surge in gold and silver prices this year?

The surge in gold and silver prices is driven by a global reset in asset allocation by central banks, shifting away from heavy reliance on US dollars and moving towards increasing their gold reserves. Additionally, concerns about currency devaluation and the need for diversification have further boosted demand.

How has the allocation of assets by central banks changed over the past few decades?

Historically, central banks held about 75-80% of their reserves in US dollar treasuries. Today, this has decreased to below 60%, with the balance now allocated to other currencies and precious metals like gold. This shift began post the 2008 financial crisis and has accelerated in recent years.

Why do some investors hesitate to enter gold and silver markets at high prices?

Investors often hesitate to enter gold and silver markets when prices are high due to the fear of buying at a peak, potentially leading to short-term losses. This creates a challenge for those looking to diversify their portfolios without risking a poor entry point.

What is the recommended approach for investing in gold and silver without risking a peak entry?

The approach should be to invest with a minimum allocation in gold and silver as part of a broader portfolio strategy. Even at high prices, a steady, gradual approach towards adding precious metals can be valuable for risk management and portfolio diversification.

How do gold and silver behave differently in volatile markets and long-term cycles?

Gold and silver behave differently in terms of volatility. Gold is often considered a safer asset during financial instability, while silver, though similar, is more volatile and may respond differently to market conditions. Investors need to consider these differences when deciding how to allocate between the two metals.

What are the suggested allocation ranges for gold in a typical portfolio?

Studies suggest that for a typical Indian pension portfolio, gold allocations below 5% or above 15% are suboptimal. The ideal range for gold in a portfolio is typically between 5% and 15%, but the exact allocation should depend on individual risk profiles and market conditions.

Does it still make sense for investors to hold physical gold in today’s market?

For investors looking to diversify through capital markets, holding physical gold may not be the best choice due to liquidity issues. Physical gold is harder to trade and may not be as liquid as gold ETFs or other forms of gold investments. However, physical gold still has value for consumption, such as in jewelry.

What are the benefits of investing in gold and silver ETFs compared to physical holdings?

Gold and silver ETFs offer better liquidity compared to physical holdings. ETFs can be easily traded, providing investors with more flexibility to raise cash when needed. Physical gold, on the other hand, is less liquid and harder to sell at market prices.

How should investors incorporate gold and silver into their broader asset allocation strategy?

Investors should incorporate gold and silver into their portfolios as part of a diversification strategy, focusing on risk management and protection against currency depreciation. These metals serve as a hedge against market volatility and provide liquidity, which is critical when adjusting a portfolio during times of financial uncertainty.

Why is gold considered a hedge against debt and currency devaluation?

Gold is considered a hedge against debt and currency devaluation because it is not tied to the credit risk of governments or institutions. As global sovereign debt continues to rise, gold offers a safe haven from potential credit events and can protect the value of an investor’s wealth in times of currency depreciation.