As detailed in one of our recent blogs, movements in interest rates have long been a key driver of gold’s performance, particularly in the short and medium term, as they represent, in part, the opportunity cost of holding gold.
As relevant as they are, however, opportunity costs are generally just one of the four key drivers of gold. Yet, our analysis indicates that over the past year, gold’s sensitivity to interest rates, accounting for other factors, has risen more than four-fold. This period began with unprecedented central bank activity in financial markets, which initially sent bond yields sharply lower worldwide in early 2020. In fact, the extent of monetary expansion during the second quarter of last year stands out even in comparison to the first wave of quantitative easing enacted in response to the Global Financial Crisis in 2008 (Chart 1). As a result, our short-term gold performance model1 showed that interest rates alone explained more than 40% of gold’s price rally to above US$2,000/oz last year.2
Chart 1: Federal Reserve’s balance sheet ballooned in 2020
Y-o-y change in Federal Reserve assets (2006–2020)*
*As of 31 December 2020. Based on US M2 Money Supply and Federal Reserve Zero Maturity Money Supply.
Source: Bloomberg
Given the extreme movement in interest rates led by rampant stimulus in 2020, it was only a matter of time before yields swung back up as investors’ inflation expectations rose. This anticipation of economic recovery coupled with the re-emergence of higher inflation, or ‘reflation’, has pushed up resource commodity prices including oil, while gold performance has lagged. At the same time, gold remains highly sensitive to interest rates, and the degree of its responsiveness to a move in rates has only grown. So far, close to 60% of the decline in gold prices year-to-date can be attributed to interest rates, a contribution more than twice that of any other variable we use to explain gold performance (Chart 2). This comes as 10-year US Treasury yields increased by 50bps over the past two months.3
Chart 2: Interest rates account for almost 60% of gold performance y-t-d
To examine gold’s recent increased sensitivity to interest rates, we compared the past year to its relationship with interest rate yields over longer time horizons that incorporated different macroeconomic environments. Currently, our model estimates that gold exhibits an approximate -10% sensitivity to rates, based on its behaviour over the previous 52 weeks ending February 2021. In other words, the portion of gold’s price that is explained by interest rates would decline by 10% for every 1% increase in interest rates, measured by the change in US 10-year yields. Therefore, US 10-year yields moving 50bps higher in the last two months would amount to an approximate 5% decline in the gold price. This accounts for the majority of gold’s 9% decline year-to-date.4 As detailed earlier, over the past year gold’s sensitivity to rates is more than four times greater compared to the full period of the model beginning in 2007, where its sensitivity was closer to just -2.5%.
Looking forward, it is important to note that the heightened sensitivity of gold to interest rates is not just a phenomenon of the past year during skyrocketing stimulus and bond purchases from the Federal Reserve, among other central banks. Gold exhibited a sensitivity of c.-11% based on its behaviour over the previous 104 weeks dating back to early 2019, which indicates that this is likely to be a significant performance driver in at least the medium term as well. In general, gold’s sensitivity to rates increases when the market is paying more attention to what the Fed is doing; whereas, when the market anticipates little change to monetary policy (e.g., when the Fed has signalled continued tightening and the market believes it), other factors become more important.5 In the current environment therefore, while an increase in interest rates may pose headwinds for gold, an increase in inflation expectations may offset some of this impact.
We recently hosted a conversation with Institutional Investor and Ned Naylor-Leyland, Jupiter Asset Management’s Head of Gold and Silver, to discuss gold performance in the current rate environment and the broader outlook for 2021.
The Executive Programme in Gold Reserves Management is the World Gold Council’s flagship training programme for central banks. Traditionally, the programme is a 2-3 day on-site event featuring academics, industry experts, and central bankers sharing their expertise on gold. The global pandemic forced us to postpone the 2020 programme to this year.
We are pleased to announce that the Executive Programme will return on 6 October 2021 in a virtual format. The event is offered in conjunction with the University of Cambridge Judge Business School and is limited to central banks and official institutions only.
In anticipation of the virtual event, we are launching a series of videos which review some of the core components of the Executive Programme. The first video, which reviews the central bank case for gold, is available below. Other videos will be launched on a monthly basis, covering topics including drivers of gold, gold reserve operations, the changing international monetary system, and accounting for monetary gold.
All of the Executive Programme videos will be hosted on a learning portal that is available here: Executive Programme portal
Please keep an eye out for a new video each month.
The Australian central bank aims to keep rates low
Like many other regions, the Australian central bank lowered its policy rate last year to battle the COVID-19 economic fallout. After rate cuts in both March and November 2020, Australia’s benchmark interest rate reached a record low of 0.1%. In its latest monetary policy decision statement on 2 March 2021, the Reserve Bank of Australia (RBA) reiterated its accommodative monetary policy stance and reaffirmed its intention to maintain the current policy rate until inflation reaches its target – something not likely to happen until 2024 by the bank’s own assessment.1 Meanwhile, the RBA also vowed to keep its three-year treasury yield under its pre-set target of 0.1% to keep the economy’s borrowing cost low.2
The RBA’s aim of maintaining Australian treasury yields within target is clear. In February, US treasury yields climbed rapidly amid global economic recovery and rising inflation expectations. Similar movements in treasury yields were seen in other markets, including Australia. In response, the RBA increased its bond-purchasing efforts. And it was reported that the Australian central bank also lifted the cost to short government bonds.
The RBA has been increasing its bond-purchasing efforts*
Weekly bond purchase under RBA's QE program (green) and additional purchase (red) to strengthen its three-year yield control
Furthermore, Philip Lowe, the Governor of the RBA, stated in his recent speech that:
The RBA will continue to keep the economy’s financing costs very low for as long as necessary
While the current market expectations imply an early increase in the target rate, the RBA holds the belief that the economic conditions will not be able to meet its rate-hiking criteria until 2024
The RBA will consider extending its bond purchase program further and will act to keep treasury yields low.
