Globally investors are now moving towards physical assets or tangibles, away from financial assets such as equities and bonds. Gold and silver have emerged as the top-performing asset class in 2022 after a poor show in the second half of 2020 and throughout 2021.
The two precious metals, gold and silver, are up nearly 5 percent each during the year so far against an 8 percent decline in the Dow Jones Industrial Average – the bellwether of the global equity market.
Historically, gold does well when traditional assets struggle to deliver. The yellow metal is also a good hedge against inflation and an alternative to fiat or official currencies for storing wealth for the long term.
Similarly, bond prices across the world are declining as the yields or the interest rates rise. For example, the yield on the benchmark United States 10-year treasury bond is up by around 50 basis points during the year so far, rising from 1.5 percent at the end of 2021 to close to 2 percent on Wednesday.
The yield on India's 10-year government bonds is also up around 30 basis points year-to-date despite the best efforts of the Reserve Bank of India to bring down the yields. Higher yields lead to lower bond prices and vice versa.
Industrial commodities or tangibles have done even better. The crude oil prices are up nearly 20 per cent year-to-date with Brent Crude rising from around $77/barrel at the end of 2021 to around $94/bbl on Wednesday. The London Metal Exchange Index (LMEX), which tracks the prices of six-key base metals including aluminium, copper, zinc, Nickel, Lead and Tin, is up over 7 percent year to date.
Most analysts expect this trend to stay for a while given the recent changes in the world economy and geopolitics.
The last three decades were golden years for risk assets such as equity and bonds fuelled by a slew of tailwinds. These factors included a steady decline in interest rates in the world’s major economies, low inflation, business deregulation, a cut in corporate taxes, a boom in cross border trade and the peace dividend provided by the end of the Cold War in 1991.
For example, the Dow Jones Industrial Average Index that tracks the stock price of the United States top 30 companies is up more than 10 times in the last 30-years appreciating at a compounded annual growth rate (CAGR) of 8.1 per cent since 1992. India's equity benchmark BSE Sensex on the other went up nearly 30X during the period up from 1880 at end of March 1992 to close at 57,232 on Wednesday. This translated into CAGR returns of 12 per cent for Indian equity investors during the period.
Many of these tailwinds are now turning into headwinds putting pressure on risk assets and it shows in the recent performance of the equity and the bond markets.
This is creating uncertainty in the global economy and raising costs for consumers and producers. The end result will be a decline in consumer demand and higher operating costs and lower profit margins for corporations. This will put stock prices under check in the foreseeable future.
Continued uncertainty in the global economy coupled with geopolitical tension such as the standoff between the West and Russia over Ukraine will fuel safe-haven investment in precious metals such as Gold and silver.
A rise in yields and higher inflation on the other hand are likely to support higher prices for energy and industrial metals. The metal and energy prices will also get a boost from American and European Union sanctions on Russia given that the country is one of the world’s top energy and industrial metal producers.
FPIs have sold nearly $3 billion worth of stocks in the secondary market during the month of February so far.
Analysts expect selling by FPIs to intensify once the US Federal Reserve starts raising interest rates in April this year. Besides, India’s economic growth and corporate earnings face significant downside risks from a rise in crude oil prices and a slowdown in public spending next fiscal as the country battles with record-high national debt.
The relative calm in the Indian equity market provides a good window of opportunity for Indian investors to reduce their exposure to direct equity and mutual funds and make additional investments in gold and silver.
They should however stay invested in commodity and energy producers such as top oil & gas and metal producers that are likely to gain from a rise in energy and metal prices.
Traditionally, gold and silver should not be more than 10 percent of your investment portfolio.
The investment in precious metals should further be split 70:30 between gold and silver. In the short-term many metal analysts expect a correction in gold and silver prices after a strong rally in February. Investors can use that to add precious metals to their portfolios.
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).