Global Private Client

Goldilocks for Gold

April
April2020
2020
Goldilocks for Gold

Apr-20

Gold is Money everything else is Credit – J.P Morgan

“Gold is Money. Everything else is Credit.” – J.P. Morgan

PRIVATE AND CONFIDENTIAL. NOT FOR CIRCULATION

“Gold is Money. Everything else is Credit.” – J.P. Morgan

Executive Summary

 Gold as an asset is poised for a multiyear uptrend on the back of favorable macro-economic factors - Slowing
Global GDP growth, Rising liquidity, Negative interest rates, Rising debt to GDP and Heightened global
uncertainty

 Goldilocks for Gold

 Gold is considered a safe haven during heightened global uncertainties and is a Risk Off asset for capital
looking for flight to safety

 Central banks & Govt. across the world embarking on unprecedented liquidity measures leading to
preference for gold over fiat currencies

 Highest ever Debt to GDP ratio for most economies could lead to potential confidence crisis in fiat
currencies

 Central banks are significant holders of gold (18% of all above ground gold) and incase of increased global
uncertainties & hostilities central banks may prefer holding more gold over other fiat currencies, treasuries

 Record low interest rates & negative yielding debt is considered favorable for gold as an asset class

 Gold in INR can benefit from potential depreciation against US Dollar

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Gold as an Asset Class

 Gold has been the oldest medium of exchange, store of value and a unit of account for longest time

 Traditional uses of gold:

 Hedge against inflation or price instability

 Proven portfolio diversifier because of its low correlation to other financial assets like equities

 Provides stability in case of debasing monetary system and crisis in financial markets

 Gold, although subject to price risk, is without counterparty risk and, unlike a paper instrument, is not
dependent on another party

 Current environment for gold has commonality with Global Financial Crisis (2008):

 Equities down by ~25% from their recent peak

 Sovereign bond yields at all-time lows

 Uncertain outlook for the financial markets

 Gold initially failed to act as a safe-haven (positions getting liquidated to meet margin calls)

 Arguments against gold as an asset class:

 Generates no internal returns through interest or dividend payouts

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Gold has proven to be a Hedge against Inflation

Gold prices and US Inflation over the longer term

CAGR
11.7%

CAGR of
CAGR 8.9% 8.9% which is
4x the rate of
US CPI of
2.1% over the
CAGR 2.1% same period

 Gold has risen from USD 289 / Oz in Jan-00 to USD 1,585 / Oz in Feb-20
 Gold has been a hedge against price instability

Gold has a proven track record as store of value and hedge against inflation

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Source: Bloomberg
Gold’s correlation with other Asset Classes

Gold prices correlation with other asset classes across time frames

Low correlation

Gold is a true portfolio diversifier given its negative to low correlation to other asset classes esp. equities

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Source: Bloomberg, Data as of Mar ‘20 end
Indian Equities is Nifty 50 TRI, Indian Debt is Nifty 10-year G-Sec Index, US Equities is S&P 500 & Gold is International Gold Prices
 Gold outperforms during periods of volatility
Dotcom Bubble Burst (Feb ‘00) Global Financial Crisis (Jan ‘08) Liquidity Squeeze + Crude (Nov ‘10)

Gold, Blend portfolio & Equity performance Gold, Blend portfolio & Equity performance Gold, Blend portfolio & Equity performance

3-year return/risk metrics 3-year return/risk metrics 3-year return/risk metrics

Better
Lower portfolio
volatility returns
Lower
drawdowns

Portfolio drawdowns and volatility are reduced through exposure to gold during uncertain time periods
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Source: Bloomberg; Blend (25:75) is 25% gold; Blended allocation above is for illustration to establish diversification and not to be construed as recommended portfolio weights
Gold performance vs. Equity during GFC and aftermath

Gold & Equity performance during GFC Gold & US VIX during GFC

Gold corrected
when financial
markets are
Gold liquidation as severely stressed
investors seek to due to margin
raise cash to meet calls
margin calls

 Global Financial Crisis in 2008 stimulated safe-haven status of gold and in the subsequent “Risk off” periods