So far, the RBA’s yield curve control efforts seem to have been successful. The 10-year Australian treasury yield has dropped by more than 26 basis points since February, and the three-year Australian treasury yield moved below the RBA’s target of 0.1% in March for the first time this year.3
Australian treasury yields saw declines after their surge in February*
Source: Bloomberg, Reserve Bank of Australia, World Gold Council
*Based on daily yield movements between 3/24/2020 and 3/24/2021
The low-return environment for Australian super funds
Lower interest rates in Australia have created challenges for asset managers. To combat economic slowdown and declining inflation, the RBA made 15 rate cuts between 2011 and 2020, bringing its interest rate to the lowest ever. And this low-rate environment has been weighing on the region’s treasury yields and local super fund – which, on average, allocates 31% of its assets to fixed-income and cash equivalent products – returns.4
Super funds' average returns have been dropping in tandem with the policy rate*
Average annual returns of 150+ Australian super funds (bar) and the RBA's cash rate target (line)
Source: Australian Prudential Regulation Authority, Reserve Bank of Australia, World Gold Council
*Note: the average returns of super funds refer to the annual average actual returns of over 150 Australian super funds tracked by the Australian Prudential Regulation Authority.
Gold: a return-generating asset in low-rate environments
Historical data shows that gold has offered attractive returns during Australia’s monetary-easing and post-easing cycles. In four rate-cutting cycles since 1990, gold in Australian dollars averaged an annualised return of 2.6%, outperforming other major assets.
Gold in Australian dollars performed well during easing cycles*
Source: Bloomberg, World Gold Council
* All returns are compound annualised growth rates based on daily data in AUD of the LBMA Gold Price AM, S&P/ASX 200 Total Return Index and Bloomberg Composite AusBond 0yrs+ Index.
** “Start” means the first rate cut following a rate hike and “end” means the last cut in the rate cutting cycle before the next rate hike.
Our analysis also shows that an average Australian super fund portfolio’s risk-adjusted return could benefit from allocating a portion of its assets to gold during these cycles. For instance, by allocating 2%~16% of its assets to gold, an average Australian super fund would have enjoyed higher risk-adjusted returns during the latest easing cycle between November 2011 and November 2020.
An average Australian super fund portfolio could benefit from allocations to gold*
Risk-adjusted returns of an average super fund portfolio with different allocation to gold
Source: Australian Prudential Regulation Authority, Bloomberg, World Gold Council
* Based on monthly total returns from 30 November 2011 to 30 November 2020. The hypothetical average Australian superannuation fund portfolio is based on the average Australian super funds’ asset allocation in 2020 according to the Australian Prudential Regulation Authority’s superannuation asset allocation update. It includes annually rebalanced total returns in AUD of a 50% allocation to equities (21% S&P/ASX 200 Total Return, 25% MSCI World ex Australia Net Total Return and 4% Australia Public Unit Trust Unlisted Equity Trusts), 21% allocation to fixed income (12% Bloomberg AusBond 1+ Year Index and 9% Bloomberg Barclays Global Aggregate ex Australia Total Return Index), 12% allocation to cash products (Bloomberg AusBond Bank Bill Index) and 17% to alternative assets (8% S&P/ASX 200 A-REIT, 6% MSCI Australia Infrastructure Net Total Return Index and 3% Eurekahedge Australia New Zealand Hedge Fund Index).
Gold also performed well during post-easing cycles in Australia. On average, gold in AUD has provided an average annualised return of 11% during the RBA’s post-easing cycles between 1990 and present, higher than stocks and bonds.
Gold can also generate sizable returns during post-easing cycles*
Source: Bloomberg, World Gold Council
* All returns are compound annualised growth rates based on daily data in AUD of the LBMA Gold Price AM, S&P/ASX 200 Total Return Index and Bloomberg Composite AusBond 0yrs+ Index.
** “Start” means the last rate cut in the last easing cycle and “end” means the first rate hike in the next tightening cycle .
Gold’s relevance as a strategic asset in Australia
Gold’s ability to generate returns during the monetary-easing and post-easing cycles in Australia stand on two legs. First, as we highlighted in The relevance of gold as a strategic asset in Australia, opportunity cost constitutes one of the four key drivers for gold’s local performance. With yields on assets such as Australian treasury notes declining drastically over the past decade, the opportunity cost of holding gold in Australia fell to almost zero, supporting gold’s performance in Australian dollars.
Second, gold has a global and diversified market. While Australia is one of the largest gold producers in the world, between 2010 and 2019 its mined gold production accounted for less than 9% of the global total on average. In fact, gold is produced on almost every continent and such geographical dispersion has brought stability to the gold market.
Gold’s demand is also diversified. It is purchased by consumers, investors and various industries as accessories, a safe-haven asset and a technology component. In 2020, when consumer demand for gold was hampered by the global economic fallout from COVID-19, investment demand for gold – including sales of gold bars and coins as well as gold ETF inflows – surged, limiting the volatility in global gold demand and underpinning gold’s stable performance in all regions.
Gold’s global and diversified supply and demand dynamics resulted in its low dependence on changes in the Australian economy. In Australian dollars, gold has offered an average compound annualised return of 6.5% during the region’s economic contractions.
Gold has performed well during Australian economic contractions*
Compound annualised returns of assets during economic contractions in Australia since 2000**
Source: Bloomberg, Melbourne Institute, World Gold Council
*Compound annualised growth returns based on daily data in Australian dollars of the LBMA Gold Price AM, S&P/ASX 200 Index and Bloomberg AusBond 0yrs+ Composite Index.
** Dates: 6/2000-11/2001, 11/2002-6/2003, 5/2007-5/2009, 1/2011-8/2012, 8/2013-3/2016, 1/2017-6/2017, 12/2019-12/2020 Economic contractions as defined by the Melbourne Institute, for more detailed information, please visit Phases of business cycles in Australia: Melbourne Institute.
