Investment Update: Gold prices swing as markets sell off

Like most asset classes, gold is being affected by the unprecedented economic and financial market conditions in play around the globe. We believe that recent volatility in the gold price has been driven by massive liquidations across all assets, and likely magnified by leveraged positions and rule-based trading. 

Gold has also likely been used to raise cash to cover losses in other asset classes because:

• it remains one of the best performing asset classes year-to-date (y-t-d), despite recent fluctuations (Chart 1)
• it is a high quality and highly liquid asset, trading over US$260 billion (bn) per day in March¹

Thus far, selling appears more concentrated on derivatives in exchanges and over-the-counter (OTC). While gold-backed ETFs have experienced outflows in recent days, flows remain positive for the year. Funds across regions have seen US$3.6bn of net inflows in March, giving a collective total of US$11.5bn y-t-d (Table 2).²

Looking ahead, we believe the deceleration in economic growth will undoubtedly impact gold consumer demand and gold’s volatility may remain high, but high risk levels combined with widespread negative real rates and quantitative easing will be supportive of gold investment demand as a safe haven.
 

Unusual times, uncertain outcomes

Perspectives on impending recessions often diverge. Some see similarities to prior crises while others focus on new signals and concerns. At this juncture, conditions in the current environment – widespread travel restrictions, complete shutdown of numerous sectors, and higher volatility in financial markets than during the 2008-2009 financial crisis – are unprecedented to many people across generations. The chances of avoiding a global recession appear low and investors are bracing themselves for more bumps ahead. If a recession does occur, its depth and duration will depend on how quickly and effectively governments are able to slow down the contagion, buffer their economies and, hopefully, find ways of treating or preventing COVID-19.

In our continuing engagement with investors two questions recur: 

1.    Why did the gold price drop alongside stocks?

The answer is linked to several factors. The most prominent of these is the massive liquidation virtually all asset classes experienced in the past week. And gold was no exception. Even longer-term US treasuries prices fell, despite a second unscheduled cut by the Fed on 15 March slashing the Fed funds rate to pre-2016 levels. The 10-year US treasury yield is trading above 1% after reaching a historical low of 0.33% on 9 March.

As a high quality, liquid asset gold may also have been used to raise cash, especially since it was – until recently – one of the few assets with positive returns this year. Gold was up 10% as of 9 March, more than any other major asset classes.³

There is historical precedent for these types of pullbacks in gold. The correlation between gold and stocks generally turns negative as stock prices tumble.⁴ However, there seems to be an exception during periods of disorderly selling when volatility spikes to extreme levels. For example, during the 2008-2009 financial crisis, as the VIX reached record highs gold came under pressure (Chart 2).

Finally, selling appears more concentrated on derivatives in exchanges. Net long positioning in COMEX futures – usually linked to speculative trading – was very high prior to gold’s pullback (Chart 3). Some investors holding these positions, which can be highly leveraged, may have been forced to sell to meet margin requirements as the price fell through various technical levels.⁵

2.    Is gold still an effective portfolio hedge given its volatility?

We believe that, so far, gold has played an important role in portfolios as a source of liquidity and collateral. And we expect it will serve as a safe haven in the longer term.
Gold experienced pullbacks at the onset of the global financial crisis too, falling between 15% and 25% in US-dollar terms a couple of times during 2008. But by the end of that year, gold was one of the few assets – alongside US treasuries – to post positive returns (Chart 4).

Table 1 Performance of gold and major stock indices in various countries

*As of 18 March 2020. Returns in local currency based on the LBMA Gold Price PM and the Nikkei 225, S&P 500, Shanghai Composite, Euro Stoxx 50, Nifty 50, and FTSE 100, respectively. 
Source: Bloomberg, ICE Benchmark Administration, World Gold Council

It is also important to note that, while the gold price is usually quoted in US dollars, its impact on portfolio performance is measured in the local currency of an investor. To date, as stock indices around the world have fallen sharply, gold’s performance has been positive in various currencies, including the pound sterling, euro, and Indian rupee (Table 1). And it has only been flat to slightly negative in renminbi, US dollar and Japanese yen.

Investors seem to agree. Despite the price pullback and selling in most gold-backed ETFs listed in the US and Europe this week, global inflows remain positive. Asia even saw inflows this week. And investors have added US$3.6bn to gold-backed ETFs in March and a total of US$11.5bn y-t-d (Table 2).

Table 2: Gold ETFs holdings and flows*

*As of 18 March 2020.
Source: Bloomberg, Company Filings, World Gold Council

What to expect next

Gold’s performance is intertwined with its unique nature as a consumer good and investment asset. And it is linked to the interaction of four key drivers:⁶

• Economic expansion
• Risk and uncertainty
• Opportunity cost 
• Momentum.

So far this year, more than 30 central banks have cut rates and many have implemented additional quantitative easing measures.⁷ Governments around the globe are pledging trillions of US dollars to support their citizens and their economies. But ballooning budget deficits, negative real rates and debasement of currencies will present structural challenges to asset managers, pension funds and personal savings. 

It may take a while for financial markets to stabilise. Amidst high volatility, the gold price may experience additional swings, but the long-term implications of an environment combining high risk and lower opportunity cost should support gold investment demand.

We also expect central banks to remain net gold buyers overall, albeit likely not at the same rate as in the past two years.

On the other hand, consumer demand may soften significantly. Early figures by the National Bureau of Statistics in China suggest a 40% contraction in purchases of gold, silver and gem jewellery during the first two months of the year, and the new travel and movement restrictions will undoubtedly affect other regions.  Historically, however, investment flows in periods of uncertainty tend to offset weakness in consumer markets. 

Footnotes

¹As of 18 March 2020. See trading volumes on Goldhub.com.

²As of 18 March 2020. See ETF flows on Goldhub.com

³Weekly Markets Commentary, 9 March 2020.

⁴The relevance of gold as a strategic asset, February 2020.

⁵Heavy selling across all four precious metals, 16 March 2020.

⁶QuarumSM, our web-based tool powered by WGC’s Gold Valuation Framework, can help investors understand how these different drivers impact gold’s long-term performance.

⁷http://www.cbrates.com/decisions.htm