Gold remained above the $1,500 level and was also able to move above the $1,510 50-day moving average. With the recent breakout, the gold price could test the ytd highs of $1,566 in the near-term.
Options and volatility:
Implied and realized volatility fell sharply in October, with 30-day realized volatility falling from 16 to 11.8, and implied volatility falling from 14.9 to 11.1. Both numbers are effectively in the 50th percentile over the past year, and represents the recent consolidation of the gold price near $1,500/oz.
Call skew, (the premium paid for bullish exposure) remains near all-time highs highlighting bullish sentiment in the market.
Gold-backed ETF flows by time periods:
$211mn worth of inflows, primarily from the UK last week, US (-$121mn) Europe (+331mn).
Flows were higher by $1.9bn in October, continuing to make all-time highs in tonnage. We will release October ETF flow analysis on Thursday at 8am EST.
Liquidity:
COMEX net longs rose slightly 904t to 941t for a second straight week, and remain well above the long-term averages.
Trading volumes fell in October to $156bn a day, which is slightly above the ytd average, but 37% above the 2018 average.
As 2019 comes to an end and 2020 begins, we believe that:
Financial and geopolitical uncertainty combined with low interest rates will likely continue supporting gold investment demand
Net gold purchases by central banks will likely remain robust even if they are lower than the record highs seen in recent quarters
Momentum and speculative positioning may keep gold price volatility high
Gold price volatility and expectations of weaker economic growth may result in softer consumer demand near term
But structural economic reforms in India and China will support demand in the long term.
Note: our comprehensive annual Outlook will be published by mid-January 2020.
Stocks outperformed in 2019 but investors remained cautious
The year 2019 proved eventful for investors. Stocks, especially in the US, continued to reach record highs but not without major pullbacks at various times during the year as economic and geopolitical risks compounded. At the same time, many central banks – the highest level since the global financial crisis – started cutting rates, expanding or implementing quantitative (or quasi-quantitative) easing and, in some instances, doing both. After having moved well above US$1,500/oz during the third quarter, the gold price was up by almost 15% as of the end of November, as investors looked to balance higher stock prices with an increasingly uncertain environment.
Investors are adding gold to their portfolios
In 2018 central banks bought the most gold ever recorded and these robust purchases have continued, y-t-d, in 2019. Gold-backed ETF holdings also reached all-time highs by October as investors responded to the high-risk, low rate environment.
High risk and low rates in the horizon
As we look ahead to 2020 we believe investors will face an increasing set of geopolitical concerns, while many pre-existing ones will likely be pushed back rather than being resolved. In addition, the very low level of interest rates worldwide will likely keep stock prices high and valuations at extreme levels. Within this context, we believe there are clear reasons for higher levels of safe-haven assets like gold.
One of the key drivers of gold, especially in the short and medium term, is the opportunity cost of holding gold relative to other assets, such as short-dated bonds. Unlike bonds, gold does not pay interest or dividends because it does not have credit risk. This perceived lack of yield can deter some investors. But in an environment where a quarter of developed market sovereign debt is trading with negative nominal rates and, once adjusted for inflation, a whopping 70% trades with negative real rates, the opportunity cost of gold almost goes away, even providing what can be seen as a positive “cost of carry” relative to sovereign bonds.
Global monetary policy has shifted by 180 degrees. Less than a year ago both Federal Reserve board members and US investors expected interest rates to continue to increase, at the very least through 2019. Instead, after a brief pause, the Fed cut rates three times during 2019 and is expected to cut at least once more in 2020.
Gold has historically performed well in the year following Fed policy shifts from tightening to “on-hold” or “easing” – the environment in which we currently find ourselves. In addition, when real rates have been negative, gold has historically returned twice as much annually as the long-term average, or 15.3%. Even low positive real rates produce higher average returns. Effectively, it has only been in periods with significantly higher real interest rates – an unlikely outcome given the current market conditions – that gold returns have been negative.
This is further supported by the surge in negative real-yielding debt, as evidenced by the strong positive correlation between the amount of debt and price of gold over the past four years. To some degree this illustrates the erosion of confidence in fiat currencies related to monetary intervention.
The low rate environment has also pushed investors to increase the level of risk in their portfolios, either by buying longer term bonds or lower-quality riskier bonds, or simply replacing them with riskier assets like stocks or alternative investments. This environment may make gold more effective than bonds in mitigating stock-market risk, providing portfolio diversification and helping investors achieve their long-term investment objectives.
Soft consumer demand
A by-product of uncertainty in geopolitics – the macro-economy and monetary policy – is likely to be high gold price volatility similar to what the market experienced in the second half of 2018 as investors adjust their expectations and change their positioning, often through levered positions in derivatives markets based on new information.
