Gold Mutual Funds: Investment Options for Hedging Against Inflation

Introduction

Gold is a popular investment for hedging against inflation. Physical gold is the most effective way to hedge against inflation, as it is the most affordable and has no counterparty risk. Gold ETFs and gold mutual funds are also options, but they have counterparty risk and may not be as affordable as physical gold. Gold IRAs are another option, as they allow you to invest in mutual fund shares, ETFs, and physical gold without actually holding onto the physical gold yourself. Gold mining stocks are not a good option for hedging against inflation, as they are more about the company's ability to run an efficient business than protecting against inflation. It is important to diversify your portfolio and not invest too much in gold, as it can be risky.

Gold Prices

Gold prices have hit a lifetime high and are riding high on the back of geopolitical tensions. More retail investors have bought Gold exchange traded funds (ETF) and sovereign gold bonds (SGB) have become popular. Gold ETFs are passively managed mutual fund schemes investing in standard gold bullion with 99.5% purity. They track the domestic price of gold closely and are available only on stock exchanges. Gold's safe haven status makes it a preferred choice during market and economic uncertainties such as the Covid-19 pandemic and the Russia-Ukraine war. Despite volatility, gold prices have risen (14.4% in the last five years). Central banks bought a lot of gold, which has been the main driver. Demand for physical gold also has been steady. Gold benefits from excess money supply and low real interest rates. The surge in fiscal deficits to battle the Covid-19 induced slowdown led to excess money being printed. Low interest rates, which could happen from late 2024, are expected to push gold prices up further. Assets Under Management (AUM) with gold ETFs more than tripled to Rs 28,530 crore after the onset of Covid-19. Prior to that, gold returns were subdued because equity markets had rallied. The geopolitical situation since February 2022 have pushed gold prices up further. Gold ETFs back their assets by buying actual physical gold of 99.5% purity. This physical gold is stored in vaults with custodian banks and valued periodically. Indian Gold ETFs held about 44.6 tonnes of gold as of February 2024. Gold ETFs from the US and Europe held about 1,611 tonnes and 1,372 tonnes, respectively. Traded volumes of gold ETFs on stock exchanges have improved significantly over the last few years. In 2023, the total traded volume on the NSE stood at Rs 9,002 crore. Most ETFs are thinly traded in India. However, there are five gold ETFs with a daily average trading volume above Rs two crore on the NSE. Investors without demat accounts can consider investing in a gold fund of funds (FoFs). The good thing about gold FoFs is that they allow a systematic investment plan (SIP). Apart from the operational structure, there is not much difference between a gold ETF and a gold FoF. It's also easier to buy/sell a gold FoF at the prevailing net asset value (NAV) at any time.

Wall Street Analysts

Gold prices are hitting record highs, and Wall Street analysts are surprised by the intensity of the ascent. The precious metal is traditionally seen as a haven in times of volatility and geopolitical risk, but this time its ascent is coinciding with investor optimism about the U.S. economy. Gold futures have notched gains for the past seven trading sessions and broken records in the past six. The latest run-up came after a drop in consumer sentiment and moderate inflation data late last month raised hopes that the Federal Reserve will cut interest rates this year. Lower rates make gold, which pays no income, more attractive relative to assets such as stocks and bonds that pay dividends and interest. Gold’s biggest enemy is a rise in real yields, which are interest rates adjusted for inflation. Yet gold has notched a 20% gain since the end of 2021. That is even as the Fed’s inflation fight has catapulted real yields to about 1.8% from around negative 1% since the end of 2021, prompting a selloff of gold exchange-traded funds in the U.S. Part of the explanation is a sense of growing economic and geopolitical risks outside the U.S. Central banks around the world began buying gold after the 2008 financial crisis and accelerated their purchases after Russia’s invasion of Ukraine in early 2022. Then in October, gold jumped 5% after Hamas attacked Israel. It is now 19% higher than when the conflict began. Bullion hoarding by central banks has approached 30% of global mining production over the past two years. Last year, those institutions snapped up more than four times the amount of gold that was ditched by ETF investors in the U.S., according to Suki Cooper, precious-metals analyst at Standard Chartered. The buying spree has continued at least through January of this year, led by central banks in Turkey and China, according to the World Gold Council. At the same time, the Royal Mint said gold purchases jumped after the U.K. entered a recession in late 2023. Demand for gold in China has also been “insatiable," said Nicky Shiels, metals strategist at MKS PAMP. The country’s real-estate market has been battered, and the benchmark stock index kicked off 2024 with a 6.3% drop in January, after falling for three years in a row. “It’s complete fear buying," she said. Her firm is seeing robust demand elsewhere. In India, investors are seeking to hedge inflation in one of the world’s fastest-growing economies. Greg Sharenow, head of commodities and real assets at Pimco, is among those who question whether gold’s latest rally can continue. Central banks have played a big role in its rise, and there is a risk that some will balk at buying more bullion at unprecedentedly high prices, he said. “They’re the tailwind," he said, “But it’s hard to know that that tailwind remains as strong since prices have really moved." Although futures buying by systematic trend-following traders has helped power gold’s rise, they are also now close to their maximum long positions, according to TD Securities. That makes it unlikely they will boost prices much higher. Everyday as well as institutional investors in the U.S. have been selling gold, though less than they ordinarily might with interest rates still high. Some might be worried that the stock market’s rally has gone too far and are hanging on to the metal as a hedge, analysts said. A trigger Gold made its last record run in December, after the prospect that interest rates had peaked sparked the so-called everything rally. Similar forces could be at play with the latest upsurge. Many on Wall Street think the gains can continue—but there needs to be a clearer signal that the Fed will indeed cut rates soon. Citigroup, J.P. Morgan and TD Securities all have $2,300 price targets. Leigh Goehring, managing partner of Goehring & Rozencwajg Associates, is buying shares of mining companies, which he thinks will outperform gold itself given their low valuations. The VanEck Gold Miners ETF is down 4.4% this year, while the S&P 500 is up 7.4%. Goehring said that Western investors need more certainty that rate cuts are coming before switching from selling to buying gold. He thinks that conviction could come at any time. “Who knows when it’s going to snap?" he said. “It could very well turn around very, very quickly."