Conclusion
Globally, central banks have responded to the turbulence in bond markets. The US, Europe, Japan and India have kept borrowing costs low to accommodate economic recoveries, while the RBA increased its efforts to cap treasury yields. Reportedly, the RBA is not expecting its current policy rate and three-year treasury yield target of 0.1% to change until 2024. And as mentioned in our 2021 Gold Outlook, while this global low-rate environment could prevail, other risks such as ballooning budget deficits, inflationary pressures and potential market corrections amid lofty valuation might also negatively impact investors’ portfolio returns.
Against this backdrop gold may offer investors a source of returns and effective diversification. As previously mentioned, in historical periods of economic contraction and low rates gold has generated relatively attractive returns compared to stocks and bonds, and improved risk-adjusted returns for Australian investors.
2 Introduced in March 2020 to lower the economy’s borrowing cost, an initial 3-year treasury yield target of 0.25% was set by the RBA. It was reduced to 0.1% in November 2020 alongside the policy rate cut.
3 10-year Australian Treasury yield’s change based on the difference between 26 February 2021- the last trading day of February – and 24 March 2021.
Is the current commodity rally just another reflationary episode or something more pervasive?
Recent market moves in commodities rank in the top 5% of six-month moves since 1971
Gold's weak performance so far is consistent with previous reflationary episodes – its time to shine may yet come.
A commodity rally began in Q2 of 2020, sharply on the heels of the COVID-19-driven broad market sell-off. It started with metals, followed by energy, and, by the summer, agricultural commodities had joined in. Investors have waited more than a decade for this type of commodities rally but perhaps their patience is about to be rewarded. The recent market moves – between August 2020 and February 2021 – now rank in the top 5% of six-month moves since 1971 and, with a 30-year low as a base, this suggests they could have further to go (Charts 1 and 2).
Chart 1. A long wait for a strong run from a low base
S&P GSCI Commodity Total Return Index from January 1971 to February 2021*
*The grey shaded areas denote six-month returns that are in the top 5% of all six-month returns.
Source: Bloomberg, World Gold Council
Chart 2. As commodities reflate, gold is left behind
S&P GSCI Commodity Total Return Index, GSCI Commodity sectors and spot US$ gold from August 2020 to February 2021*
*All series are GSCI Total Return series except for spot US$ gold.
Source: Bloomberg, World Gold Council
In an environment where many assets appear expensive, commodities stand out as an enticing prospect for return-hungry investors. However, if this run is likely to continue and simultaneously perhaps stoke inflation in the process, why is gold yet to shine?
Firstly, it is important to reiterate that while gold shares characteristics with other commodities and is represented in the large commodity indices, it is a financial asset first and foremost. Its behaviour is different, often countercyclical when commodities are procyclical, and with diversified sources of supply and demand. As such it is not subject to disruptions in any one sector.
Secondly, if the recent commodities run is a reflation story, some precedents are worth exploring to help investors navigate current market dynamics.
‘Reflation’ is loosely characterised as an environment of resurgent economic growth twinned with rising inflation and interest rates. Defining ‘reflation’ as the period after a recession,1 Chart 3 shows how gold and commodities have fared, on average, up to three years before and after the start of the reflation period since 1991. Chart 4 expands the period of analysis by including both the 1980 and 1982 recessions, although we lose the impact on energy commodities as total return series are unavailable for that period. The key dots to focus on are the first and last large dots for each series, representing average six-month and three-year returns after the start of a period of reflation, respectively.
Chart 3. Commodities have started reflationary periods with a bang, but gold has caught up
S&P GSCI Commodity Total Return Indices and spot US$ gold performance before and after US recessions*
*Each dot in the chart represents the annualised return for a series. The large dots show performance after the reflation period began and the small dots show the performance prior. Each dot also shows the high and low ranges of returns. All series are GSCI Total Return series except for spot US$ gold. The period analysed is March 1988 to February 2020.
Source: Bloomberg, World Gold Council
Chart 4. Adding the 1980 and 1982 reflationary periods tells a similar story but at lower absolute levels
S&P GSCI Commodity Total Return Indices and spot US$ gold performance before and after US recessions*
*Each dot in the chart represents the annualised return for a series. The large dots show performance after the reflation period began and the small dots show the performance prior. Each dot also shows the high and low ranges of returns. All series are GSCI Total Return series except for spot US$ gold. The period analysed is November 1979 to February 2020.
Source: Bloomberg, World Gold Council
Gold’s current underperformance between August 2020 and February 2021 is consistent with its average performance during previous reflationary episodes. Similarly, the current outperformance observed in major commodity groups is in line with their historical performance. Interestingly, gold fared well, both relatively and absolutely, in the months leading up to a period of reflation. Conversely, the opposite is true of the rest of the commodity complex, with energy posting the worst average performance over the preceding six months.
So, this initial ‘rotation’ from the safety of gold to the return potential from commodities makes sense in this most recent period. Also, let’s not forget that gold hit an all-time high of US$2,067.15 in August 2020,2 which may have compelled some investors to take profit.
Another plausible reason for gold’s relative underperformance has been the initial pick-up in both interest rates and equity returns, which both increase the opportunity cost of holding gold. Charts 5 and 6 show that gold didn’t fare as well in reflationary environments where real interest rates rose.3 From July 1980, real rates rose almost 12%, three years into the reflationary episode. It was undoubtedly a major factor in driving gold prices down: they ended the three-year period down an annualised 12%. This also followed through into the 1982 reflation period.
Chart 5. A major headwind for gold prices in the early 1980s was the significant rise in real yields…
Relative change in real yields before and during reflation periods*
*Chart shows the performance of ‘realised’ real yields (US 10-year Treasury yield less US headline CPI) three years before and three years into a reflation period. 0 is the end of an NBER recession. The period analysed is November 1979 to February 2020.