Higher gold price volatility, combined with expectations of weaker economic growth, may result in softer gold consumer demand near term. But structural economic reforms in India and China will likely support long-term demand.
It’s all connected
Gold demand, supply and, in turn, price performance, respond to four broad sets of drivers:
Economic expansion: periods of growth are very supportive of jewellery, technology and long-term savings
Risk and uncertainty: market downturns often boost investment demand for gold as a safe haven
Opportunity cost: the price of competing assets, such as bonds (through interest rates), currencies and other assets, influence investor attitudes towards gold
Momentum: capital flows, positioning and price trends can ignite or dampen gold's performance.
In this context we believe that although consumer demand may be soft and speculative activity could amplify price movements, overall it is likely that investment demand will remain robust and central banks will continue their net purchasing trend.
Gold rallied nearly 4% in December, mainly in the second half of the month, and recently moved to an intraday high of US$1,613/oz as the US-Iran confrontation unfolded. We believe there are a few likely reasons for the move:
A technical breakout
Bullish positioning in derivatives markets
Light trading volumes
Portfolio rebalancing at the end of 2019 especially as investors hedged risk asset allocations
The gold price was at a pivotal level in early December, near the top of the 50-day moving average as well as a bullish pennant1 formation (Chart 1). As gold moved above US$1,500/oz and the moving average the breakout was confirmed, suggesting the price would move to the top of the pennant around US$1,575/oz – effectively where it topped out.
Bullish positioning in derivatives markets
Investors were actively buying upside call options in gold during December. In particular, the purchases were significantly out of the money (OTM), as a long volatility position. This type of positioning typically requires dealers who are selling volatility to the investor to hedge their trade by buying gold, potentially pushing the price higher. This bullish positioning was also reflected by the options volatility skew2 that reached an all-time high in Q4 2019 (Chart 2). This positioning often signals that market participants expect a higher likelihood of a price increase.
Light trading volumes
Gold trading volumes moved sharply higher in November, reaching US$170bn a day – well above the 2019 average of US$145bn. However, this reversed significantly in December, falling 26% to US$126bn a day. The lower volume may have reflected fewer willing sellers toward the end of the year, providing support for a larger move to the upside.
Rebalancing ahead of 2020
We saw a pullback in investor demand for gold in November, as demonstrated by outflows in gold-backed ETFs and a reduction in COMEX net longs. This reversed in December, with net longs moving back near all-time highs and gold-backed ETF holdings reaching all-time highs (Chart 3).
Anecdotal evidence suggests that investors may be inclined to maintain exposure to risk-on assets such as stocks, but not without hedging their portfolios in preparation for potential pullbacks – especially given the high level of geopolitical and geo-economic risks that have been carried over from 2019. And data suggests that gold may be a recipient of some of this activity.
Fed repo activity
The Fed began reducing their balance sheet in 2018, but reversed this decision in the second half of 2019 (Chart 4). In particular, they began regular repurchase (repo) market injections totaling nearly US$500bn in the fourth quarter. This activity has continued into 2020 and has been described by some market participants simply as another form of quantitative easing (QE) – often dubbed “QE light” – and causing some investors to worry about liquidity in the Treasury market as a whole. And, historically, expansions of QE have led to increases in the gold price.
Increased geopolitical risk
Tensions in the Middle East, driven by the US-Iran confrontation, supported safe-haven flows, pushing the gold price to a six-year high. While a more conciliatory tone by President Trump has recently eased concerns and pushed the price down to the US$1,550/oz level, gold remains up by approx. 2.4% as of 9 January 2020.
2 The skew, computed as the difference in premia paid between puts and calls at equivalent strikes, implies that market participants were willing to pay a significant premium for upside versus downside exposure.
Last week, in a “flight-to-safety” move following the bombings of US bases in Iraq, gold and oil both rallied sharply in after-hours trading, However, on the heels of the announcement that Iran was “standing down,” oil finished the week dipping 6%, while gold was up nearly 1% in US dollars. And while gold is one of the strongest performing asset classes this year, oil is one of the weakest.
What is driving this divergence?
Gold stands apart from the broader commodities complex because of its unique market dynamics and performance drivers.
