Recent inflation data, combined with the Reserve Bank of Australia’s (RBA) repeated sentiments about keeping interest rates higher for longer, could see gold emerge as a “strategic component” in Australian portfolios, according to Ray Jia, senior research analyst at the World Gold Council (WGC).

Reflecting market expectations in recent months, he noted that June’s inflation data came as a pleasant surprise after two consecutive months of hotter-than-expected CPI readings in Australia.

Trimmed average inflation came in at 4.1% year-on-year, down from 4.4% in May. Meanwhile, the RBA’s second-quarter average inflation eased to 3.9 per cent year-on-year, below both the first quarter’s 4 per cent and the consensus 4 per cent.

Those signs of a slowdown "encouraged investors," Jia noted, as market expectations "made a 180-degree turn" from rate hikes to potential rate cuts by the end of 2024.

However, those expectations were short-lived after the RBA's last meeting on August 6, he said, as the central bank opted to keep interest rates on hold for a sixth straight time and highlighted potential risks to inflation.

Shortly afterwards, at the press conference following the RBA meeting, Governor Michelle Bullock also confirmed that a short-term cut in the cash rate was "not consistent with the board's current thinking" over the next six months.

"As a result, expectations for Australia's future interest rate have changed again," Jia said, pointing out that this had two main implications for Australian portfolios. First, the correlation between bonds and stocks is likely to remain high for the foreseeable future, he warned.

"We are witnessing such a pattern between 2022 – when the RBA started the hikes – and now,” he said.

Also, government bond yields could become volatile depending on changes in RBA sentiment and the rate of inflation, Jia continued, with macro uncertainty tending to keep local bond volatility at its multi-year high.

“This is likely to have implications for Australian portfolios. The recent rapid changes in yields, amid notable changes in interest rate expectations and equity turbulence, have resulted in a spike in volatility in the traditional 60/40 portfolio,” Jia said.

Against this backdrop, gold can become a strategic component in portfolios, offering diversification benefits.

“Unlike bonds, gold has demonstrated a consistently low correlation with Australian shares. This is mainly due to the fact that the valuation of gold is not determined by any one country, thanks to its diverse sources of demand – which is spread across regions and sectors – and supply,” the analyst said.

The commodity has already generated a double-digit return of 22 percent year-to-date, outperforming most other asset classes, despite perceptions that gold "doesn't generate returns."

It also hit a record high of $2,480 an ounce in mid-July, driven by lower 10-year Treasury yields and, to a lesser extent, a weaker U.S. dollar, according to the return attribution model of gold by the World Gold Council.

"Gold has actually been the best performer among major global and Australian assets so far in 2024," Jia said, noting that strong global central bank buying, strong demand for investment in Asia and heightened geopolitical risks had supported the performance of gold in the first half of the year.

"It is worth noting that gold has generated positive returns every year since 2016. so far, averaging 10 per cent per annum in AUD,” he added.

Looking ahead, as geopolitical risks rise, financial markets face increased volatility and the future path of Australia's interest rates looks uncertain, gold appears an ideal asset to enhance returns and reduce risk in Australian portfolios, Jia said.

Earlier this month, the WGC found July to be the strongest month for global gold ETFs since April 2022, with Western funds leading the way with inflows.

It noted that gold ETFs attracted US$3.7 billion in inflows last month, marking the third straight month of inflows.

Australia recorded inflows of around US$26.3 million, "likely fueled by the strong performance of the gold price in the depreciating local currency", to bring total AUM to US$3.2 billion.