How to Tweak Your Investment Strategy when Gold Prices are Rising?

The big news in the last few weeks was the rapid rally in the price of gold. Gold prices are rallying; not only in the international markets, but even domestic prices of gold are gradually inching closer to Rs.40,000/10 grams. This is already a life-time high for gold prices in India.

International gold prices are already at the highest level in the last 6 years, although it is much lower than the peak of 2011; when gold had scaled $1850/oz. The decision to tweak your portfolio strategy will predicate on whether this rally is temporary or sustainable?

Historically, gold has rallied structurally when the global economic and geopolitical uncertainty has been at a high. For example, through the 1970s in the midst of the Arab oil embargo, the price of gold went up from $35/oz to $850/oz. Later in 2008, post the Lehman crisis the price of gold nearly doubled in 3 years to $1850 by September 2011. There are signs of global uncertainty in 2019 too. The US-China trade war is showing signs of escalation and that is impacting global GDP growth. A no-deal BREXIT is likely to push Europe into a slowdown. Above all, the US yield curve is showing inversion with the 2-year bond yields exceeding the 10-year bond yields. In the last 70 years, this indicator has correctly signalled a slowdown in 80% of the cases. In short, there is a strong case for gold.

How to tweak your investment strategy vis-à-vis gold?

While gold continues to be a peripheral asset in most portfolios, here are a few points to remember about gold in your portfolio, especially in the current scenario.

• The normal allocation to gold in your long term portfolio should be in the range of 10-15%. Since this looks like a structural rally in gold, it would be an opportunity to increase your allocation to gold to 15%. That will not only enhance portfolio returns but also give greater stability to your overall portfolio mix.

• Secondly, you can also look at gold as part of your peripheral trading portfolio too, while keeping your core gold allocation at 15%. That means; instead of going long on equities from a long term perspective, trade long on gold ETFs to make the best of the gold price movement. After all, gold gives sharp price movements only once in 3-4 years and you can design your trading strategy to make the best of it.

• There are a lot of investors who store their funds in foreign currencies within the RBI permitted limits. A sharp rally in gold prices is normally a vote against most fiat currencies. That is hardly surprising considering that easy money policy in the last 10 years has made paper currencies less valuable. If you are looking at currencies, then it may make a lot more long term sense to look at gold as a currency.

Gold rally also has an impact on your equity strategy

This is the more interesting part of the gold price rally. Apart from having an impact on your gold strategy, it also has an impact on your stock market trading strategy. Check the chart below.

Chart Source: Bloomberg

If you look at the comparative chart of the Nifty and spot gold, the relationship is clearly negative. We have just plotted the relation for the last 1 year when both the Nifty and gold have been quite active and volatile in the market. But what really strikes you is how gold and equities have diverged as shown in the shaded portion above. What does this chart tell us about equity strategy?

• Historically, gold and equities have moved against each other. When growth expectations are high, equities automatically tend to perform better and gold tends to stay tepid or loses value. To that extent any sharp rally in gold must be taken as a lead indicator of likely weakness in equities. You need to look at ways to tweak your stock portfolio and buy stocks online accordingly.

• Look to reduce weightage in stocks that have been part of the last rally and also sectors like capital goods and metals that are most vulnerable to an economic slowdown. These are highly sensitive and have a high multiplier dependence on GDP growth.

• Focus on shifting more of your existing equity portfolio into defensive sectors like FMCG and other consumer driven sectors which may see weaker demand but are not structurally threatened. You need to alter your stock market trading strategy to effectively balance your portfolio.

A gold rally is an advance warning system for any stock market. It is time to act on your portfolio and tweak accordingly!