Source: Bloomberg, World Gold Council
Chart 6. ...a factor in gold’s weak performance during those reflationary periods in absolute terms
Relative change in real yields before and during reflation periods*
* Chart shows the performance of spot gold in US$/oz, three years before and three years into a reflation period. 0 is the end of an NBER recession. The period analysed is November 1979 to February 2020.
Source: Bloomberg, World Gold Council
Despite initial headwinds, gold has on average caught up to most major commodity groups by the second and third years from the start of a reflationary period since 1991. It has also caught up to metals and agricultural commodities since 1980. And while the absolute level of returns vary, gold has done well against commodities on a relative basis.
In our view, the analysis using data since 1991 may be more indicative of the current environment since central banks’ commitment to accommodative policy should prevent real rates from rising in a similar fashion to the early 1980s.4
The 2009 period of reflation saw the best absolute and relative performance for gold. Its high returns likely reflected lingering concerns about the health of the global economy and concerns about inflation driven by quantitative easing, among other things. On top of this, higher growth amidst ongoing uncertainty meant that both investors and consumers were supporting price rises. If economies recover this year and next from the COVID-19-related slowdown, it is conceivable that we could see a similar pattern emerge: growth supporting the consumer and high global debt, continued liquidity stimulus and record high valuations in equity and bond markets keeping investors on board.
Footnotes
1Using National Bureau of Economic Research (NBER) recession index (RINDEX Index) via Bloomberg to determine analysis starting points. In our analysis a reflation begins during the last month of the NBER recession.
2Based on the all-time high reached by the LBMA Gold Price PM USD during 6 August 2020.
3Real interest rates defined as US 10-year Treasury yield less US headline Consumer Price Index (CPI) inflation.
In the inaugural segment of our new Strategic Edge video series, our Chief Market Strategist, John Reade, talks to George Cheveley, Global Gold Strategist at Ninety One, about the state of the gold market.
A recent NY Times article closed with this quote from Morgan Stanley Private Wealth Management senior VP Katerina Simonetti: “There is a psychological component in owning gold that goes back for centuries…It’s an asset that gives peace of mind to investors. It just makes investors feel safe and secure.”
Global retail investors view gold as long-term security that helps protect against inflation
% of those surveyed that agreed with each statement
As of August 2019. Results from a quantitative survey carried out by Hall & Partners of 12,371 men and women across six countries: India, China, Germany, the US, Canada and Russia. The online survey captured the responses of active retail investors – classified as people who had made at least one investment in the past 12 months, excluding those who had only added money to a savings account and had only ever invested in a defined list of non-core investment products. Fieldwork took place in Q2 and Q3 2019.
Results are responses to the question ‘Please indicate how strongly you agree or disagree with each of the statements below.’ Respondents selected from the following five-point scale: strongly agree; somewhat agree; neither agree or disagree; somewhat disagree; strongly disagree.
Base: total sample (12,371)
Source: Hall & Partners, World Gold Council
Which helps explain recent rocketing demand for gold coins in the US. As we report in our recent Gold Market commentary, Q1 sales of gold Eagle coins, at more than 400,000 oz (12.5t, US$720mn), were the third highest on record for the first quarter. And the Perth Mint report similarly impressive sales so far this year, with a record 330,000 oz of gold sold in the first quarter – with manufacturing pivoting towards ‘products that are hot in the US right now’ according to General Manager Minted Products, Neil Vance.
While rising interest rates have dominated gold’s performance so far this year, the inflationary expectations that have fuelled those rate rises may be behind much of the strength in physical demand. Our consumer research data confirms that gold’s role in a portfolio is primarily viewed as being for wealth protection or to provide above-inflation returns.
Global retail investors see gold’s main role as wealth protection and providing real returns
Notes as per previous chart.
Results are individual responses to the question ‘How would you describe the main role of this investment?’ Respondents selected one option for each investment product that they owned (including for each different type of gold product).
Base sample: number of responses (7,540)
Source: Hall & Partners, World Gold Council
And this is far from being a US-specific phenomenon: 85% of retail investors across six global markets identified these as being gold’s main role. Building inflationary pressures may also continue to fan the flames of robust physical demand noted in China and India throughout January and February. Keep an eye out for our forthcoming issue of Gold Demand Trends, which will give detailed coverage of the size and scale of gold demand – and supply – in Q1 2021.
In the latest video from our Strategic Edge series, James Steel, Chief Precious Metals Analyst at HSBC Bank, joined our Global Head of Research, Juan Carlos Artigas to discuss market dynamics impacting gold performance.
Watch now!
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Short-term gold model: interest rates ignite prices in 2021
Bharat Iyer
Former Research Associate World Gold CouncilAs detailed in one of our recent blogs, movements in interest rates have long been a key driver of gold’s performance, particularly in the short and medium term, as they represent, in part, the opportunity cost of holding gold.
As relevant as they are, however, opportunity costs are generally just one of the four key drivers of gold. Yet, our analysis indicates that over the past year, gold’s sensitivity to interest rates, accounting for other factors, has risen more than four-fold. This period began with unprecedented central bank activity in financial markets, which initially sent bond yields sharply lower worldwide in early 2020. In fact, the extent of monetary expansion during the second quarter of last year stands out even in comparison to the first wave of quantitative easing enacted in response to the Global Financial Crisis in 2008 (Chart 1). As a result, our short-term gold performance model1 showed that interest rates alone explained more than 40% of gold’s price rally to above US$2,000/oz last year.2
Chart 1: Federal Reserve’s balance sheet ballooned in 2020
Y-o-y change in Federal Reserve assets (2006–2020)*
*As of 31 December 2020. Based on US M2 Money Supply and Federal Reserve Zero Maturity Money Supply.
