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Why Dumping Gold ETFs Now Is Stupid! - Outside View by PersonalFN

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Why Dumping Gold ETFs Now Is Stupid!
Sep 28, 2018

The Assets Under Management (AUM) of the Indian mutual fund industry have grown at 22.4% between August 2017 and August 2018. The growing participation of investors in equity-oriented mutual fund schemes has helped the industry record to steadily rise.

[Read: Does AUM Size Affect Mutual Fund Performance? Here's What You Must Know]

However, following the on-going market correction, it will be interesting to see how equity mutual fund investors react in the foreseeable future.

Will they start withdrawing their investments in equity-oriented mutual funds here onwards?

Or, will the downturn invite more investments?

It's usually observed that investors consider the recent performance of an asset to determine its attractiveness.

Take for example, gold.

When adjusted for inflation and tax, gold has generated negative returns over the last five years.

Gold- losing lustre?
  1 Year (%) 2 Years (%) 3 Years (%) 5 Years (%)
Average returns of Gold ETFs and Gold Savings Funds 2.1 1.6 3.0 -0.4
Gold-India 4.0 3.2 4.3 0.8
Data as on September 21, 2018
Rolling Returns considered
Returns upto 1 year are absolute, while over for periods over 1 year are compounded annualized
(Source: ACE MF, PersonalFN Research)

Since gold hasn't been able to display much sheen in terms of performance, in fact, it has deteriorated; investors are less enthused to invest in gold now. And this is true across the globe, not just in India (see chart below).

Are investors losing confidence in gold?
(Source: www.gold.org)

As per the World Gold Council data, the precious yellow metal has generated -7.2% returns over the last 1 year in US Dollar (USD) terms.

Indian investors, on the other hand, have been slightly fortunate, witnessing a gain of tepid +3.2% in Indian Rupee (INR) terms. But that's mainly because of the steep fall the markets have witnessed in the value of INR.

[Read: Has The Rupee Really Depreciated The Way It Looks? Know Here...]

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Not so surprisingly, the AUM of Gold Exchange Traded Funds (ETFs) in India fell 14.3% on Year-on-Year (YoY) basis in August 2018 ---more or less in line with the global gold ETF trends.

Can you avoid gold as an asset class, especially at this juncture?

Will it be a bad decision and a costly mistake?

Gold was a popular investment avenue between 2008 and 2013 since the Federal Reserve (Fed) in the US adopted ultra-liberal monetary policies. This dragged the real interest rates on dollar-denominated debt into negative territory, thereby making gold extremely attractive.

Now that the Federal Reserve is increasing interest rates consistently and expected to hike even in the future, gold has started losing lustre.

How far can the Fed hike rates?

If Quantitative Easing (QE) paved ways for dollar-carrying trades and caused emerging market bubbles, junk bond bubbles; Quantitative Tightening (QT) and thus normalisation of interest rates will reverse all these trades.

Further rate hikes by the Federal Reserve would expose global bonds, real estate, and equity markets to higher risk. And, you can't ignore the chances of the global economy slipping into a recession. Recessionary pressure might send gold northwards.

At some point, it will be a challenge for the Federal Reserve to continue increasing interest rate because the impact of its actions will also have significant negative repercussions on the US economy as well.

If the Federal Reserve reconsiders its stance, it will be a positive for the gold markets globally, simply because rising interest rates in the US have been the primary cause of depressed gold markets.

What are the other factors that might work in favour of gold in the foreseeable future?

The geopolitical instability is building up fast which could augur well for gold.

Rising crude oil prices are causing regional tensions...

The Organisation of Petroleum Exporting Countries (OPEC) has remained unfazed by the rising oil prices and has snubbed the strident demands of the U.S. President, Donald Trump, to increase the crude oil output.

In the wake of potential US sanctions on Iran, which will come into effect this November, it would result in a deficit of upto 1.4 million barrels of oil per day. OPEC is of the view that currently there's enough oil in the market, and to compensate for this loss of supply; the output doesn't need to go up.

As a result of these recent developments, Brent crude has shot above US$ 80 per barrel for the first time after 2014.

Snubbing the US sanctions, some major economies of the world including China, U.K, Russia, France, and Germany are figuring out alternative payment mechanism. Iranian exports can't be settled in US dollar terms after sanctions apply in November.

At the time of writing this piece, the news flash stated the European Union striking a deal with Iran to legalise oil trades outside the US dollar. It will be crucial to track further developments on this story.

Is this the first instance of a major de-dollarisation trend that could unfold in decades to come?

Or is this merely a pressure tactic to deter the US from pulling out of the Iran deal?

The reaction from Washington remains crucial as the Trump administration has been facing public wrath over rising gasoline prices, at a time when the midterm elections in the US are around the corner.

Come what may, the geographic-political uncertainty is likely to heighten in the future, which in turn would turn the spotlights on gold and bode well.

Gold might spike up at the first sight of de-dollarization and regrouping of the world.

Weak economies of the globe may offer tailwinds to gold

The on-going currency crisis in Turkey and Argentina and the potential crisis in Italy may cause a rally in gold globally, if they aren't contained quickly.

Furthermore, any accumulation of gold by any major central bank of the world would prove supportive for the precious yellow metal. To protect from the ill-effects of trade wars, central banks across the gold may try to diversify their reserves.

Indian macroeconomic conditions look ugly...

Rising USD and rising crude oil prices have put a tremendous pressure on India's Current Account Deficit (CAD) position. At 2.5%, India's CAD is already at an alarming level and any further rise from here on could weigh on the value of INR.

In the election year, containing fiscal deficit at the budgeted levels would be extremely difficult for the government, which may exacerbate the fall in INR. Depreciating INR would make gold a pricy asset class.

Moreover, if the Indian equity markets fall and debt markets fail to recover from on-going liquidity shocks, gold would be perceived as a store of value ---a safe haven.

What investors should do?

If you haven't invested in gold as per your asset allocation or you haven't chalked out a personalised asset allocation plan for any reason, now is the time to act. Your personalised asset allocation should take into account your financial goals and risk appetite.

Why you should invest in gold?

  • Gold has historically served as a portfolio diversifier
  • Potentially, gold can act as a hedge during economic uncertainties
  • Gold could shield you from currency crisis and inflation
  • Gold becomes a preferred asset class in global recessions
  • It protects your wealth from the geopolitical instability and political turmoil
  • Gold is a store of value and could serve as a lender of last resort

For all these reasons, you should have at least 10%-15% of your portfolio in gold. The allocation may vary a bit as per your personalised asset allocation.

And when it comes to investing in gold, gold ETFs, gold saving funds, and Sovereign Gold Bond Schemes (as and when open) are the best alternatives.

The long-term secular uptrend exhibited by gold is something that invites attention and highlights the importance of owning gold in the portfolio with a longer investment horizon.

The poor performance of gold over five years shouldn't worry you about the long-term prospects of gold.

Political systems across the world are increasingly becoming unstable, irrational, and immoral.

On this backdrop, what's your reason for not investing in gold?

Editor's note:

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And over the long-term, poor quality funds can lead to disappointing returns. So, you need to find and invest in the 'right' ones.

Recognize hidden gems before the crowd discovers them.

If you think, you don't have the time and skills to do this on your own, don't lose heart. Want to know which are these 'Undiscovered' funds? Click here to read more...

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Happy Investing!

Author: PersonalFN Content & Research Team

This article first appeared on PersonalFN here.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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