Why Gold may be a smart investment as geopolitical unpredictability returns

The price of gold has fluctuated wildly over the past five years. Early in 2016, after reaching a high of $1900/oz (gold prices are measured internationally in Dollars per Troy Ounce), gold prices plummeted to a low of $1050/oz. However, the first Fed rate hike in nine years, which occurred in December 2015, caused a crisis in the equity and bond markets. During this time, the price of gold surged to $1350/oz, making it one of the best-performing asset classes in the first half of 2016. However, Trump's victory in late 2016 and the Indian government's demonetization campaign caused the price of gold to decrease. Therefore, it would be fascinating to comprehend what factors influence the gold price and what the current situation portends for the future of gold prices.

What drives the price of gold?

Historically, the price of gold has been influenced by a handful of major factors. Dollar value has been negatively correlated with gold prices. Therefore, a powerful dollar index causes gold prices to decline. Second, when there is geopolitical uncertainty, investors prefer the safety of gold, which increases gold's value. We witnessed this in the 1970s and again following the Lehman crisis in 2008. When currencies are devalued due to excessive money printing, gold emerges as an alternative currency. Interestingly, while India and China account for the majority of gold demand, traditional jewelry demand has rarely influenced the price of gold.

 
How is gold poised to perform in 2017?

Let's examine the future of gold in light of the aforementioned considerations. To begin, WGC estimates that 2017 will be a better year for gold demand than 2016 was. But this interest isn't expected to keep gold's price at current levels for long. Second, how strong is the dollar? The Federal Reserve has indicated that there may be two additional rate increases in 2017. The dollar will strengthen and bond yields will rise under a hawkish rate scenario. Although the dollar probably won't see a wild rally as it did in the past, the Dollar Index should still do well.

As for my third point, we must wonder if governments would continue to devalue their currencies by flooding the market with even more cash. The Federal Reserve of the United States currently has $4.5 trillion in bonds, while the European Central Bank holds €4.1 trillion in bonds. After 2008, central banks injected liquidity into the economy by mopping up bonds, which led to the creation of this huge bond portfolio. The US narrative is changing toward monetary tightening, though, and this will necessitate a steady winding down of this bond portfolio. The European Central Bank and the Bank of Japan may do the same in the future. So, geopolitical unpredictability is the sole real reason for a spike in gold prices. The continued global uncertainty may be a result of the United States' bombing of targets in Syria and Afghanistan and North Korea's threatening rhetoric. For this reason, the safe-haven appeal of gold will ensure its continued demand.

So how do Indian investors go about investing in gold?

First, there's a small disclaimer to make. Unlike equities, bonds, and real estate, gold defies easy categorization. Gold is, at most, an insurance policy against the world's instability. As a result, no more than 8–12% of a portfolio's value should be invested in gold, depending on the state of international politics. But how do you put your money into gold?

While buying gold in the form of bars or jewelry has been the norm in the past, more modern, evidence-based alternatives are beginning to emerge. Try out a few of them

Long-term gold investors may want to consider purchasing Gold ETFs, or exchange traded funds focused on gold. For the standard stock market charge, these can be bought and traded. They're easily traded and follow the gold price in tandem. It also eliminates the need for you to worry about securing, insuring, or storing anything. Gold Bonds have significant tax consequences, which can be read about here.

Futures contracts on gold can be purchased on the commodity markets for a little margin. Gold futures are a leveraged asset, which means that gains can be magnified, but losses can also be magnified.The government has just introduced a new bond program called Gold Bonds, in which investors can gain exposure to gold price fluctuations and receive interest at a rate of 2.50% per year. These bonds are backed by the Indian government and can be purchased on the stock market.

Finally, you can take part in the Gold Demonetization Scheme, but it hasn't really taken off yet.

In short, investors will be drawn to gold as a safe haven from the effects of geopolitical unpredictability. Investors should primarily consider gold exposure from the angle of providing portfolio stability and inbuilt insurance.

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