The recent performance of cryptocurrencies coupled with year-to-date outflows from gold ETFs has led to questions about whether cryptocurrencies are displacing interest in gold.
Andrew Naylor, regional CEO APAC (ex China) of the World Gold Council, explains why this is not the case.
A question often asked is the impact of cryptocurrencies on gold as an asset class, and whether interest in crypto will displace interest in gold.
The short answer is no – they are fundamentally different asset classes. Gold is also a physical asset and by definition crypto-currencies are not. But arguably one of the most significant differences is the very different nature of demand for both assets.
Unlike crypto, gold has a very diverse demand profile and use-case(s). It also has intrinsic value. If you look at the sources of demand for gold over the period 2010-2020, investment demand accounts for approximately 42 per cent of annual demand, jewellery 34 per cent, central banks 17 per cent, and technology about 7 per cent.
Each of these sectors of demand has different drivers – jewellery and tech demand often increase in times of economic expansion.
Investment demand is driven by uncertainty, and central bank demand by a combination of both. The unique and diverse nature of demand for gold, underpinned by different drivers, means gold performs differently from other asset classes, including crypto.
The result is that gold is often not significantly correlated to most other assets, particularly in downturns, making gold a potential diversifier.
There are other factors that distinguish gold from crypto – its liquidity, volatility profile and its role in a portfolio.
Crypto assets can be volatile and are not without risk so an argument can be made that the higher the exposure to crypto, the greater the need for an asset that can mitigate risk such as gold. It is therefore important to consider the different roles that cryptocurrencies and gold play.
Earlier this month bitcoin futures were launched. Whilst an interesting development, they are structurally different to physically-backed gold ETFs.
The bitcoin ETF does not hold the underlying asset – it is based on cash-settled bitcoin futures. Physical gold ETFs hold the underlying asset – physical gold.
The final point to consider on cryptocurrencies is the regulatory framework. This is constantly evolving and is not yet settled, adding another element of risk to the cryptocurrency market.
So if cryptocurrencies are not displacing gold, what are the reasons for gold’s mixed performance so far this year?
It has been an interesting year for gold. From last year’s record high gold price and inflows into ETFs, gold has so far had a more mixed year. The World Gold Council’s latest Gold Demand Trends Q3 report showed an overall decline in demand of seven per cent year-on-year.
Retail demand has started to pick up as the ending of COVID restrictions and recovery of economic activity in many markets has increased consumer sentiment – jewellery demand increased 33 per cent year-on-year and bar and coin demand – a category of physical gold products overwhelmingly bought by retail investors – saw a year-on-year increase of 18 per cent.
But despite consumer demand starting to recover, ETF outflows, albeit modest, were enough to place overall gold demand into a year-on-year decline. This is a reflection of gold’s dual nature.
Economic growth is a primary driver of consumer demand. But institutional investment demand has other drivers, including the interest rate outlook and market uncertainty.
Gold ETFs have experienced outflows in six of the first 10 months of the year as ETF investors have generally followed gold price trends. The picture though is mixed – European and North American ETFs have seen outflows, but Asia-based ETFs have seen modest inflows this year.
Outside of slightly negative Q2 flows, Asian gold ETFs have consistently stood out as the often lone growth driver among global funds, having added nearly $US1.3 billion ($1.8 billion), or 18 per cent, in the year to end-October as concerns mount around regional economic growth.
Australia has similarly seen inflows where (as at October 31), gold ETFs saw inflows of 6.5 per cent.
Despite the overall modest outflows from ETFs in the last quarter, gold is once again regaining its shine. In October, gold gained 1.5 per cent in the face of a surge in inflation expectations, higher bond yields, and a weaker dollar. More recent news suggests that this will be sustained, meaning institutional interest in gold could once again pick up.
Inflation may drive interest in gold
As countries emerge from lockdowns and economies continue to recover from the impact of COVID, consumer demand (jewellery, bars and coins, and technology demand) is likely to be supported. When it comes to institutional investment demand, the shifting policy environment may be a challenge.
While gold has been inversely correlated with nominal interest rates over recent years, gold strengthened during October despite higher nominal rates. One of the reasons for this could be inflation expectations.
In the United States, CPI and wages grew the most in 30 and 20 years respectively. Here in Australia, core inflation jumped higher than forecast at the end of October, the quickest increase in six years. Inflation will be a consideration in the minds of policymakers, businesses and investors for some time to come. This may renew institutional interest in gold.
This article appeared in the December issue of Australian Resources & Investment.