Specifically, gold has historically benefited from six key differentiators:
1. better long-term, risk-adjusted returns than other commodities and broad-based commodity indices
2. more effective diversification than other commodities, particularly in market downturns
3. better performance than other commodities in low inflation periods
4. lower volatility than most single commodities and similar volatility to broad-based commodity indices
5. proven store of value as commodity values fell sharply against gold following the end of the gold standard
6. high liquidity
Ultimately, while commodities can be a relevant tactical asset, a strategic gold allocation of 2%-10% can supplement or replace a broad-based commodities investment alone and may offer more widespread benefits and better risk-adjusted returns
“It just doesn’t get any bigger than this”. At least that is how President Trump is portraying the signing of the “Phase One” deal with China last week. But while talks between the two nations are undoubtedly positive for global trade, do they really make a substantive change in circumstances? Equity markets don’t seem to think so – they were only fractionally higher in response to the news.1 By contrast, gold initially fell by 0.27% before slowly reclaiming some of that marginal decline.
This modest reaction is in line with what is a modest step. The “Phase One” deal seems to omit many of the key issues which lie at that heart of US-China tensions. For example, the US will maintain tariffs on around two-thirds of Chinese imports as talks continue on the next phase of a deal. Plenty of questions remain on how some of the thornier issues will be addressed in any further talks. Scepticism remains high.
As a result, uncertainty and volatility will likely remain elevated, something we discussed in our outlook for 2020. While investors have been accustomed to such conditions in recent years, complacency has not set in. Last year, in search of an effective diversifier to protect against such risks, institutional investors and central banks flocked to gold. ETF demand hit 400t in 2019, while central bank demand approached 600t at the end of November. And at the start of this year, the gold price has already gained 2%, building on the 18% rally in 2018 which saw the price reach its highest level since 2013.
So, while the US and China have taken their first step towards trade negotiations, optimism seems fragile as many questions remain unanswered. This should, for now, be supportive for gold, as investors continue to look for effective diversifiers in the face of persistent uncertainly and volatility.
Footnotes
1 Although some of this more muted reaction could be the fact this deal was expected by the market.
It’s been less than two months since the 2019 novel coronavirus (COVID19) was first reported in China, and a recurring question we hear from investors is: ‘How might gold react to an epidemic like this?’
What we know from SARS
The 2003 SARS epidemic started in late 2002 in southern China but developed primarily between late March and early July 2003.1 While COVID19 is already evolving differently from the SARS epidemic, it provides the most applicable – even if imperfect – comparison available to understand how COVID19 may affect the gold market. With the qualification, of course, that both the Chinese economy and the gold market were much smaller and looked very different in 2003 than they do today, as we discuss below.
Chinese jewellery demand
Chinese jewellery demand is quite seasonal (Chart 1): the first and fourth quarters are traditionally strong while the second quarter is generally weak.2 However, even after adjusting for this seasonal pattern, Chinese jewellery consumption contracted more than expected during the 2003 epidemic – roughly by an additional 10% to 15%.3 In the main, this effect was transient as gold demand rebounded fairly quickly and, by the second half of the year, was back in line with seasonal averages.
Gold price performance
Our analysis shows that the impact on Chinese demand during SARS was fairly evident. However, its impact on price was not. The gold price increased by approximately 3% during Q2 2003 with an intra-quarter maximum of 16% (Chart 2). But it’s not easy to assess the contribution of SARS, if any, to gold’s performance, as the 2003 epidemic coincided with the start of the US invasion of Iraq and a period during which the US dollar generally weakened.
The evolution of China since SARS
While the comparison to SARS may provide some guidance, important changes have been experienced in China and the Chinese gold market since the 2003 outbreak.
The Chinese economy in 2003 represented US$1.7trn compared to an estimated US$14.3trn in 2019.4 On a relative basis, China has become a more important component of the global economy, contributing close to 15% of world GDP today, relative to 3% back in 2003. In addition, the structure of Chinese GDP has markedly changed from being mostly investment driven to mostly consumption led (Chart 3).
The Chinese gold market has also changed a lot. Chinese consumer demand accounted for 8% of the world’s total in 2003. Today, China is the largest gold market, contributing 30% of consumer demand in 2019. The sources of demand have also changed: investment was virtually nonexistent before the establishment of the Shanghai Gold Exchange (SGE) in 2002 and the legalisation of private gold investment in 2004 (Chart 4).
These changes to the size and makeup of the Chinese economy and the gold market have relevant implications on the likely effect of COVID19.
For example, the fact that Chinese GDP includes a higher contribution from consumption means that GDP may suffer more than it did in 2003 given the reduced economic activity it has already experienced so far this year. At the same time, the impact of softer Chinese growth will affect the global economy and increase investor uncertainty, which may support flight-to-quality flows into gold – in China and abroad. Some of this effect is already visible by the increase in trading volumes at the Shanghai Gold Exchange following the Chinese New Year, as well as by continued inflows into gold-backed ETF over the same period. On the other hand, however, the drag from a potential deceleration of Chinese gold consumer demand may have a more noticeable effect on price than it did in 2003.