Source: Bloomberg
Given the extreme movement in interest rates led by rampant stimulus in 2020, it was only a matter of time before yields swung back up as investors’ inflation expectations rose. This anticipation of economic recovery coupled with the re-emergence of higher inflation, or ‘reflation’, has pushed up resource commodity prices including oil, while gold performance has lagged. At the same time, gold remains highly sensitive to interest rates, and the degree of its responsiveness to a move in rates has only grown. So far, close to 60% of the decline in gold prices year-to-date can be attributed to interest rates, a contribution more than twice that of any other variable we use to explain gold performance (Chart 2). This comes as 10-year US Treasury yields increased by 50bps over the past two months.3
Chart 2: Interest rates account for almost 60% of gold performance y-t-d
2021 y-t-d gold performance attribution*
*As of 28 February 2021. Calculated using weekly inputs for all variables from 28 February 2020 to 28 February 2021. For more information, see Short-Term Gold Price Drivers | What Affects Gold Prices | Goldhub.
Source: Bloomberg, World Gold Council
To examine gold’s recent increased sensitivity to interest rates, we compared the past year to its relationship with interest rate yields over longer time horizons that incorporated different macroeconomic environments. Currently, our model estimates that gold exhibits an approximate -10% sensitivity to rates, based on its behaviour over the previous 52 weeks ending February 2021. In other words, the portion of gold’s price that is explained by interest rates would decline by 10% for every 1% increase in interest rates, measured by the change in US 10-year yields. Therefore, US 10-year yields moving 50bps higher in the last two months would amount to an approximate 5% decline in the gold price. This accounts for the majority of gold’s 9% decline year-to-date.4 As detailed earlier, over the past year gold’s sensitivity to rates is more than four times greater compared to the full period of the model beginning in 2007, where its sensitivity was closer to just -2.5%.
Looking forward, it is important to note that the heightened sensitivity of gold to interest rates is not just a phenomenon of the past year during skyrocketing stimulus and bond purchases from the Federal Reserve, among other central banks. Gold exhibited a sensitivity of c.-11% based on its behaviour over the previous 104 weeks dating back to early 2019, which indicates that this is likely to be a significant performance driver in at least the medium term as well. In general, gold’s sensitivity to rates increases when the market is paying more attention to what the Fed is doing; whereas, when the market anticipates little change to monetary policy (e.g., when the Fed has signalled continued tightening and the market believes it), other factors become more important.5 In the current environment therefore, while an increase in interest rates may pose headwinds for gold, an increase in inflation expectations may offset some of this impact.
Footnotes
1 Based on weekly inputs to World Gold Council’s Short-term gold price drivers model. For more information please see Short-Term Gold Price Drivers | What Affects Gold Prices | Goldhub.
2 LBMA Gold Price PM reached a high of US$2,067/oz on 6 August 2020.
3 As of 28 February 2021. Based on Bloomberg’s US Government Generic 10-year Yield Index.
4 Based on the LBMA Gold Price PM as of 28 February 2021.
5 See Investment Update: Gold tracks the dollar as rates take a back seat | World Gold Council.
Webinar: Hedging risk while driving returns in a low rate environment
Juan Carlos Artigas
Regional CEO (Americas) and Global Head of Research World Gold CouncilWe recently hosted a conversation with Institutional Investor and Ned Naylor-Leyland, Jupiter Asset Management’s Head of Gold and Silver, to discuss gold performance in the current rate environment and the broader outlook for 2021.
Watch below!
Executive Programme Virtual Modules: Gold as a Reserve Asset
Shaokai Fan
Head of Asia Pacific (ex China) & Global Head of Central Banks World Gold CouncilThe Executive Programme in Gold Reserves Management is the World Gold Council’s flagship training programme for central banks. Traditionally, the programme is a 2-3 day on-site event featuring academics, industry experts, and central bankers sharing their expertise on gold. The global pandemic forced us to postpone the 2020 programme to this year.
We are pleased to announce that the Executive Programme will return on 6 October 2021 in a virtual format. The event is offered in conjunction with the University of Cambridge Judge Business School and is limited to central banks and official institutions only.
In anticipation of the virtual event, we are launching a series of videos which review some of the core components of the Executive Programme. The first video, which reviews the central bank case for gold, is available below. Other videos will be launched on a monthly basis, covering topics including drivers of gold, gold reserve operations, the changing international monetary system, and accounting for monetary gold.
All of the Executive Programme videos will be hosted on a learning portal that is available here: Executive Programme portal
Please keep an eye out for a new video each month.
The low-return environment in Australia and gold’s role
Ray Jia
Head of Research (Asia Pacific, ex-India) and Deputy Head of Trade Engagement (China) World Gold CouncilThe Australian central bank aims to keep rates low
Like many other regions, the Australian central bank lowered its policy rate last year to battle the COVID-19 economic fallout. After rate cuts in both March and November 2020, Australia’s benchmark interest rate reached a record low of 0.1%. In its latest monetary policy decision statement on 2 March 2021, the Reserve Bank of Australia (RBA) reiterated its accommodative monetary policy stance and reaffirmed its intention to maintain the current policy rate until inflation reaches its target – something not likely to happen until 2024 by the bank’s own assessment.1 Meanwhile, the RBA also vowed to keep its three-year treasury yield under its pre-set target of 0.1% to keep the economy’s borrowing cost low.2
The RBA’s aim of maintaining Australian treasury yields within target is clear. In February, US treasury yields climbed rapidly amid global economic recovery and rising inflation expectations. Similar movements in treasury yields were seen in other markets, including Australia. In response, the RBA increased its bond-purchasing efforts. And it was reported that the Australian central bank also lifted the cost to short government bonds.
