Gold’s price performance has been supported by strong investment demand. Illustration: Chaitanya Dinesh SurpurS
o far this year, global investors have seen first-hand gold’s attributes as a safe haven. Gold surged past $2,000/oz in early March as equities tumbled, driven by the war in Ukraine, swelling commodity prices, and, more generally, potential knock-off effects for the global economy.
While the price of gold has pullback as equities have gained ground, gold is still 6 percent higher year-to-date, significantly outperforming global equities which are down 11 percent over the same period (see chart). Gold has also outperformed the US dollar and global bonds. And gold’s role as a store of value stands in stark contrast to cryptocurrencies, which have instead performed in line with equities during the recent crisis.
Gold’s price performance has been supported by strong investment demand. Gold-backed ETFs, often favoured by investors as a cost-effective way to gain exposure to gold, have seen $11.2 billion of inflows so far in 2022. These inflows have more than offset the total annual outflows of $9.1 billion seen last year. There’s also been increased interest in gold futures. Net long positioning on COMEX has risen to $65 billion, the highest level since March 2020. Retail investors have also been buying gold: The US Mint has sold close to $1 billion year-to-date, and there’s similar anecdotal evidence from other markets.
Events like the war in Ukraine represent a clear example of why gold is such an effective and well-established hedge against expected and unexpected market risks. Historical analysis suggests that gold has reacted positively to tail events linked to geopolitics and, despite price volatility, tended to keep those gains in the months following the initial event. In addition, gold trades in a deep and highly liquid market, with collective volumes surpassing $120 billion a day on average and tight bid-ask spreads. All these, combined with the fact that bullion carries no credit risk, makes gold a sought-after safe haven asset.
The risk of stagflation around the world is rising. Europe may feel it most acutely, fuelled by a combination of soaring commodity prices, energy dependency, and a weaker economic and financial environment—all of this now exacerbated by the war in Ukraine. And while stagflation is also a risk for the US, it may not feel to the same extent. Both hard and soft economic data still signal the US economy is resilient. However, movements in US Treasury markets may signal that market participants anticipate a contraction down the line. Should energy and food prices stay high, stagflation risks might just be realised.
Needless to say, stagflation environments are not good for the financial markets or the economy. Slowing incomes and rising prices are an uneasy combination to say the least. Equities are historically hit the hardest, while commodities and gold have done well (see chart). We are already seeing these dynamics play out in the beginning of 2022 and gold appears to be doing exactly what investors would expect it to. Performing well as a hedge when other assets are not.
Yet, not all current dynamics are supportive for gold. In recent months, central banks across the global have signalled a more hawkish stance. With inflation racing to multi-decade highs, and likely to be more persistent, financial expectations are now for a quicker tightening of the loose monetary policy conditions which have long been supporting markets. The expectations of future monetary policy actions—expressed through bond yields—have historically been a key influence on gold price performance.
With many central banks—most notably the US Fed—beginning to enter a tightening cycle, interest rates will likely rise. For gold, this can be a headwind to future performance, as it increases the opportunity cost for investors holding it. But while it has historically underperformed in the months leading up to a Fed tightening cycle, it has also significantly outperformed in the months following the first rate hike (see chart). Gold may have partly been aided by the US dollar which exhibited the opposite pattern.
In addition, the war in Ukraine has impacted expectations about the number of hikes expected from the Fed this year, and some central banks, including China, may cut interest rates to support the economy. Overall, even taking into account potential rate hikes, absolute levels of real and nominal interest rates worldwide will likely remain at historically low levels for some time.
In our view, the war in Ukraine is one of many geopolitical tensions that are starting to resurface after taking a back seat during the Covid pandemic. This, combined with stubbornly high inflation, which may not recede as quickly as previously thought, will likely continue to support gold investment demand this year. And while some of the recent surge may cool down, we don’t need to look too far back to see that investors often make long-term strategic allocations to gold during these events and not just tactical ones. For example, gold ETFs saw $49 billion of inflows in 2020 as Covid upended the global economy, but less than 20 percent of those flows came out in 2021 as conditions improved.
As such, while the world’s attention has naturally shifted to the war in Ukraine, we believe that geopolitical events in isolation are neither the only nor the main reason why investors should own gold. Gold’s role as a strategic asset is linked to its broad contribution to returns, diversification, liquidity and positive portfolio impact. The writer is global head of research, World Gold Council
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(This story appears in the 08 April, 2022 issue of Forbes India. To visit our Archives, click here.)