In the last one year, gold has emerged as one of the best performing asset classes. For example, gold prices are up by nearly 30% in the last one year as the turmoil in the markets has led to increased demand for gold. Gold has historically had a positive relationship with political and economic uncertainty. It is times of uncertainty that gold performs the best. Let us look back over the last 50 years.
Gold had a massive rally from $35/oz to $900/oz between 1971 and 1979. This was the period of high volatility in the form of the withdrawal of the gold standard, the Arab Israeli war, the Iran Iraq war and USSR invading Afghanistan. The second big rally started post 2007 when the sub-prime crisis broke out taking the world to the brink. During this period, the price of gold rallied from $700/oz to $1900/oz.
On the other hand, gold prices have tended to be tepid during times of economic growth. During the period from 1981 till 1999 when global growth parameters were at their peak, the gold prices faltered and during this time it was the equity indices that performed exceptionally well. Similarly, gold peaked in 2011 and has been trending lower after global markets gave a liquidity boost to equity markets.
Also Read Gold – Is it really a safe haven for an investor?
That brings us to the current situation. Should investors buy gold or debt in the current market context? Before going into the decision, let us first look at the relative merits and demerits of gold and debt as asset classes.
Looking at debt as an asset class in the current context
Investments in debt instruments also bear market risks, but they are not as volatile as equities. There are different means of investing in debt products and the same can be done either directly or indirectly. Debt investments may be done either by investing directly in bonds or other debt instruments issued by companies, government and RBI, or through diversified portfolios of debt mutual funds. Debt can also be classified on the basis of risk viz. you can go for low risk government bonds or for higher risk credit risk corporate bonds of second rung companies. Let us look at the merits of debt investment. Here are some of the key merits of investing in debt.
- Investments are made in fixed-maturity debt instruments, which are relatively stable and the returns are quite predictable
- This helps the investor in achieving the target better. The predictable return also provides an opportunity to use the instruments for periodic returns.
- Debt is very useful as an asset class because it helps you preserve your wealth. It is unlike equities which have a huge market risk embedded in it.
- Quite often, debt instruments and debt MFs are allowed to take indexation benefit while calculating the long-term capital gain at the time of redemption. The indexation benefit makes debt both inflation and tax efficient and reduces the tax outflow on debt related incomes.
However are there downsides to debt too! Debt is an assured return product and hence it does not offer that higher alpha that equities can offer. Hence debt cannot really be of help in wealth creation, it can only protect wealth and that limits its utility.
Looking at Gold as an asset class in the current context
Gold is a natural haven in times of economic and geopolitical turmoil. Normally, people take refuge by investing in gold. So, gold is often used more as a hedge instrument, rather than creating wealth. In fact, it is advisable to keep a part of your portfolio allocated to gold to give stability to the portfolio. This range can normally be around 10-15% depending on the market conditions. Gold has merits and some downsides.
On the positive side, the presence of gold in any investment portfolio helps in combating the impact of inflation and economic uncertainties in returns. The yellow metal helps in managing risks of investing in equities and debts. To the extent it is a good hedge. But the downside risk is that investment in gold is not tax efficient and provides limited opportunity to generate long-term return.
What to choose in current markets: gold or debt?
Normally, times of economic uncertainty are when debt defaults are at high levels. Hence you need to be cautious on corporate debt. Yields on high quality debt are headed lower. This is not the time to increase your allocation to debt. Instead you can look to push your gold allocation closer to the 15% level. That would be a better choice.