Three reasons why gold has surged 20 per cent in last one year

Gold has been on the fast lane, with the precious metal growing 20 per cent in the last 12 months. Let's understand why that's the case.

1. Store of value

Let's start with the most enduring reason for gold's popularity. Over multiple decades, the precious metal has been recognised as an excellent store of value. In other words, it usually shines whenever there is global uncertainty or fear in the financial markets, offering a safe haven for investors.

So, in turbulent periods, which we are in at the moment due to the bloodshed in Russia-Ukraine and the Middle East, gold has become a beacon of stability. People start buying gold as its value has survived centuries.

Heck, even the central banks of some major emerging markets have been stockpiling more and more of the precious metal in recent years.

The invasion of Ukraine by Russia in 2022 really showed how important having gold reserves can be. When the US and other Western nations froze and seized many of Russia's assets held in US dollars as part of sanctions, it showed how a country's reserves could be vulnerable. However, gold reserves remain untouched, providing nations with a dependable financial safeguard during challenging periods.

So, countries bulking up their gold reserves may be driving up the metal's price, too.

2. Impact of rupee depreciation

Gold is globally traded in US dollars. Since we buy the metal in rupees, and historically, the rupee has fallen in value against the US dollar over time, the gold we hold becomes even costlier. This means we have to spend more rupees to buy the same quantity of gold now.

For example, even as gold returned absolute returns of around 70 per cent in dollar terms over the last five years, it delivered a return of around 105 per cent in rupee terms. To reiterate, this has happened because the rupee has weakened compared to the dollar in the past five years.

3. Anticipation of rate cuts

Gold prices generally move in the opposite direction of interest rates. The metal becomes more attractive when interest rates are low because there's less opportunity cost. Meaning, you don't miss out on potential returns from putting your money elsewhere, like in a high interest-paying fixed deposit (FD).

Conversely, higher interest rates make gold less appealing, as a fixed-income investment can earn more money than the yellow metal.

Since the US Federal Reserve is expected to start cutting interest rates this year, many experts believe that investors have pre-empted the chop and started buying gold.

What you should do

It's tough to ignore an investment that has delivered 20 per cent-plus returns. That's natural.

However, Value Research has always viewed gold as an unproductive asset class because it relies on market demand for its value increase.

Although the short-term returns of gold might look appealing, historically, it has yielded only 7-8 per cent annually, considerably lower than equity, which has provided around 14 per cent returns (S&P BSE 500) in the last 10 years.

That said, some investors may want to add gold to their portfolio. If you are one of them, we suggest you look at sovereign gold bonds (SGBs), and not in any other form, for two key reasons:

1. While SGB and physical gold prices grow at the same pace, the former offers an additional interest of 2.5 per cent each year.
   
2. What's more,if you hold the SGB until its maturity, the gains are tax-free.

Also read: Are gold's golden years coming?