In our recent strategic write-up, we have advocated that having some allocation to gold or gold-related instruments will help investors to hedge their portfolios against geopolitical risks and further ring-fence their portfolios.
Some investors have asked why this asset class is a good hedge under the current rising market volatility environment.
We have outlined below the investment rationales for adding gold or its related instruments to your portfolio:
For investors who are sceptical that bonds and stocks may not provide sufficient diversity to their portfolios given the heightened global uncertainties, adding a portion of gold or gold-related instruments could achieve just that. Gold is commonly considered a safe haven in times of economic or geopolitical tensions mainly because it is not at risk of becoming worthless, unlike fiat currencies or other assets bearing credit risk. We have seen both institutional and retail investors increase their allocations to gold in the first quarter of this year as a flight to safety hedge, particularly with the initiation of the Russia-Ukraine.
The demand for gold as a safe haven hedge is expected to stay strong if global uncertainties persist.
As illustrated below, gold has a low or negative correlation against other major assets. In fact, empirical studies have shown that gold typically displays an increased negative correlation with equities during extreme market downturns. We believe it is due to the inherent belief in gold's stable asset value, which acts as a good hedge for investors during a major market downturn.
Therefore, including gold or gold-related instruments in an investor's portfolio serves as an effective portfolio diversifier to reduce the overall risk in a portfolio. This is an essential feature since diversification allows investors to achieve the desired return without taking as much risk.
While gold is traditionally seen as an inflation hedge, it does not pay yield. This makes gold a less attractive investment proposition in a rapidly rising interest rate environment. Furthermore, gold is negatively correlated to the US dollar. Therefore, the current US dollar strength could limit the gold price's upside potential.
Gold provides investors protection against geopolitical events and global uncertainties. To some extent, it serves as insurance against broader systemic risks. Therefore, it is considered a safe haven, which shields investors during crises.
As such, owning gold is not about generating excessive upside potential, particularly during the rapidly rising rate environment by the US Fed. It acts as an insurance policy to minimise downside risk to the portfolio. Given that adding gold mainly serves as an effective portfolio diversifier for downside protection, we believe that investors should allocate no more than 15% to their overall portfolio.