Written By: Miles Pearson – Forex Focus
With global stock markets sliding, will the negative correlation lead to a surge in gold prices?!
It’s been a while since precious metals have witnessed a major rally. 2010 may have been the last year that prices of gold, silver and platinum surged in unison. Gold ended that year with gains of close to 30 percent, while prices of silver and platinum swelled more than 80 percent during the year. Since then, prices of these metals have shown signs of reversing their falls several times, even signalling technical rebounds at times, but in the end proving it to be false optimism.
Coming to gold, the precious metal has remained in a tight $1,050-1,350 band for the last few years, in spite of some of the other asset classes such as equities and fixed-income instruments generating fabulous returns. Although historically gold is negatively correlated to these asset classes, the yellow metal was not a complete wash-out after managing to eke out small gains in the last couple of years as the cost of production kept prices from slipping into oblivion. However, from the longer-term perspective, gold is still lower by more than 30 percent from its 2011 peak of $1,920 per troy ounce.
Let’s take a look at some of the key fundamentals that have kept gold prices on a tight leash during the last few years against the backdrop of a sharp correction in the equities markets, rising inflation, geopolitical unrest and the likely end of an era of low interest rates.
According to the World Gold Council (WGC), demand for gold slipped by 7 percent in 2017 compared with a year earlier on the back of a decline in central-bank purchases, a sharp slide in inflows into gold ETFs (exchange-traded funds) and a 10-percent fall in coin investments. However, the 4-percent annual increase in jewellery demand for the first time since 2013 was not enough to dent the overall demand figures for the precious metal. China and India were the major contributors, with the two countries accounting for more than 90 percent of total gold purchases. Even official gold reserves were down by 5 percent last year, with total reserves growing by 371 tons in 2017.
On the supply front, gold output from mine production, which accounts for more than half the exploration budget of all non-ferrous metals, led to record growth in 2017. This was mostly offset by a 9-percent fall in Chinese mining activities due to stringent environmental controls and a 10-percent fall in recycled gold, leading to an overall supply deficit of 4 percent in 2017.
To sum up the demand-supply stats:
- Total gold demand in 2017: 4,072 tons.
- Total gold supply in 2017: 4,398 tons.
Low to negative correlation to traditional asset classes
Historically, gold is either negatively correlated or has very low correlation to traditional asset classes such as bonds and equities, and there are periods when these asset classes either outperform or underperform the others correspondingly. However, gold has had the distinction of outperforming these traditional assets in the long-run; and according to a research report by PwC (PricewaterhouseCoopers), gold delivered returns of 6.7 percent per annum over the last 10 years, outperforming equities and bonds, which generated returns of 4.9 and 4.5 percent respectively. In addition, sovereign wealth funds—which generally diversify their portfolios to include a small portion of alternate assets such as gold, private equity and real estate—are likely to raise their allocations following the low yield in government bonds over the last couple of years.
The following chart illustrates the correlation between gold and the US Dollar Index:
The rise of crypto-currencies
There is no clear-cut evidence that the growth in the crypto-currency market has led to stagnation in the prices of precious metals, but looking at the investments pouring into cryptos, especially the heavyweights, one can assume that digital currencies have billed themselves as a safe haven for investors to park their funds, thereby replacing gold, which for decades has been the go-to asset class.
The frenzy leading to the sharp spike in the prices of crypto-currencies could have something to do with investors dumping precious metals, which have hardly fetched any returns in the last few years. In addition, analysts believe that the market cap in crypto-currencies, which was about 2 to 3 percent of liquid gold in 2016, rose to more than 20 percent last year, capturing a sizable chunk of the precious-metals market share.
However, there are those analysts who believe that the rapid rise in crypto-currencies has nothing to do with investors diverting capital away from physical gold but has more to do with the issue of paper gold by the market-makers on COMEX. Institutional investors rarely invest in the precious metal, let alone crypto-currencies for that matter, and according to them, investments in gold are generally carried out by retail investors in countries such as India and China, with central banks contributing to the rest of the global demand.
According to median estimates of bullion analysts participating in the 20th annual LBMA (London Bullion Market Association) competition, gold prices are expected to surge about 5 percent this year to $1,318 per ounce. Of the 24 analysts forecasting prices for 2018, seven see gold prices averaging around $1,200, while eight analysts expect prices to average between $1,350-1,370.
Analysts believe that the underperformance of gold over the last few years makes it an all-the-more attractive investment opportunity and a likely outperformer compared to other asset classes in the next few years, along with private equity and real estate.