March 2020 saw market prices pull back to 2008 global financial crises levels on account of the COVID-19 global pandemic. Kofi Pianim, the Head of Global Markets at First National Bank shares some insights on the outplay of the cash and gold market.
“Sustained periods of market volatility and equity sell-off left investors scrambling for safe-haven assets such as cash instruments and certain commodities including the yellow metal”, says Kofi.
Due to their largely negative correlation with other financial assets, commodities such as gold are very useful for managing portfolio risk, helping to maximize the benefits of portfolio diversification especially during periods of high market uncertainty. The figure below shows the trend of gold prices over the past 20 years.
Looking back at 2008, gold was negatively correlated to market performance, meaning when markets went down the gold price increased. The reason for this is that investors pulled their funds from equities and invested in gold, increasing the demand for the commodity and thus increasing the price.
The same pattern emerged in March 2020 where global equity markets experienced another mass selloff. Investors with exposure to gold during 2008 and 2020 were effectively hedged in reducing some of the downside equity risks when market sell-off occurred.
Rising prices of commodities such as gold have a positive impact on net bullion exporters such as Ghana. Ghana is one of the world’s major exporters of gold, exporting a total value of USD 6.8bn worth of gold in 2020, up from USD 6.2bn in a prior year according to Bank of Ghana data.
The rising price of gold also positively impacts BoG’s gross international reserves, allowing the country to record a higher import cover. This favorably positions the Central Bank to intervene on the local FX spot and forward markets as it deems fit.
In addition to its gold exports, Ghana produces other commodities such as cocoa and crude oil for the international markets. As can be seen from the figures below, both cocoa and gold prices initially took hits in March 2020 due to the covid-19 pandemic. However, gold quickly recovered and helped to cushion the shortfall in Government revenue from the export of cocoa. Cash is another asset class that can be used as an effective tool to hedge equity risk:
Cash as a diversification tool
Investing in the Ghana Stock market and holding cash instruments might appear to be mutually exclusive options on the surface. However, cash instruments play a more crucial role in the successful diversification of the investor’s portfolio.
In times of economic downturn and market pullbacks, cash instruments, being defensive assets, can play a hedging role in protecting wealth from equity downside. For example, whereas the Ghana Stock exchange recorded a 14% fall in its All Share Index in 2020, the yield on the 1-yr GoG t bill was +16.98%.
Having cash in a portfolio means being able to take advantage of opportunities when they present themselves in the market. Warren Buffet quoted cash as “Cash is to business as oxygen is to an individual, never thought about when present, the only thing in mind when absent”.
In times of market volatility and increased risk, cash instruments should be considered by investors as a diversification and risk mitigation tool. Adding a cash element to a portfolio allows an investor to decrease portfolio risk and secure an additional income stream in the form of interest.
Long-term investors see cash instruments as a defensive asset that produces consistent, reliable returns in a risk-averse manner. However, this asset class can also be used by investors to go on the offensive. Investors with large amounts of cash in their portfolios can easily take advantage of investment opportunities and potentially buy assets of value at discounted prices when markets pull back.
Cash as an asset class is extremely liquid and can be used to purchase assets when needed. Just having exposure to equities will mean having to sell those shares to acquire another investment. This can mean selling shares at the incorrect time when market prices do not reflect value.
Having cash exposure can result in an investor having a war chest for when the right opportunity presents itself in the market, as well as receiving stable, consistent returns on the cash instrument utilized.
Types of cash instruments:
There are a number of different cash instruments that can be utilized in achieving investment goals. Cash investment is far more than just a traditional savings account. Money market accounts and funds can be utilized to achieve higher cash returns than a traditional savings account.
Investors receive higher returns on account of the minimum deposit required as well as maintaining certain balance amounts. Money market funds like mutual funds give investors access to different cash securities, however, these securities are all liquid and maturing within 12 months.
These types of assets allow investors to gain exposure to both the Repo rate as well as short-term fixed interest. Investors can also look at investing in instruments for a certain period through a call or fixed deposit.
The difference between these instruments is that a call account generally has a variable rate of return, where a fixed deposit allows an investor to secure the interest rate for the duration of the investment. Both assist investors in diversifying risk through reliable and consistent interest streams. In closing:
One thing that comes to light on account of the global pandemic is the role diversification plays in sheltering investors from total losses. In a bull market, diversification can be overlooked by investors as prices are increasing.
However, in a market event, any weakness in a diversification strategy is magnified. Diversification means investing in assets that do not move in the same direction through economic cycles. Gold and cash instruments are useful tools that should be considered by investors looking to spread portfolio risk, building a portfolio that will stand strong against future market events.
Source: Ghana Web