The RBA has been increasing its bond-purchasing efforts*
Weekly bond purchase under RBA's QE program (green) and additional purchase (red) to strengthen its three-year yield control
Source: Reserve Bank of Australia, World Gold Council
*Data based on the RBA’s bond purchase program statistics between 1 November and 22 March 2021.
Furthermore, Philip Lowe, the Governor of the RBA, stated in his recent speech that:
So far, the RBA’s yield curve control efforts seem to have been successful. The 10-year Australian treasury yield has dropped by more than 26 basis points since February, and the three-year Australian treasury yield moved below the RBA’s target of 0.1% in March for the first time this year.3
Australian treasury yields saw declines after their surge in February*
Source: Bloomberg, Reserve Bank of Australia, World Gold Council
*Based on daily yield movements between 3/24/2020 and 3/24/2021
The low-return environment for Australian super funds
Lower interest rates in Australia have created challenges for asset managers. To combat economic slowdown and declining inflation, the RBA made 15 rate cuts between 2011 and 2020, bringing its interest rate to the lowest ever. And this low-rate environment has been weighing on the region’s treasury yields and local super fund – which, on average, allocates 31% of its assets to fixed-income and cash equivalent products – returns.4
Super funds' average returns have been dropping in tandem with the policy rate*
Average annual returns of 150+ Australian super funds (bar) and the RBA's cash rate target (line)
Source: Australian Prudential Regulation Authority, Reserve Bank of Australia, World Gold Council
*Note: the average returns of super funds refer to the annual average actual returns of over 150 Australian super funds tracked by the Australian Prudential Regulation Authority.
Gold: a return-generating asset in low-rate environments
Historical data shows that gold has offered attractive returns during Australia’s monetary-easing and post-easing cycles. In four rate-cutting cycles since 1990, gold in Australian dollars averaged an annualised return of 2.6%, outperforming other major assets.
Gold in Australian dollars performed well during easing cycles*
Source: Bloomberg, World Gold Council
* All returns are compound annualised growth rates based on daily data in AUD of the LBMA Gold Price AM, S&P/ASX 200 Total Return Index and Bloomberg Composite AusBond 0yrs+ Index.
** “Start” means the first rate cut following a rate hike and “end” means the last cut in the rate cutting cycle before the next rate hike.
Our analysis also shows that an average Australian super fund portfolio’s risk-adjusted return could benefit from allocating a portion of its assets to gold during these cycles. For instance, by allocating 2%~16% of its assets to gold, an average Australian super fund would have enjoyed higher risk-adjusted returns during the latest easing cycle between November 2011 and November 2020.
An average Australian super fund portfolio could benefit from allocations to gold*
Risk-adjusted returns of an average super fund portfolio with different allocation to gold
Source: Australian Prudential Regulation Authority, Bloomberg, World Gold Council
* Based on monthly total returns from 30 November 2011 to 30 November 2020. The hypothetical average Australian superannuation fund portfolio is based on the average Australian super funds’ asset allocation in 2020 according to the Australian Prudential Regulation Authority’s superannuation asset allocation update. It includes annually rebalanced total returns in AUD of a 50% allocation to equities (21% S&P/ASX 200 Total Return, 25% MSCI World ex Australia Net Total Return and 4% Australia Public Unit Trust Unlisted Equity Trusts), 21% allocation to fixed income (12% Bloomberg AusBond 1+ Year Index and 9% Bloomberg Barclays Global Aggregate ex Australia Total Return Index), 12% allocation to cash products (Bloomberg AusBond Bank Bill Index) and 17% to alternative assets (8% S&P/ASX 200 A-REIT, 6% MSCI Australia Infrastructure Net Total Return Index and 3% Eurekahedge Australia New Zealand Hedge Fund Index).
Gold also performed well during post-easing cycles in Australia. On average, gold in AUD has provided an average annualised return of 11% during the RBA’s post-easing cycles between 1990 and present, higher than stocks and bonds.
Gold can also generate sizable returns during post-easing cycles*
Source: Bloomberg, World Gold Council
* All returns are compound annualised growth rates based on daily data in AUD of the LBMA Gold Price AM, S&P/ASX 200 Total Return Index and Bloomberg Composite AusBond 0yrs+ Index.
** “Start” means the last rate cut in the last easing cycle and “end” means the first rate hike in the next tightening cycle .
Gold’s relevance as a strategic asset in Australia
Gold’s ability to generate returns during the monetary-easing and post-easing cycles in Australia stand on two legs. First, as we highlighted in The relevance of gold as a strategic asset in Australia, opportunity cost constitutes one of the four key drivers for gold’s local performance. With yields on assets such as Australian treasury notes declining drastically over the past decade, the opportunity cost of holding gold in Australia fell to almost zero, supporting gold’s performance in Australian dollars.
Second, gold has a global and diversified market. While Australia is one of the largest gold producers in the world, between 2010 and 2019 its mined gold production accounted for less than 9% of the global total on average. In fact, gold is produced on almost every continent and such geographical dispersion has brought stability to the gold market.
Gold’s demand is also diversified. It is purchased by consumers, investors and various industries as accessories, a safe-haven asset and a technology component. In 2020, when consumer demand for gold was hampered by the global economic fallout from COVID-19, investment demand for gold – including sales of gold bars and coins as well as gold ETF inflows – surged, limiting the volatility in global gold demand and underpinning gold’s stable performance in all regions.
Gold’s global and diversified supply and demand dynamics resulted in its low dependence on changes in the Australian economy. In Australian dollars, gold has offered an average compound annualised return of 6.5% during the region’s economic contractions.
Gold has performed well during Australian economic contractions*
Compound annualised returns of assets during economic contractions in Australia since 2000**
Source: Bloomberg, Melbourne Institute, World Gold Council
*Compound annualised growth returns based on daily data in Australian dollars of the LBMA Gold Price AM, S&P/ASX 200 Index and Bloomberg AusBond 0yrs+ Composite Index.
