With stock markets rising, should investors still hold gold?

With equity markets soaring and the gold rally pausing for breath, investors are debating whether they should maintain their allocations to gold or exit the asset class.

It’s appalling how easily we discount and look beyond the value that an asset class brings to the table, especially when its “falling out of favor” like gold is currently. We get busy chasing the best performing asset class, which seems to be equities for now.

Here are two reasons why doing that wouldn’t be prudent.

Owning gold is not about the upside potential, it is about minimizing risk to the downside

Every asset class plays a role in the portfolio. While equities generate growth and debt brings regular income, gold because of its lower correlation to the other two provides diversification and lends stability. We saw these characteristics play out as recently as this year when stock markets fell off the cliff and gold climbed to new peaks, in addition to gold’s history of improving portfolio risk-adjusted returns.

Yes, the recovery in stock markets since the collapse of March has been phenomenal, and could continue going forward, but let’s not forget that the steep fall wiped off a third of investor capital within a matter of days. For an investor to participate in and benefit from the unprecedented equity market rally we’ve seen this year, he should have firstly been able to digest the massive losses of March and stay on. An all equity portfolio for the three months ending 31st March 2020 was down 28% compared to a diversified portfolio with 40-40-20 allocation to equities, debt and gold which fell by only 8% based on Sensex TRI, Crisil Composite Bond Fund Index and Domestic Price of Gold.
Those with diversified portfolios were hurt less and probably are the ones who managed to stick it out through the volatility and reap the benefits that followed.

So, while it is true that investing in shares can give you a better return than investing in gold, it’s important to appreciate that the presence of portfolio diversifier like gold, which tend to do well when risk assets like equities perform poorly, is what enables us to take on higher risk that comes with equity investing in the first place.

Thus don’t question gold’s relevance in your portfolio and do maintain adequate gold allocation.

No asset class can go up in a straight line, including equities

Despite historic damage to economic activity, equity markets, with the help of massive fiscal and monetary stimulus, ended the year in the green with valuations at all-time highs.

The optimism surrounding the economic rebound and the cheap liquidity backdrop is expected to encourage further risk taking in search for yield and continue to propel equities in 2021. This could be a headwind for gold and could limit its rise next year. However, the fact remains that the economic rebound is prone to setbacks like vaccine inefficacy, further waves of infections, the new virus strain now detected in the UK and fresh lockdowns.

If the recovery falters or is weaker than expected, investors might question the rich valuations resulting in repricing to historical averages and market corrections. With investors vulnerable to a host of potential disappointments, cautious optimism seems to be the way forward. And with low yields limiting bond markets’ ability to act as a hedge against equity price volatility, gold could be an effective portfolio diversifier in the case of another stock market correction and renewed risk aversion. In addition, weak economic growth will require continued doses of fiscal and monetary stimulus, which too will bode well for gold.

So to answer the question in the title, the choice investors have to make isn’t between equities or gold, but in fact it is equities and gold.

Source: World Gold Council, Bloomberg