Conclusion
The coronavirus outbreak in China is evolving rapidly. While expanded diagnostics have increased the number of reported cases, there are indications that the spread of disease is starting to decelerate, especially outside of Hubei Province, where the virus first struck. How it plays out is yet to be determined but, in our view, it is all but certain that China’s consumer demand will ease. Q1 demand may contract by at least 10-15% if history serves as a guide. Whether demand rebounds or continues to soften will depend on the duration of the epidemic and its impact on economic growth.
The impact on gold’s price performance is less clear:
If the situation is resolved relatively quickly and the global impact is contained, the outcome may be limited to softer Chinese gold demand and a transient impact on price
If the epidemic spreads further and continues to affect investor sentiment, global flight-to-quality flows, amidst concerns of a global deceleration, may have a more sustained (positive) impact on the gold price.
2 All outliers – marked with asterisks (“*”) – on Chart 1 correspond to 2013 demand when the gold price dropped substantially and demand did not follow historical seasonal patterns.
3 While we are not including bar and coin demand in the analysis below because the market was too small at the time, the limited data available still suggests a similar behaviour.
At the end of January, the new head of the European Central Bank (ECB), Christine Lagarde, announced the launch of a year-long strategic review of the bank’s monetary policy strategy.1 Stemming from this, there has been much discussion recently about the ECB’s existing “below but close to 2%” inflation target, and whether this needs to be made more specific, both in aim and measurement.2 Especially as the bank has failed to meet this target since 2013.
The ECB – like many other central banks around the world – has already taken unprecedented steps to try and take control of the situation.3 Last year, the ECB restarted its quantitative easing program, buying €20bn of bonds each month, in order to ensure the cost of borrowing remains low.
But concerns around the impact that these low and negative rates may have are being discussed.4 Rather than jump-starting growth in the region, the economic situation remains stalled. While the ECB’s main refinancing operations rate (0%) and its marginal lending facility rate (0.25%) remain in positive territory, its deposit rate facility rate turned negative in 2014 and hasn’t looked back – it currently sits at -0.5%. And this is putting stress on the region’s financial system.5 6
Couple this with the increasing number of European sovereign bonds which are providing negative yields, the situation for investors and savers is fraught with challenges and risks.
Note: Data as of 14 February 2020. Source: Bloomberg
But with the ECB taking the next 12 months to assess its approach, how can investors manage these risks in the interim?
While gold’s lack of yield – owning to not having credit risk – may deter some, the opportunity cost of holding it is drastically reduced in the current interest rate environment. As we note in our Gold Outlook 2020: “… in an environment where a whopping 90% of developed market sovereign debt is trading with negative real rates, we believe the opportunity cost of gold almost goes away. And it may even provide what can be seen as a positive “cost of carry” relative to bonds.”7
Gold’s performance has also positively correlated to the level of negative yielding debt over the last four years and has shown historical strength when during periods of negative rates.
Weakness in the euro – against the US dollar – as a result of Europe’s ongoing issues has helped boost the euro gold price to record levels over €1,460/oz in recent days. This is almost 30% higher than at the end of 2018.
And we have seen evidence that monetary policy decisions – not just by the ECB – have been a major driver of gold investment in recent years. And his has been most visible in gold-backed ETFs. Inflows into these funds have been totalled almost 1,300t over the last four years, taking global holdings to 2,885.5t at the end of 2019.8 And 57% of these inflows have been into European-listed funds. As we noted in our Fully Year 2019 Gold Demand Trends report: “Four years ago, US-listed funds accounted for almost two-thirds of global holdings (922.8t) and European-listed funds for just over one-third (583.6t). This regional split is now closer to 50:50 after holdings of European-listed funds more than doubled: by the end of 2019, they held 1,322.1t.”9
And we have continued to see inflows into 2020, with a net 61.7t added in January – 33t of which was into European funds – as geopolitical and economic uncertainty persisted. We believe with the ECB likely to maintain low/negative interest rates in the short term, expectations of further cuts from the Fed, and the sluggish growth outlook, gold investment is likely to remain well supported.10
Despite a chorus of calls for further clarity in monetary policy from the ECB – and central banks in general – it seems that little will substantially change until President Lagarde has left no stone unturned.