** Dates: 6/2000-11/2001, 11/2002-6/2003, 5/2007-5/2009, 1/2011-8/2012, 8/2013-3/2016, 1/2017-6/2017, 12/2019-12/2020 Economic contractions as defined by the Melbourne Institute, for more detailed information, please visit Phases of business cycles in Australia: Melbourne Institute.
Conclusion
Globally, central banks have responded to the turbulence in bond markets. The US, Europe, Japan and India have kept borrowing costs low to accommodate economic recoveries, while the RBA increased its efforts to cap treasury yields. Reportedly, the RBA is not expecting its current policy rate and three-year treasury yield target of 0.1% to change until 2024. And as mentioned in our 2021 Gold Outlook, while this global low-rate environment could prevail, other risks such as ballooning budget deficits, inflationary pressures and potential market corrections amid lofty valuation might also negatively impact investors’ portfolio returns.
Against this backdrop gold may offer investors a source of returns and effective diversification. As previously mentioned, in historical periods of economic contraction and low rates gold has generated relatively attractive returns compared to stocks and bonds, and improved risk-adjusted returns for Australian investors.
Footnotes
1 Statement by Philip Lowe, Governor: Monetary Policy Decision, RBA, 2 March 2021.
2 Introduced in March 2020 to lower the economy’s borrowing cost, an initial 3-year treasury yield target of 0.25% was set by the RBA. It was reduced to 0.1% in November 2020 alongside the policy rate cut.
3 10-year Australian Treasury yield’s change based on the difference between 26 February 2021- the last trading day of February – and 24 March 2021.
4 Based on the average asset allocation of over 180 Australian super funds’ between December 2019 and December 2020 according to the Australian Prudential Regulation Authority’s website.
Gold, commodities and reflation
Johan Palmberg
Senior Quantitative Analyst World Gold CouncilA commodity rally began in Q2 of 2020, sharply on the heels of the COVID-19-driven broad market sell-off. It started with metals, followed by energy, and, by the summer, agricultural commodities had joined in. Investors have waited more than a decade for this type of commodities rally but perhaps their patience is about to be rewarded. The recent market moves – between August 2020 and February 2021 – now rank in the top 5% of six-month moves since 1971 and, with a 30-year low as a base, this suggests they could have further to go (Charts 1 and 2).
Chart 1. A long wait for a strong run from a low base
S&P GSCI Commodity Total Return Index from January 1971 to February 2021*
*The grey shaded areas denote six-month returns that are in the top 5% of all six-month returns.
Source: Bloomberg, World Gold Council
Chart 2. As commodities reflate, gold is left behind
S&P GSCI Commodity Total Return Index, GSCI Commodity sectors and spot US$ gold from August 2020 to February 2021*
*All series are GSCI Total Return series except for spot US$ gold.
Source: Bloomberg, World Gold Council
In an environment where many assets appear expensive, commodities stand out as an enticing prospect for return-hungry investors. However, if this run is likely to continue and simultaneously perhaps stoke inflation in the process, why is gold yet to shine?
Firstly, it is important to reiterate that while gold shares characteristics with other commodities and is represented in the large commodity indices, it is a financial asset first and foremost. Its behaviour is different, often countercyclical when commodities are procyclical, and with diversified sources of supply and demand. As such it is not subject to disruptions in any one sector.
Secondly, if the recent commodities run is a reflation story, some precedents are worth exploring to help investors navigate current market dynamics.
‘Reflation’ is loosely characterised as an environment of resurgent economic growth twinned with rising inflation and interest rates. Defining ‘reflation’ as the period after a recession,1 Chart 3 shows how gold and commodities have fared, on average, up to three years before and after the start of the reflation period since 1991. Chart 4 expands the period of analysis by including both the 1980 and 1982 recessions, although we lose the impact on energy commodities as total return series are unavailable for that period. The key dots to focus on are the first and last large dots for each series, representing average six-month and three-year returns after the start of a period of reflation, respectively.
Chart 3. Commodities have started reflationary periods with a bang, but gold has caught up
S&P GSCI Commodity Total Return Indices and spot US$ gold performance before and after US recessions*
*Each dot in the chart represents the annualised return for a series. The large dots show performance after the reflation period began and the small dots show the performance prior. Each dot also shows the high and low ranges of returns. All series are GSCI Total Return series except for spot US$ gold. The period analysed is March 1988 to February 2020.
Source: Bloomberg, World Gold Council
Chart 4. Adding the 1980 and 1982 reflationary periods tells a similar story but at lower absolute levels
S&P GSCI Commodity Total Return Indices and spot US$ gold performance before and after US recessions*
*Each dot in the chart represents the annualised return for a series. The large dots show performance after the reflation period began and the small dots show the performance prior. Each dot also shows the high and low ranges of returns. All series are GSCI Total Return series except for spot US$ gold. The period analysed is November 1979 to February 2020.
Source: Bloomberg, World Gold Council
Gold’s current underperformance between August 2020 and February 2021 is consistent with its average performance during previous reflationary episodes. Similarly, the current outperformance observed in major commodity groups is in line with their historical performance. Interestingly, gold fared well, both relatively and absolutely, in the months leading up to a period of reflation. Conversely, the opposite is true of the rest of the commodity complex, with energy posting the worst average performance over the preceding six months.
So, this initial ‘rotation’ from the safety of gold to the return potential from commodities makes sense in this most recent period. Also, let’s not forget that gold hit an all-time high of US$2,067.15 in August 2020,2 which may have compelled some investors to take profit.
Another plausible reason for gold’s relative underperformance has been the initial pick-up in both interest rates and equity returns, which both increase the opportunity cost of holding gold. Charts 5 and 6 show that gold didn’t fare as well in reflationary environments where real interest rates rose.3 From July 1980, real rates rose almost 12%, three years into the reflationary episode. It was undoubtedly a major factor in driving gold prices down: they ended the three-year period down an annualised 12%. This also followed through into the 1982 reflation period.
