After BREXIT should you look at Gold ETFs as an asset class?

The day Britain voted to exit the EU; the impact was visible on two major commodities. Oil fell sharply on expectations that the slowdown in EU and UK will lead to a compression in demand for oil. Secondly, the price of gold showed a sharp recovery. Remember, gold is already up nearly 25% from the lows of January. The question then is should mutual fund investors look at Gold ETFs seriously as an asset class? The answer is they must look at gold as a serious asset class from here on. Here is why…

There will be safe haven demand for gold…

One of the obvious outcomes of the BREXIT will be that there will be a spurt in volatility and uncertainty in the global financial markets. Bond markets will be confused about the likely interest rate direction globally. Equity investors are not sure what would be the combined impact of a slowdown in UK and the EU on global equity valuations. It is in these circumstances that gold normally emerges as a safe haven investment. Investors are normally more convinced with the value implicit in physical assets like gold rather than in paper assets like equities and bonds. That means gold prices could only get stronger from here.

Gold will emerge as an alternative currency…

There are currently five hard currencies in the IMF SDR basket viz. US$, UK£, Euro, Japanese ¥ and the Chinese Yuan. The Yuan is a new entrant into the SDR basket. Of the remaining four, UK£ and the Euro will be under intense pressure due to an economic slowdown in both these regions due to BREXIT. We are already beginning to see investors trying to shift out of £ and € assets into Dollar and Yen assets. That will reduce the number of preferred hard currencies to just two. The irony is that both the US and Japanese central banks have been following an accommodative monetary stance. The BREXIT will mean that any prospects of a US Fed rate hike are put off for the time being. Under these circumstances all the leading currencies are likely to see value debasing due to loose monetary policies. The only currency that has the potential to hold value due to its finite supply is gold. Remember, investors like Stanley Druckenmiller are already touting gold as the next big currency.

Gold will emerge as the asset class of choice due to low inflation…

With abundant central bank liquidity and weak global demand, the world economy seems to be poised to enter a period of low inflation. A combination of low inflation and near-zero interest rates will mean that debt may not be an attractive proposition any longer. The world is already sitting on $10 trillion worth of negative yield bonds and investors are beginning to look for alpha. Equities are stuck in a high value zone driven by too much liquidity. Central banks are keeping the liquidity taps open and that has sustained equity valuations even at the risk of asset inflation. Low inflation and low interest will mean that that there is little margin of safety in equities. That is where gold comes in. Being a low return investment, it automatically becomes valuable in a low inflation environment. As gold increasingly emerges as an alternate currency, its dependency on the US$ will reduce giving a new formula for pricing gold altogether.

That brings us back to the fundamental question; should mutual fund investors look at Gold ETFs? We believe that gold ETFs should become a necessary part of your mutual fund asset allocation. An exposure to gold ETFs will not only give you a better hedge against the risk of equities and debt but also provide alpha at a time when the margin of safety in debt and equity is limited. Instead of purely focusing on MF SIPs, expand your asset profile by adding a SIP on gold ETFs. As gold continues to gain value in volatile times, the phased approach to gold ETFs will ensure that you get the best of gold price volatility. The time has come for gold to emerge once again as a credible asset class. An SIP on gold ETFs could be your gateway to participate in this gold story.

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