The following is an edited report from the World Gold Council, release on March 19, 2020. For the full report visit www.gold.org.
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, despite recent fluctuations; and it is a high quality and highly liquid asset, trading over US$260 billion per day in March
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$3.6 billion of net inflows in March, giving a collective total of US$11.5 billion.
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 for 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 early March. And gold was no exception. Even longer-term US treasuries prices fell, despite a second unscheduled cut by the Fed on March 15 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.
There is historical precedent for these types of pullbacks in gold. The correlation between gold and stocks generally turns negative as stock prices tumble. 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.
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. 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.
2. Is gold still an effective portfolio hedge given its volatility?
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.
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. And it has only been flat to slightly negative in renminbi, US dollar and Japanese yen.
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: economic expansion; risk and uncertainty; opportunity cost; and momentum.
So far this year, more than 30 central banks have cut rates and many have implemented additional quantitative easing measures. 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 stabilize. 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 jewelry 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.