Gold implied and realized volatility fell sharply in October
Adam Perlaky
Former Senior Analyst, Americas World Gold CouncilGold performance/technicals:
Options and volatility:
Gold-backed ETF flows by time periods:
Liquidity:
Currency crises, over-leverage and low rates – potential drivers of a gold bull market
Dr Lu Zhengwei
Chief Economist of China Industrial Bank, Chief Economist of Huafu Securities and Vice Chairman of China Industrial Bank Research LimitedKey trends to watch as we conclude 2019
Juan Carlos Artigas
Regional CEO (Americas) and Global Head of Research World Gold CouncilAs 2019 comes to an end and 2020 begins, we believe that:
Note: our comprehensive annual Outlook will be published by mid-January 2020.
Stocks outperformed in 2019 but investors remained cautious
The year 2019 proved eventful for investors. Stocks, especially in the US, continued to reach record highs but not without major pullbacks at various times during the year as economic and geopolitical risks compounded. At the same time, many central banks – the highest level since the global financial crisis – started cutting rates, expanding or implementing quantitative (or quasi-quantitative) easing and, in some instances, doing both. After having moved well above US$1,500/oz during the third quarter, the gold price was up by almost 15% as of the end of November, as investors looked to balance higher stock prices with an increasingly uncertain environment.
Investors are adding gold to their portfolios
In 2018 central banks bought the most gold ever recorded and these robust purchases have continued, y-t-d, in 2019. Gold-backed ETF holdings also reached all-time highs by October as investors responded to the high-risk, low rate environment.
High risk and low rates in the horizon
As we look ahead to 2020 we believe investors will face an increasing set of geopolitical concerns, while many pre-existing ones will likely be pushed back rather than being resolved. In addition, the very low level of interest rates worldwide will likely keep stock prices high and valuations at extreme levels. Within this context, we believe there are clear reasons for higher levels of safe-haven assets like gold.
One of the key drivers of gold, especially in the short and medium term, is the opportunity cost of holding gold relative to other assets, such as short-dated bonds. Unlike bonds, gold does not pay interest or dividends because it does not have credit risk. This perceived lack of yield can deter some investors. But in an environment where a quarter of developed market sovereign debt is trading with negative nominal rates and, once adjusted for inflation, a whopping 70% trades with negative real rates, the opportunity cost of gold almost goes away, even providing what can be seen as a positive “cost of carry” relative to sovereign bonds.
Global monetary policy has shifted by 180 degrees. Less than a year ago both Federal Reserve board members and US investors expected interest rates to continue to increase, at the very least through 2019. Instead, after a brief pause, the Fed cut rates three times during 2019 and is expected to cut at least once more in 2020.
Gold has historically performed well in the year following Fed policy shifts from tightening to “on-hold” or “easing” – the environment in which we currently find ourselves. In addition, when real rates have been negative, gold has historically returned twice as much annually as the long-term average, or 15.3%. Even low positive real rates produce higher average returns. Effectively, it has only been in periods with significantly higher real interest rates – an unlikely outcome given the current market conditions – that gold returns have been negative.
This is further supported by the surge in negative real-yielding debt, as evidenced by the strong positive correlation between the amount of debt and price of gold over the past four years. To some degree this illustrates the erosion of confidence in fiat currencies related to monetary intervention.
The low rate environment has also pushed investors to increase the level of risk in their portfolios, either by buying longer term bonds or lower-quality riskier bonds, or simply replacing them with riskier assets like stocks or alternative investments. This environment may make gold more effective than bonds in mitigating stock-market risk, providing portfolio diversification and helping investors achieve their long-term investment objectives.
Soft consumer demand
A by-product of uncertainty in geopolitics – the macro-economy and monetary policy – is likely to be high gold price volatility similar to what the market experienced in the second half of 2018 as investors adjust their expectations and change their positioning, often through levered positions in derivatives markets based on new information.
Higher gold price volatility, combined with expectations of weaker economic growth, may result in softer gold consumer demand near term. But structural economic reforms in India and China will likely support long-term demand.
It’s all connected
Gold demand, supply and, in turn, price performance, respond to four broad sets of drivers:
In this context we believe that although consumer demand may be soft and speculative activity could amplify price movements, overall it is likely that investment demand will remain robust and central banks will continue their net purchasing trend.
Drivers behind the recent gold rally
Adam Perlaky
Former Senior Analyst, Americas World Gold CouncilGold rallied nearly 4% in December, mainly in the second half of the month, and recently moved to an intraday high of US$1,613/oz as the US-Iran confrontation unfolded. We believe there are a few likely reasons for the move:
A technical breakout
The gold price was at a pivotal level in early December, near the top of the 50-day moving average as well as a bullish pennant1 formation (Chart 1). As gold moved above US$1,500/oz and the moving average the breakout was confirmed, suggesting the price would move to the top of the pennant around US$1,575/oz – effectively where it topped out.
