Commodity Trade Mantra

Positive Correlation Between Economic Growth And Gold Demand

Positive Correlation Between Economic Growth And Gold Demand

Positive Correlation Between Economic Growth And Gold Demand

This seventh edition of “Gold Investor” is out. The report, released by World Gold Council, discusses gold’s positive link to economic growth, explore its value as a hedge in times of duress, and discuss the impact that ETFs have had on the gold market. The report includes three articles:

  1. The growth dividend: how rising GDP lifts consumer’s gold demand
  2. A practical hedge: less exotic, multipurpose, lower cost
  3. Ten years of gold ETFs: a wider and more efficient market

Below are some excerpts. Readers who want access to the full report should register here before downloading the report.

Executive summary:

Current data on the world’s economies is mixed. There is both positive and negative news about developed and emerging markets but many investors – particularly in the US – are optimistic about a return to growth. Conventional wisdom says this will be bad news for gold demand. We believe the true picture is more complex. Gold benefits from both the growth and contraction phases of the business cycle, and our analysis, based on new third-party research, highlights the positive link between economic growth and consumer’s gold demand.

The positive impact of economic growth on gold demand:

Conventional wisdom holds that good economic times are bad for gold. This is based on the fact that investment demand for gold tends to soften during times of growth. Over the short (and sometimes medium) term, gold investment can exert strong pressure on prices – whether via the physical (and physically backed) markets, through derivatives in exchanges, or over-the-counter products. But over the longer term, economic growth tends to be good for gold. For example, India and China’s combined share of world gold demand grew from 25% in the early 1990s to more than 50% by 2013. Consumers and investors in China bought more than 1,200 tonnes of gold in 2013 – 20% more gold than the current combined gold holdings of all US-listed gold-backed ETFs. In both India and China gold demand is closely correlated to increasing wealth.

Outlook: the practical impact of consumer demand on gold:

The price of gold can be explained as a long-term (and slow-moving) trend that deviates due to short- or medium-term market developments. Over the short (and potentially medium) term, gold investment – whether via the physical (and physically backed) markets or through derivatives in exchanges or other-the-counter (OTC) – can exert strong pressure on gold prices. This type of demand grows with uncertainty and falls as investor confidence grows. However, the longer-term trend is more closely linked to global consumption, savings and, at the same time, by the availability of supply (or lack thereof).

Our analysis suggests there is a clear, positive relationship between economic growth and consumer demand for gold through rising incomes. So it seems reasonable to suggest that positive GDP growth will not necessarily be negative for the gold market. Not only consumption and gold savings demand make up the largest share of demand worldwide, but they even represent an important market in developed countries such as US – where 50% of gold demand is linked to consumers.

A practical hedge: less exotic, multipurpose, lower cost:

The 2008-2009 financial crisis spawned the tail-risk hedge, an instrument that aims to protect investors from the worst of sudden, hard-to-predict market crashes. These hedges can be rather like exotic sports cars: impressive performers, but expensive to own and too technically complex for most. Our research shows that gold may not perform like a high- octane tailored hedge but can be a practical alternative. It is straightforward, delivers acceptable performance and is less costly to own.

Ten years of gold ETFs: a wider and more efficient market:

Ten years ago it would have been difficult to predict that a new investment product, a variant of a mutual fund, would change the gold investment landscape. Odder still to suggest that this new type of vehicle might one day accumulate more gold holdings than many central banks. Yet the gold-backed ETF has done both these things and more.

We examined the ten-year history and growth catalysts of gold ETFs and asked whether they have delivered value for investors and for the wider gold market. We have also analysed the impact, if any, gold ETFs have had on gold price volatility

Gold as a hedge:

Excluding the high costs of most hedges, gold has not – at least over recent and very short windows – been a particularly effective tail risk hedge. Our previous research has shown that in the longer term and over longer windows, gold’s attributes are far more certain. But the return profile of gold is compelling. The asymmetric correlation means it straddles the ground between a dedicated tail risk hedge and a risk asset. It contributes to portfolio performance during normal environments but still displays the properties of a tail-risk hedge. This suggests that some combination of hedges – following the old adage of not putting all of one’s eggs in one – should perform better than any single hedge. Gold’s unique profile further suggests that it should typically form a part of this combination.

 

 
Courtesy: Goldsilverworlds

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