Rising inflation and high stock valuations: Can gold provide stability to your portfolio?

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The economy is likely to face a prolonged period of high inflation. Though retail inflation has dropped marginally to 6.26% in June from a six-month high of 6.30% in May, most analysts feel that inflation will remain sticky given the high commodity and fuel prices.

Negative real yield

Rising inflation leading to negative real interest rates make debt instruments unattractive for investors. Real yields on the bank deposits are negative and investing in fixed income is like losing money if inflation persists at current levels.

Though equity comes in to fill the gap, the current high level of the stock market which is ruling near its all time highs and the consequent high valuation, has taken equities into a high-risk zone. Stocks offer high returns in the long term, but they can be volatile in the short term. If you cannot digest volatility and are risk-averse it is better to avoid large exposure to equities.

Adding a bit of gold can cushion the downside

Will gold as an asset class become attractive given the various factors at play? Investment advisors and analysts feel that having a bit of gold in the portfolio can help provide stability in the current situation by cushioning the downside.

“Gold comes into play during times of rapid increase in inflation. Investors look at other safe asset classes when real yields go into the negative territory. At present, gold is in a consolidation zone and may look unattractive. But this is the best time for an investor to accumulate in a phased manner,” Brijesh Bhatia, Senior Research Analyst, Equitymaster said.

Gold may outperform stock markets

Bhatia says past trends suggest gold could outperform the stock market from 2022 onwards. “Every asset class has their bull and bear phase, and equities are in a bull phase now. If we analyze the time cycle of Dow Jones and the performance of gold, they have an average period of 35 months (since 1997) of each outperforming against the other. The last outperformance of Dow Jones over gold started in July 2019 and I expect it to end by June 2022 (+/- 3months). The analysis concludes that gold might outperform Dow Jones from mid-2022 and it should always be part of one’s portfolio as diversification,” he said.

Gold had hit a lifetime high of Rs 56,191 per 10 grams on the MCX in August 2020. However, it has slid thereafter and during recent times has been trading at a range of Rs 47,000-48,000.

“Gold works as a hedge against the stock market i.e. most of the time gold does well when stock markets are correcting. Hence, some allocation in gold does work in your interest if stock markets do not do well. Also, during rising inflation, the currency depreciates but gold continues to hold its value. Historically in India, gold has been able to beat inflation over the long term. But a lot depends on the price that you pay to build your portfolio in gold just like other asset classes,” Harshad Chetanwala Co-Founder, MyWealthGrowth.com, said.

Overexposure can be detrimental

However, overexposure can be detrimental to overall portfolio returns and one must control the urge to go overboard.  “Investment in gold has to be more from an asset allocation perspective. Investing more than required in gold can prove counterproductive. Investors who would like to invest in gold can have 5%-10% of overall assets in gold,” Chetanwala said.