Bullish positioning in derivatives markets
Investors were actively buying upside call options in gold during December. In particular, the purchases were significantly out of the money (OTM), as a long volatility position. This type of positioning typically requires dealers who are selling volatility to the investor to hedge their trade by buying gold, potentially pushing the price higher. This bullish positioning was also reflected by the options volatility skew2 that reached an all-time high in Q4 2019 (Chart 2). This positioning often signals that market participants expect a higher likelihood of a price increase.
Light trading volumes
Gold trading volumes moved sharply higher in November, reaching US$170bn a day – well above the 2019 average of US$145bn. However, this reversed significantly in December, falling 26% to US$126bn a day. The lower volume may have reflected fewer willing sellers toward the end of the year, providing support for a larger move to the upside.
Rebalancing ahead of 2020
We saw a pullback in investor demand for gold in November, as demonstrated by outflows in gold-backed ETFs and a reduction in COMEX net longs. This reversed in December, with net longs moving back near all-time highs and gold-backed ETF holdings reaching all-time highs (Chart 3).
Anecdotal evidence suggests that investors may be inclined to maintain exposure to risk-on assets such as stocks, but not without hedging their portfolios in preparation for potential pullbacks – especially given the high level of geopolitical and geo-economic risks that have been carried over from 2019. And data suggests that gold may be a recipient of some of this activity.
Fed repo activity
The Fed began reducing their balance sheet in 2018, but reversed this decision in the second half of 2019 (Chart 4). In particular, they began regular repurchase (repo) market injections totaling nearly US$500bn in the fourth quarter. This activity has continued into 2020 and has been described by some market participants simply as another form of quantitative easing (QE) – often dubbed “QE light” – and causing some investors to worry about liquidity in the Treasury market as a whole. And, historically, expansions of QE have led to increases in the gold price.
Increased geopolitical risk
Tensions in the Middle East, driven by the US-Iran confrontation, supported safe-haven flows, pushing the gold price to a six-year high. While a more conciliatory tone by President Trump has recently eased concerns and pushed the price down to the US$1,550/oz level, gold remains up by approx. 2.4% as of 9 January 2020.
Footnotes
1 Pennants are continuation patterns where a period of consolidation is followed by a breakout: https://www.investopedia.com/terms/p/pennant.asp.
2 The skew, computed as the difference in premia paid between puts and calls at equivalent strikes, implies that market participants were willing to pay a significant premium for upside versus downside exposure.
Recent gold and oil movements highlight inconsistent long-term correlation
Adam Perlaky
Former Senior Analyst, Americas World Gold CouncilLast week, in a “flight-to-safety” move following the bombings of US bases in Iraq, gold and oil both rallied sharply in after-hours trading, However, on the heels of the announcement that Iran was “standing down,” oil finished the week dipping 6%, while gold was up nearly 1% in US dollars. And while gold is one of the strongest performing asset classes this year, oil is one of the weakest.
What is driving this divergence?
Gold stands apart from the broader commodities complex because of its unique market dynamics and performance drivers.
Specifically, gold has historically benefited from six key differentiators:
1. better long-term, risk-adjusted returns than other commodities and broad-based commodity indices
2. more effective diversification than other commodities, particularly in market downturns
3. better performance than other commodities in low inflation periods
4. lower volatility than most single commodities and similar volatility to broad-based commodity indices
5. proven store of value as commodity values fell sharply against gold following the end of the gold standard
6. high liquidity
Ultimately, while commodities can be a relevant tactical asset, a strategic gold allocation of 2%-10% can supplement or replace a broad-based commodities investment alone and may offer more widespread benefits and better risk-adjusted returns
Watch this video to learn more about why gold is the most effective commodity investment.
The Art of the Trade Deal
Alistair Hewitt
Former Head of Market Intelligence World Gold Council“It just doesn’t get any bigger than this”. At least that is how President Trump is portraying the signing of the “Phase One” deal with China last week. But while talks between the two nations are undoubtedly positive for global trade, do they really make a substantive change in circumstances? Equity markets don’t seem to think so – they were only fractionally higher in response to the news.1 By contrast, gold initially fell by 0.27% before slowly reclaiming some of that marginal decline.
This modest reaction is in line with what is a modest step. The “Phase One” deal seems to omit many of the key issues which lie at that heart of US-China tensions. For example, the US will maintain tariffs on around two-thirds of Chinese imports as talks continue on the next phase of a deal. Plenty of questions remain on how some of the thornier issues will be addressed in any further talks. Scepticism remains high.
