In March, the World Gold Council, the market development organization for the gold industry, published the eight edition of its research report Gold Investor. What are the main conclusions from this publication?
We recommend investors to read the whole report (as well as the previous issues), but for those without the time we are going to provide a short summary (with the obvious caveat that the World Gold Council may be a little biased in favor of gold).
The first part, entitled “Interconnections: the factors that drive gold”, highlights the same truth we have been constantly repeating in our Market Overview: that gold prices depend on many factors, therefore explanations based on single driver, like the greenback or the U.S. real interest rates, must be oversimplified. Except fluctuations in the currency markets and changes in interest rates, the gold prices depend on consumer spending and income growth (rise in disposable incomes promotes the demand for jewelry and technological applications), short-term investment flows, supply-side factors, inflation/deflation developments and systemic and tail risks (gold as a safe-haven), according to the WGC.
The second chapter, under the title “Gold in a rising dollar environment” is perhaps the most interesting piece. Although it is true that a strong U.S. dollar puts pressure on gold, the relationship between the greenback and the yellow metal is not simple. According to the WGC, it is actually asymmetric, i.e. gold prices rise more on a weak U.S. dollar than they fall on a strong U.S. dollar. Gold performs best (+14.9 percent) during periods when the greenback is falling. When the U.S. dollar is flat, the yellow metal usually experiences positive but lower returns (+7.8 percent). Conversely, the gold price usually falls (-6.5 percent) in times when the greenback rises, which means that “Gold prices have usually gone up more than twice as much when the dollar was weak compared to how much they have fallen, on average, when the dollar appreciated.”
Indeed, between January 2014 and March 20, 2015, the greenback went up 20.3 percent, yet the gold price fell only by 1.2 percent over the same period (the WGC numbers – for us, a bit biased, but it is a fact that the gold prices did not fall proportionally to the U.S. dollar rally). The WGC believes that this resistance may be due to the fact that non-dollar gold demand (China and India alone account for 50% of all gold demand) is not overly sensitive to dollar movements.
The third part, entitled “The market may be wrong about gold and US interest rates” points out that the significance of the relationship between the yellow metal and U.S. interest rates is also often overstated. According to the WGC, there are two reasons why higher U.S. rates will not necessarily have a devastating effect on the gold demand. First, higher interest rates increase the opportunity cost of investing in gold; however, not all demand is investment. Actually, jewelry and technology demand make up almost 60 percent of annual physical gold demand. Second, economic conditions are different than in the past. The inflation rate and interest rates are very low. And the developed-market gold demand, which is more sensitive to U.S. rate changes than emerging-market demand (currently, about 70 percent of annual demand), has declined to less than 30 percent of annual demand over the past decade from more than 60 percent in the 1970s.
We believe that the WGC pays too much attention to the physical demand from the Asian investors. The size and reach of the U.S. and European investor-markets are still likely to exert a strong, if not the most important, influence on the gold prices (at least in the short term). However, it is true that gold remains a valuable portfolio asset even if interest rates rise. Actually, according to the WGC, gold is better at reducing portfolio risk during periods of moderate real rates. We may add that the Fed’s tightening may trigger some systemic shock, which would be positive for the gold market.
Summing up, investors should avoid simple, single-driver explanations of the gold prices. The yellow metal’s performance depends on many factors, not only on the greenback or U.S. interest rates. The relationship between gold and those factors is evolving and depends always on the broader economic situation.
Thank you.
Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor
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