Chart 5. A major headwind for gold prices in the early 1980s was the significant rise in real yields…
Relative change in real yields before and during reflation periods*
*Chart shows the performance of ‘realised’ real yields (US 10-year Treasury yield less US headline CPI) three years before and three years into a reflation period. 0 is the end of an NBER recession. The period analysed is November 1979 to February 2020.
Source: Bloomberg, World Gold Council
Chart 6. ...a factor in gold’s weak performance during those reflationary periods in absolute terms
Relative change in real yields before and during reflation periods*
* Chart shows the performance of spot gold in US$/oz, three years before and three years into a reflation period. 0 is the end of an NBER recession. The period analysed is November 1979 to February 2020.
Source: Bloomberg, World Gold Council
Despite initial headwinds, gold has on average caught up to most major commodity groups by the second and third years from the start of a reflationary period since 1991. It has also caught up to metals and agricultural commodities since 1980. And while the absolute level of returns vary, gold has done well against commodities on a relative basis.
In our view, the analysis using data since 1991 may be more indicative of the current environment since central banks’ commitment to accommodative policy should prevent real rates from rising in a similar fashion to the early 1980s.4
The 2009 period of reflation saw the best absolute and relative performance for gold. Its high returns likely reflected lingering concerns about the health of the global economy and concerns about inflation driven by quantitative easing, among other things. On top of this, higher growth amidst ongoing uncertainty meant that both investors and consumers were supporting price rises. If economies recover this year and next from the COVID-19-related slowdown, it is conceivable that we could see a similar pattern emerge: growth supporting the consumer and high global debt, continued liquidity stimulus and record high valuations in equity and bond markets keeping investors on board.
Footnotes
1Using National Bureau of Economic Research (NBER) recession index (RINDEX Index) via Bloomberg to determine analysis starting points. In our analysis a reflation begins during the last month of the NBER recession.
2Based on the all-time high reached by the LBMA Gold Price PM USD during 6 August 2020.
3Real interest rates defined as US 10-year Treasury yield less US headline Consumer Price Index (CPI) inflation.
4Federal Reserve issues FOMC statement, 17 March 2021
Strategic Edge Video Series: George Cheveley of Ninety One
World Gold Council
The experts on goldIn the inaugural segment of our new Strategic Edge video series, our Chief Market Strategist, John Reade, talks to George Cheveley, Global Gold Strategist at Ninety One, about the state of the gold market.
Watch as they discuss…
Security and protection motives underpin strong physical gold demand
Louise Street
Senior Markets Analyst World Gold CouncilA recent NY Times article closed with this quote from Morgan Stanley Private Wealth Management senior VP Katerina Simonetti: “There is a psychological component in owning gold that goes back for centuries…It’s an asset that gives peace of mind to investors. It just makes investors feel safe and secure.”
Ms Simonetti is bang on. Our consumer research data shows that, globally, almost two thirds of retail investors say that owning gold makes them feel secure over the long term.1 Still more see it as a good safeguard against inflation and currency fluctuations – a fact that is increasingly relevant in the current environment. As Ninety One’s Global Gold Strategist, George Cheveley, asserts, “..inflation expectations have risen so fast this year…”
Global retail investors view gold as long-term security that helps protect against inflation
% of those surveyed that agreed with each statement
As of August 2019. Results from a quantitative survey carried out by Hall & Partners of 12,371 men and women across six countries: India, China, Germany, the US, Canada and Russia. The online survey captured the responses of active retail investors – classified as people who had made at least one investment in the past 12 months, excluding those who had only added money to a savings account and had only ever invested in a defined list of non-core investment products. Fieldwork took place in Q2 and Q3 2019.
Results are responses to the question ‘Please indicate how strongly you agree or disagree with each of the statements below.’ Respondents selected from the following five-point scale: strongly agree; somewhat agree; neither agree or disagree; somewhat disagree; strongly disagree.
Base: total sample (12,371)
Source: Hall & Partners, World Gold Council
Which helps explain recent rocketing demand for gold coins in the US. As we report in our recent Gold Market commentary, Q1 sales of gold Eagle coins, at more than 400,000 oz (12.5t, US$720mn), were the third highest on record for the first quarter. And the Perth Mint report similarly impressive sales so far this year, with a record 330,000 oz of gold sold in the first quarter – with manufacturing pivoting towards ‘products that are hot in the US right now’ according to General Manager Minted Products, Neil Vance.
While rising interest rates have dominated gold’s performance so far this year, the inflationary expectations that have fuelled those rate rises may be behind much of the strength in physical demand. Our consumer research data confirms that gold’s role in a portfolio is primarily viewed as being for wealth protection or to provide above-inflation returns.
Global retail investors see gold’s main role as wealth protection and providing real returns
Notes as per previous chart.
Results are individual responses to the question ‘How would you describe the main role of this investment?’ Respondents selected one option for each investment product that they owned (including for each different type of gold product).
Base sample: number of responses (7,540)
Source: Hall & Partners, World Gold Council
And this is far from being a US-specific phenomenon: 85% of retail investors across six global markets identified these as being gold’s main role. Building inflationary pressures may also continue to fan the flames of robust physical demand noted in China and India throughout January and February. Keep an eye out for our forthcoming issue of Gold Demand Trends, which will give detailed coverage of the size and scale of gold demand – and supply – in Q1 2021.
Footnotes
1Correct as at August 2019
Strategic Edge Video Series: James Steel of HSBC Bank
World Gold Council
The experts on goldIn the latest video from our Strategic Edge series, James Steel, Chief Precious Metals Analyst at HSBC Bank, joined our Global Head of Research, Juan Carlos Artigas to discuss market dynamics impacting gold performance.
Watch now!