 Gold initially corrected during Jun-Oct ‘08 as investors liquidated positions to meet margin calls; then gold rallied to life time
high as central banks cut interest rates and pumped liquidity

 During Nov ‘08 – Aug ‘11, gold delivered ~170% gains on flight to safety; Equities yielded only ~30%

During financial crisis and aftermath led by heightened uncertainty & excess liquidity, gold performed
exceptionally well as an asset class

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Source: Bloomberg
Bear Markets and Gold Performance

 Every market cycle has unique factors creating Bull & Bear phases however underlying principles and stages of
economy – Trough, Expansion, Peak & Contraction tend to repeat itself

Magnitude of Gold USD 1 Yr Gold US 3 Yr

S&P 500 Reason for Market Crash
Equity Decline % Return % Return CAGR

1968 - 69 -36% 6% 18%  Rising Inflation & Vietnam War

1972 - 73 -48% 67% 35%  Oil Embargo, Rising Oil Prices, Watergate Scandal

2000 - 01 -49% 25% 16%  Dot Com Tech Bubble

2007 - 08 -57% 24% 22%  US Mortgage & Credit Crisis

Average -45% 31% 22%

2020 -30% ? ?  Outbreak of Coronavirus

During financial crisis and aftermath led by heightened uncertainty & excess liquidity, gold performed
exceptionally well as an asset class

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Source: Bloomberg, All numbers are indicatively only and subject on point to point risk & variance
Gold prices and US Treasury yields correlation

Gold prices & US Treasury Real Yield

Lower interest rates -

reduces the opportunity
cost of owning gold, thereby
aids gold prices – an
inverse relationship

Lower US
Treasury
Persistent lower real yields real yields
supported gold prices

 Gold closely ties to the changes of US Treasury real yields

 Lower interest rates - reduces the opportunity cost of owning gold
 Persistent lower US yields (nominal and real) aided gold post GFC recovery

Gold prices are negatively correlated with US treasury yields for certain periods and currently lower
treasury yields builds a case for gold allocation

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Source: Bloomberg
Gold exhibiting similar behavior as during GFC

Gold & Equity performance since 2018 Gold & US VIX since 2018

With VIX still at

Gold experienced weakness due to historical higher range,
margin calls; then recovered gold will have support
sharply on flight of safety

 Gold prices were lower in 2018 (low financial market volatility); However, elevated geopolitical & trade tensions hold up gold in
2019

 Gold did well since the outbreak of COVID-19; Briefly, gold advances got curbed by margin-related liquidation

 Gold appears attractive:

 Even if volatility abates a bit, it may well stay historically high to keep gold well supported

 With equities under pressure, diversification benefits and hedge against inflation should not be overlooked

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Source: Bloomberg
Lower real yields and rising negative yielding debt

US Treasury real yields & Gold prices Gold’s performance & amount of negative-yielding debt

Rising negative-yielding debt

lowers cost of gold ownership

Lower real yields do

augur well for gold prices

 Lower real interest rates reduces the opportunity cost of owning gold

 Drop in real yields in US and declines elsewhere has increased the amount of negatively yielding sovereign debt

 Key central banks resorted to aggressive rate cuts to stalk market volatility

 Lead to debasement of value of key currencies globally

 The need to protect value, may invite higher gold allocation in days ahead

 Impact of COVID-19 may strain international relations, set back globalization, trade and thus, indirectly aid gold demand

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Source: Bloomberg
 Investment Horizon, Allocation & Risks

 Investment Horizon:
 Investment horizon is approx. 18-24 months

 Allocation:
 Portfolio allocation upto 10% and investors should stagger the allocations over 1 -3 Months

 Indicative Gold Portfolio Allocation:

 Risks:
 Risk from excess volatility in equity markets as investors might liquidate safe assets to meet margin calls
 Demand from major end use gold consumers, India and China have contracted sharply due to the lockdown;
Prolonged extension of weak EM physical demand can likely impact gold prices in the short term
 Govt. regulations like restricting imports, imposing custom duties, etc.
 Gold prices can be impacted by Risk off – Risk on scenarios

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ETFs – Exchange Traded Funds, SGB – Sovereign Gold Bond

THANK YOU

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