In the digital age, we often overlook the physical attributes of what we buy, sell, or hold in the digital universe. Gold ETF (exchange-traded fund) investors may seldom get to hold the sparkly gold bars that the ETF Trust buys on their behalf. While the splendour of gold jewellery and ornaments is admirable, the yellow metal is over twice as heavy as iron, has exceptional thermal and electrical conductivity, and is one of the least reactive elements. That explains why most gold ever mined is still around.
Gold was embraced by mankind thousands of years ago due to its aesthetics. Subsequently, gold’s monetary benefits were recognised, and it became a proxy currency until the demise of the Gold Standard in 1971. Since then, central banks marginally depleted their gold reserves until the 2008 financial crisis. Post that, central banks have steadily increased holdings. Now banks are eager to diversify their bloated US dollar holdings.
Central banks like gold because of liquidity, intrinsic value, and lack of credit risk. Also, gold provides stability during economic turmoil. In a scenario of low or negative nominal or real interest rates gold’s appeal as a portfolio diversifier increases. Since most central banks have expanded their balance sheets to support their pandemic-hit economies, it is probable that proportional increase in allocation to gold may be round the corner. The Yuan and CBDC (Central Bank Digital Currencies) may compete with gold for that space. After a pause in 2020, central banks’ gold buying has been quite steady in 2021.
The gold versus crypto debate rages on with neither side ready to concede. Cryptocurrencies may be an exciting future prospect, but gold is liquid with a robust trading and settlement infrastructure, globally reinforced by banks and financial institutions that provide safety for market participants.
Liquidity is one reason why Gold ETF is the instrument of choice for investors. It offers better liquidity than physical gold — especially for retail investors. Along with convenience, there is also the safety factor as Gold ETFs are regulated funds, listed on leading stock exchanges and backed by gold bars of high quality conforming to best international standards.
While past data may have no bearing on future prospects, gold has a hard to ignore track record as a portfolio diversifier and hedge during uncertain times. Investors focusing on risk-weighted returns rather than absolute returns may consider gold for portfolio diversification. Using ETFs is a cheaper and convenient way to create a diversified portfolio.
As inflation moves centre stage, the role of gold as inflation hedge gains traction. While the relationship between gold prices and inflation is a complex one, however effects of disparate money printing by central banks over the years are quite visible. Fifty years ago, 1-kg gold was at par with $1,300 bills; now it is almost equal to $600 bills. The optics is more compelling while comparing with emerging market currencies. If inflation turns out to be higher and stickier than anticipated; gold will be in demand.
Gold jewellery demand has rebounded sharply this year but is still below pre-pandemic levels. The next year  may be a better year for jewellery demand, according to the latest World Gold Council report and that should underpin gold prices.
Investment demand has been in the red this year so far as some of the pandemic gold hedges got unwound. After record inflows last year, this is the first year since 2015 when Gold ETFs globally have seen net outflows.
The overall picture for gold is a mixed bag as steady central bank buying and recovering physical demand provides the floor for prices under current levels, whereas patchy investment demand is keeping prices under check. What may move the needle is the developing inflation scenario and trajectory of real interest rates. If both prove favourable for the yellow metal in the medium term then the fact that gold is undervalued against the majority of assets on a historical basis, the risks will shift on the upside for gold.