As a result, uncertainty and volatility will likely remain elevated, something we discussed in our outlook for 2020. While investors have been accustomed to such conditions in recent years, complacency has not set in. Last year, in search of an effective diversifier to protect against such risks, institutional investors and central banks flocked to gold. ETF demand hit 400t in 2019, while central bank demand approached 600t at the end of November. And at the start of this year, the gold price has already gained 2%, building on the 18% rally in 2018 which saw the price reach its highest level since 2013.
So, while the US and China have taken their first step towards trade negotiations, optimism seems fragile as many questions remain unanswered. This should, for now, be supportive for gold, as investors continue to look for effective diversifiers in the face of persistent uncertainly and volatility.
Footnotes
1 Although some of this more muted reaction could be the fact this deal was expected by the market.
Potential impact of the coronavirus on gold
Juan Carlos Artigas
Regional CEO (Americas) and Global Head of Research World Gold CouncilIt’s been less than two months since the 2019 novel coronavirus (COVID19) was first reported in China, and a recurring question we hear from investors is: ‘How might gold react to an epidemic like this?’
What we know from SARS
The 2003 SARS epidemic started in late 2002 in southern China but developed primarily between late March and early July 2003.1 While COVID19 is already evolving differently from the SARS epidemic, it provides the most applicable – even if imperfect – comparison available to understand how COVID19 may affect the gold market. With the qualification, of course, that both the Chinese economy and the gold market were much smaller and looked very different in 2003 than they do today, as we discuss below.
Chinese jewellery demand
Chinese jewellery demand is quite seasonal (Chart 1): the first and fourth quarters are traditionally strong while the second quarter is generally weak.2 However, even after adjusting for this seasonal pattern, Chinese jewellery consumption contracted more than expected during the 2003 epidemic – roughly by an additional 10% to 15%.3 In the main, this effect was transient as gold demand rebounded fairly quickly and, by the second half of the year, was back in line with seasonal averages.
Gold price performance
Our analysis shows that the impact on Chinese demand during SARS was fairly evident. However, its impact on price was not. The gold price increased by approximately 3% during Q2 2003 with an intra-quarter maximum of 16% (Chart 2). But it’s not easy to assess the contribution of SARS, if any, to gold’s performance, as the 2003 epidemic coincided with the start of the US invasion of Iraq and a period during which the US dollar generally weakened.
The evolution of China since SARS
While the comparison to SARS may provide some guidance, important changes have been experienced in China and the Chinese gold market since the 2003 outbreak.
The Chinese economy in 2003 represented US$1.7trn compared to an estimated US$14.3trn in 2019.4 On a relative basis, China has become a more important component of the global economy, contributing close to 15% of world GDP today, relative to 3% back in 2003. In addition, the structure of Chinese GDP has markedly changed from being mostly investment driven to mostly consumption led (Chart 3).
The Chinese gold market has also changed a lot. Chinese consumer demand accounted for 8% of the world’s total in 2003. Today, China is the largest gold market, contributing 30% of consumer demand in 2019. The sources of demand have also changed: investment was virtually nonexistent before the establishment of the Shanghai Gold Exchange (SGE) in 2002 and the legalisation of private gold investment in 2004 (Chart 4).
These changes to the size and makeup of the Chinese economy and the gold market have relevant implications on the likely effect of COVID19.
For example, the fact that Chinese GDP includes a higher contribution from consumption means that GDP may suffer more than it did in 2003 given the reduced economic activity it has already experienced so far this year. At the same time, the impact of softer Chinese growth will affect the global economy and increase investor uncertainty, which may support flight-to-quality flows into gold – in China and abroad. Some of this effect is already visible by the increase in trading volumes at the Shanghai Gold Exchange following the Chinese New Year, as well as by continued inflows into gold-backed ETF over the same period. On the other hand, however, the drag from a potential deceleration of Chinese gold consumer demand may have a more noticeable effect on price than it did in 2003.
Conclusion
The coronavirus outbreak in China is evolving rapidly. While expanded diagnostics have increased the number of reported cases, there are indications that the spread of disease is starting to decelerate, especially outside of Hubei Province, where the virus first struck. How it plays out is yet to be determined but, in our view, it is all but certain that China’s consumer demand will ease. Q1 demand may contract by at least 10-15% if history serves as a guide. Whether demand rebounds or continues to soften will depend on the duration of the epidemic and its impact on economic growth.
The impact on gold’s price performance is less clear:
Footnotes
1 Center for Disease Control: https://www.cdc.gov/about/history/sars/timeline.htm
2 All outliers – marked with asterisks (“*”) – on Chart 1 correspond to 2013 demand when the gold price dropped substantially and demand did not follow historical seasonal patterns.
