It's not as bad as you think... - Outside View by Chirag Mehta

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It's not as bad as you think...
May 26, 2014

I believe that one should have an allocation to gold based on the premise that it is generally negatively correlated with other asset classes and hence tends to act as a diversification tool. Like any other asset, gold too will have its ups and downs. Due to the recent drop in gold prices the prophets of doom are working overtime to announce the demise of gold, however one should not be too hasty since the fundamentals remain as they were and gold continues to be a good portfolio diversifier.

In our Path to Profit - Quantum AMC's investor awareness program meets and my previous Golden Truth articles, we have maintained that one should allocate 10%-20% of their portfolio to gold and then pray hard that gold prices should fall significantly. Sounds strange doesn't it, however, a careful analysis does make it sound very logical. Gold generally has a low to negative correlation with most of the other asset classes over the long run. Therefore, when gold prices are not doing well, it is likely that the other majorallocations of your portfolio (the remaining 80%-90%) may be doing better than gold.

The current scenario is no different from what we have just described; gold prices have corrected significantly and your equity and bond portfolios should be doing well.

As explained above gold is a portfolio diversification tool and helps you to diversify your portfolio efficiently. This aids in stability of returns of an overall portfolio and may even be your respite during bad times. The other ability of gold is to maintain value over long time periods as, unlike paper money gold cannot be debased by Central Banks at will. Many financial 'pundits' criticize gold as a non-revenue generating asset as it does not have a set stream of income like interest, dividend or rent unlike other assets. Well, think of gold as a fort for your portfolio, you cannot attack with a fort since it is immobile, however you can defend yourself against attack or even retreat into it if the battle doesn't go in your favour. Continuing the analogy, gold therefore doesn't earn any interest etc, so no forward movement, but acts as a fort for your portfolio when the battle between the bulls and the bears of the market does not pan out in your favour.

A simple investing maxim to remember - a correction cannot change an assets characteristic. It is inevitable - all market determined assets will have corrections.

As investors, we should look at gold from a portfolio perspective and returns should not be the prime consideration for investing in gold. The positive price environment is just an icing on the cake. All bull markets have sharp corrections. Like in any other asset class the current bull run in gold, had corrections to the tune of 20%-30% therefore, for long term investors it is just the other end of the pendulum of gold prices, yes this is a problem for the short term speculative investor, but for average investors like us, this drop in gold prices shouldn't worry us unduly.

The rationale for owning gold continues to remain simple: continuous printing of money and a growing need to debase currencies in order to meet future obligations. This disturbing trend is observed across the 'developed' world, whether it's in the U.S., Europe or Japan. We are in a phase of experimental central banking, which could end badly due to the dislocation of capital it has caused through prolonged periods of negative rates.

The policy of printing money, quantitative easing and extraordinary monetary policy accommodation remains in place at the U.S. Fed, the ECB and the BOJ, - which for now shows no signs of letting up in the foreseeable future; is incredibly bullish for gold over the long term.

Despite the positive outlook, do not forget the main reason to own gold is the fact that it is a good portfolio diversification tool and thereby helping you to reduce overall portfolio risk.

Source: Bloomberg, World Gold Council

Chirag Mehta is Fund Manager, Commodities for Quantum Mutual Fund and manages the Quantum Gold Fund ETF and the Quantum Gold Savings Fund among others.

Disclaimer:

The views expressed in this Article are the personal views of the author Chirag Mehta and not views of Quantum Asset Management Company Private Limited(AMC), Quantum Trustee Company Private Limited (Trustee) and Quantum Mutual Fund (Fund). The AMC, Trustee and the Fund may or may not have the same view and DO not endorse this view.

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