Gold and Asset Allocation: Striking the Right Balance

The association of gold with money persisted into modern times. After World War II, the Bretton Woods system pegged the US Dollar to gold, and other currencies were linked to the dollar. Although this system ended, gold remains significant in global finance.

Today, central banks, including India’s, hold gold as part of their foreign exchange reserves. As of Oct 2024, 9.3% of India’s reserves ($ 65.7 billion) were held in gold, reflecting its enduring value as a financial asset.

Gold’s Dual Role: Safe Haven and Inflation Protector

In modern times, gold has become an essential part of one’s portfolio due to 2 reasons. 

Firstly, gold is a safe haven asset class. When there is turmoil in the market due to macro events and equity markets are facing a lot of volatility, gold as an asset class tends to do well. Hence it is an effective hedge against equities. Hedging is a strategy employed to reduce the risk of adverse price movements in an asset. The approach helps mitigate the losses in an asset/instrument by gains in another investment. This helps navigate market correction. The below table compares the performance of gold against the Nifty 50 performance during times of crisis.

Inflation is the rate of increase or decrease in prices over a specific period. It indicates how much more expensive or cheaper a particular set of goods and services has become over a certain period, like a quarter or a year. Historically, inflation has impacted returns on equity and gold in different ways. High inflation has generally correlated with lower equity returns. On the other hand, over the long term, gold acts as an efficient hedge against inflation. 

The below table illustrates the performance of Nifty 50 and gold during periods of increasing inflation. We have considered wholesale price inflation for the purpose of the below analysis.

Gold in Review: How It Performed in 2024 and Outlook for 2025

In 2024, gold achieved its best annual performance since 2010. It is up over 28%, since 1st Jan 2024, as investors turned to it for safety amidst global uncertainties and expectations of monetary policy changes. It was the best performer compared to other safe-haven assets like the 10-year US bond, US Dollar, Swiss Franc, and Japanese Yen. 

Several key factors fueled gold’s impressive rise in 2024. Central banks played a pivotal role by steadily increasing their gold reserves as part of a broader effort to diversify away from traditional currencies, creating sustained institutional demand that bolstered prices throughout the year. Global central banks bought 694 tonnes of gold during the first nine months of 2024. 

Geopolitical tensions also acted as a significant driver, prompting investors to turn to gold for its traditional safe-haven appeal. The Federal Reserve’s three interest rate cuts in 2024 significantly bolstered gold’s appeal, contributing to its rally in the year’s second half. However, the Fed’s signal of a slower pace of rate cuts in 2025 tempered gold’s momentum, with prices pulling back slightly after the December rate reduction. The future trajectory of interest rate cuts remains a key factor for gold’s outlook.

Renewed interest from retail investors also influenced market dynamics, with gold-linked Exchange Traded Commodities (ETCs) seeing substantial inflows. This increased retail participation provided additional momentum to the rally, especially during times of market uncertainty.

Wall Street analysts predict that gold will continue to gain support from global central bank purchases and interest rate cuts by the US Federal Reserve. Additionally, concerns over rising US government debt under President-elect Donald Trump, along with ongoing conflicts in the Middle East and Ukraine, are expected to further drive prices higher.

Building a balanced portfolio with gold

Investors are increasingly seeking strategies to protect their portfolios while pursuing growth in unpredictable markets. Asset allocation offers a balanced approach by diversifying investments across equities, debt, and gold, helping manage risk and enhance returns. This strategy is particularly valuable during market volatility, providing flexibility to adapt and protection against downturns.

Market cycles are challenging to predict, even for seasoned investors. For instance, while pure-equity smallcases perform well in bull markets, they can face significant losses in downturns, highlighting the need for diversification. Asset allocation smallcases address this by shifting to safer assets like gold and debt during equity market sell-offs, preserving capital and reducing losses.

Understanding Equity & Gold smallcase

A portfolio that includes both equity and gold is an efficient way to achieve capital protection and sustainably create wealth. The performance of gold will offset the poor performance of equities during unfavorable macro events or persistently high inflation.

The Equity & Gold smallcase provides exposure to both equity large cap and gold asset classes via Nifty Bees and Gold Bees in the proportion of 70% and 30%. While the equity portion of the smallcase assists in growing investment, the gold part of the smallcase protects the portfolio from large drawdowns. 

Since its inception in Jan 2019, the smallcase has generated higher compounded returns compared to the universe of large-cap stocks. In addition, the risk-adjusted returns, returns earned per unit of risk, have also been significantly higher.  

Maximum Drawdown is a risk metric that measures the largest peak-to-trough decline in the value of a portfolio over a specific period of time. It represents the maximum potential loss an investor could experience before the asset or portfolio begins to recover. The Equity & Gold smallcase has a drawdown of -25.5% compared to the -38.1% drawdown of equity largecaps. 

Conclusion

Throughout history, gold has consistently proven to be more than just a precious metal—it is a financial pillar, a symbol of stability, and a strategic asset in portfolio management. Its unique qualities as a safe-haven and inflation hedge have made it invaluable in times of uncertainty.

In the modern investment landscape, gold remains a critical component of asset allocation strategies, providing protection during market volatility and complementing equity investments. As seen in 2024, global economic and geopolitical shifts continue to drive the demand for gold, reaffirming its status as a reliable store of value.

However, it is crucial for investors to maintain a balanced approach when incorporating gold into their portfolios. While it offers protection and stability, it is not a tool for quick gains but rather a means to preserve wealth over the long term. Limiting gold’s allocation to 10-15% of the portfolio ensures diversification without overexposure.

As markets evolve and uncertainties persist, gold will continue to shine as a cornerstone of financial security—bridging the past, present, and future with its enduring value.

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