3 While we are not including bar and coin demand in the analysis below because the market was too small at the time, the limited data available still suggests a similar behaviour.
4 National Bureau of Statistics of China.
ECB review signals little change in short-term
Krishan Gopaul
Senior Analyst, EMEA World Gold CouncilAt the end of January, the new head of the European Central Bank (ECB), Christine Lagarde, announced the launch of a year-long strategic review of the bank’s monetary policy strategy.1 Stemming from this, there has been much discussion recently about the ECB’s existing “below but close to 2%” inflation target, and whether this needs to be made more specific, both in aim and measurement.2 Especially as the bank has failed to meet this target since 2013.
The ECB – like many other central banks around the world – has already taken unprecedented steps to try and take control of the situation.3 Last year, the ECB restarted its quantitative easing program, buying €20bn of bonds each month, in order to ensure the cost of borrowing remains low.
But concerns around the impact that these low and negative rates may have are being discussed.4 Rather than jump-starting growth in the region, the economic situation remains stalled. While the ECB’s main refinancing operations rate (0%) and its marginal lending facility rate (0.25%) remain in positive territory, its deposit rate facility rate turned negative in 2014 and hasn’t looked back – it currently sits at -0.5%. And this is putting stress on the region’s financial system.5 6
Couple this with the increasing number of European sovereign bonds which are providing negative yields, the situation for investors and savers is fraught with challenges and risks.
Note: Data as of 14 February 2020. Source: Bloomberg
But with the ECB taking the next 12 months to assess its approach, how can investors manage these risks in the interim?
While gold’s lack of yield – owning to not having credit risk – may deter some, the opportunity cost of holding it is drastically reduced in the current interest rate environment. As we note in our Gold Outlook 2020: “… in an environment where a whopping 90% of developed market sovereign debt is trading with negative real rates, we believe the opportunity cost of gold almost goes away. And it may even provide what can be seen as a positive “cost of carry” relative to bonds.”7
Gold’s performance has also positively correlated to the level of negative yielding debt over the last four years and has shown historical strength when during periods of negative rates.
Weakness in the euro – against the US dollar – as a result of Europe’s ongoing issues has helped boost the euro gold price to record levels over €1,460/oz in recent days. This is almost 30% higher than at the end of 2018.
And we have seen evidence that monetary policy decisions – not just by the ECB – have been a major driver of gold investment in recent years. And his has been most visible in gold-backed ETFs. Inflows into these funds have been totalled almost 1,300t over the last four years, taking global holdings to 2,885.5t at the end of 2019.8 And 57% of these inflows have been into European-listed funds. As we noted in our Fully Year 2019 Gold Demand Trends report: “Four years ago, US-listed funds accounted for almost two-thirds of global holdings (922.8t) and European-listed funds for just over one-third (583.6t). This regional split is now closer to 50:50 after holdings of European-listed funds more than doubled: by the end of 2019, they held 1,322.1t.”9
And we have continued to see inflows into 2020, with a net 61.7t added in January – 33t of which was into European funds – as geopolitical and economic uncertainty persisted. We believe with the ECB likely to maintain low/negative interest rates in the short term, expectations of further cuts from the Fed, and the sluggish growth outlook, gold investment is likely to remain well supported.10
Despite a chorus of calls for further clarity in monetary policy from the ECB – and central banks in general – it seems that little will substantially change until President Lagarde has left no stone unturned.
Footnotes
1 www.reuters.com/article/us-ecb-policy/ecbs-lagarde-launches-policy-overhaul-that-will-leave-no-stone-unturned-idUSKBN1ZL32Y
2 www.bloomberg.com/opinion/articles/2020-02-05/why-your-housing-costs-matter-to-christine-lagarde-and-the-ecb
3 www.gold.org/goldhub/gold-focus/2019/10/gold-thriving-lower-interest-rates
4 www.ft.com/content/7efcedb4-ea25-11e9-85f4-d00e5018f061
5 www.bloomberg.com/news/articles/2020-01-31/german-banks-are-hoarding-so-many-euros-they-need-more-vaults
6 www.bloomberg.com/opinion/articles/2019-12-17/negative-interest-rates-are-destroying-our-pensions
7 www.gold.org/goldhub/research/outlook-2020
8 www.gold.org/goldhub/data/global-gold-backed-etf-holdings-and-flows
9 www.gold.org/goldhub/research/gold-demand-trends/gold-demand-trends-full-year-2019/investment
10 www.axios.com/market-fed-rate-cuts-2020-f347ea30-4ca1-4e65-9414-f14c54eac728.html