Mt Todd

The gold outlook for 2022

After 2021’s ups and downs, what can we expect of gold in 2022? Andrew Naylor, regional CEO APAC (ex China) of the World Gold Council, details the year ahead and the various factors that could impact the commodity’s performance.

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Gold

The great gold vs crypto debate

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.

Andrew joined the World Gold Council in 2016 and has led the regional office in Singapore since 2020.

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.

Northern Star

With inflation occupying increasing mindshare, what is gold’s strategic role?

By Andrew Naylor, World Gold Council Regional Chief Executive Officer, APAC and Public Policy

With second quarter CPI (consumer price index) in Australia jumping to its highest in more than 13 years, inflation is emerging as a key concern for investors. 

As a consequence, institutional and retail investors are looking for ways to protect against rising prices. In the long term, gold is a proven hedge against inflation, but its short-term performance is less convincing. 

More recent analysis by the World Gold Council shows that gold can indeed be an important component of an inflation-hedging portfolio.

Why is inflation a concern?

Investors in many markets around the world have been used to decades of relatively low inflation. COVID-19 has been a game changer. Supply chains have been tightened, and with the prospect of a quick economic recovery on the horizon in many markets, demand in many areas could substantially outstrip supply. 

Commodity prices in particular are reflecting this, as are business inventory data and shipping rates. Other factors are also coming into play – a huge increase in government debt (to fund unprecedented support packages during the height of the pandemic) and an indication that monetary authorities will tolerate higher inflation suggests that the risks are skewed toward the upside. 

Relationship between gold and inflation

Most global conversations on inflation focus on US CPI given the hegemony of the US dollar and US interest rates. But for all the discussion on gold as an inflation hedge, gold’s relationship to US CPI is surprisingly weak – historically CPI changes and gold returns have had a weak linear relationship.

And since 1971, when the US fully exited the Gold Standard, only 16 per cent of the changes in gold prices can be explained by CPI inflation. Other factors come into play. Another reason is that there are several tools that are used as inflation hedges – gold is just one. 

More recent analysis has compared gold to other inflation hedges, such as TIPs and REITs. Whilst this analysis shows that TIPs and REITs are the most consistent hedges against inflation, gold actually ranks third in rising inflation environments, and second in persistently high inflation environments. Sensitivity to inflation is just one consideration – others include reliability, accessibility and cost. 

A similar conclusion can be drawn from the long run picture and whilst there is more work to be done, gold’s financial asset status and its value as a means of saving, ties it more closely to economic growth and money supply growth in the long run, rather than just CPI. 

Strategic case for gold

So whilst gold can be an effective inflation hedge, along with other assets, what makes gold different? When analysing the strategic case for gold there are a number of attributes that make it an attractive asset class.  

First, it can be a source of returns. Investors have long considered gold as a beneficial asset during periods of uncertainty. Historically, it has generated long-term positive returns in both good and bad economic times. Looking back almost half a century, the price of gold in US dollars has increased by an average of nearly 11 per cent per year since 1971 when the Gold Standard collapsed. Over this period, gold’s long-term return is comparable to equities and higher than bonds. 

Gold has also outperformed many other major asset classes over the past five, 10 and 20 years. The average annual return of gold in Australian dollars was more than nine per cent between December 2000 to December 2020. 

This duality of gold (its long-term performance in both good and bad economic times) reflects the diverse sources of demand for gold and differentiates it from other investment assets. Gold is often used to protect and enhance wealth over the long term as it is no one’s liability, and it operates as a means of exchange due to its global recognition.  

Demand also comes from a range of sectors, including investment, jewellery, central banks and technology. Each has different drivers making gold a unique asset class. 

A second attribute is it can be an effective diversifier. The benefits of diversification are widely acknowledged – but it is hard to find effective diversifiers. Many assets become increasingly correlated as market uncertainty rises and volatility is more pronounced, driven in part by risk-on/risk-off investment decisions. 

As a result, many so-called diversifiers fail to protect portfolios when investors need them most. Gold is different in that its negative correlation to risk assets generally increases as these assets sell off.

Thirdly, gold is a liquid asset. It is traded globally and average daily trading volumes between December 2010 and December 2020 exceeded $245 billion.

Taking these factors together suggests that gold can enhance a portfolio’s risk-adjusted returns and it is for these reasons that institutions and individuals have long recognised the strategic role of gold.  

Australia is a critical component of the global gold market – in 2020 Australia was the third largest producer of gold in the world, after China and Russia. 

It is also home to some of the largest international refineries, processing material for the domestic and international markets. And with an estimated $2.7 trillion invested in superannuation funds alone (including self-managed funds) there is an opportunity for gold to play a larger role in protecting the wealth of the nation. 

Andrew Naylor

Andrew joined the World Gold Council in 2016 and since 2020 has led its regional office in Singapore. Originally part of the central banks and public policy team, Andrew was responsible for its Islamic finance initiative, culminating in the launch of the AAOIFI Shari’ah Standard on Gold.

Andrew Naylor.

Andrew started his career at international consultancy firm Cicero Group advising financial institutions on foreign investment and trade policy in Asia, and the global regulatory reform agenda. In this role, he provided economic and political commentary for global broadcasters including the BBC, Bloomberg, CNBC and China Central TV.

To read the analysis referenced in this article, or to access the World Gold Council’s gold valuation tool Qaurum, please visit www.goldhub.com. 

This story also appears in the October issue of Australian Resources & Investment.

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