Investment demand for gold will remain strong in 2020, spurred by higher risk and lower opportunity cost, says Juan Carlos Artigas, Executive Director and Head of Research, World Gold Council (WGC), in an exclusive interview with BusinessLine.
He thinks gold’s behaviour thereafter may depend on the speed of the recovery and the duration of monetary policy and fiscal stimuli. He also explained the utility of the Quarum tool introduced on the WGC website. Excerpts from the interview:
What is the objective behind the Quarum tool that has been put on the WGC website? Who is it directed at?
The objective is to provide anyone interested in gold markets with a tool that allows them to understand how different macro-economic variables and scenarios influence gold performance.
It is particularly useful for investors looking at gold as a strategic asset to see how the metal will perform over a longer period of time.
There are four drivers used in the Quarum — economic expansion, risk, momentum and opportunity cost. Which driver carries higher weight in the algorithm?
That’s an interesting and important question. We have a full methodology page on Quaraum on our website.
The tool looks for balance or imbalance created by demand and supply. To give you an example, from our quantitative work, we know that gold jewellery sales can be explained by GDP growth and also it has a negative relation to price.
However, investment demand is influenced by risk metrics — credit spreads, interest rates, etc.
For investment demand, the relationship to price tends to be positive. What the algorithm does, based on macro economic variables, it figures out how gold demand and supply will move.
Most of the time, if you hold the price constant, there will be an imbalance between demand and supply.
The tool tries to find the implied return in gold that will bring the market back to equilibrium. To answer your question, the weight of each variable will vary depending on the macro-economic environment and the time horizon.
The methodology allows interplay between the investment and consumption demand for gold that are, in fact, moving against each other.
In 2020, for instance, we have seen investment demand increasing even as consumption demand has been decelerating.
We are witnessing higher investment demand for gold, of late, driven by gold ETFs, compared with consumption demand. How long will investment demand sustain?
That depends on the economic condition. But what we know from our quantitative analysis is that a combination of high risk and low opportunity cost, as captured by measures of risk and uncertainty, supports investment demand.
When this state is combined with accommodative monetary policy and negative interest rates, it’s good for investment demand.
If these conditions prevail, then investment demand can continue. As you pointed out, investors are already trying to hedge or protect their portfolios by adding gold.
Is price also a factor driving gold demand, because gold has been one of the best-performing asset classes over the past two years?
Indeed, there is a positive momentum as well in the financial market, and as gold prices perform well, there is more investment demand. But what is interesting about gold is its dual nature. The returns will be supportive of investment demand, but they also have a negative impact on consumer demand, jewellery or technology demand.
What we also know, looking at historic data, is that investment demand tends to offset consumer demand in such periods.
Will demand for gold bars and coins reduce going ahead, with demand shifting to gold ETFs (exchange-traded funds)?
I think there has always been room for gold bars and coins, even in places like the US or Europe, where gold-backed ETFs are very well-established. Different vehicles for gold investment meet different objectives and they do not impact demand for other vehicles.
Since gold-backed ETFs are backed by physical gold, they also impact gold demand. These vehicles have expanded the market for gold, as they are more cost- effective. But if you see, over the longer term, gold bars and coins form a much larger portion of the gold investment demand.
How do you see the demand from global central banks going ahead?
We do expect central banks to be net buyers this year. We also don’t expect the central bank purchases to be as strong in 2020 compared with 2018 and 2019; central bank purchases had touched multi-decade records then.
But even through March 2020, we have seen net purchases from central banks.
We conducted a survey of central banks across the world recently, which shows that central banks still consider gold as a very important part of their portfolios, especially at a time when there is pressure on fiat currencies. Gold helps to hedge some of the credit risk.
There are certain phases when gold price movement is not inversely related to equity markets. We saw one such phase in March. What is your view on such phases?
There was a period in March when there was widespread asset liquidation that affected all asset classes, even long-term treasuries. Investors were looking for cash, some to meet margin calls or just to come out of some of their portfolios.
Gold also fell during that phase, but then gold recovered after that, so the fall was temporary.
And, as you mentioned, gold, along with US Treasuries, is one of the best-performing asset classes this year. The current conditions caused by Covid-19 is unprecedented in many ways, but when we look back in history at previous periods of economic crisis, for instance, the global financial crisis, we see that there was volatility, but gold was one of the assets that managed to end with net positive returns.
We are still trying to understand the impact of the Covid-19 pandemic — there could be volatility in gold prices this year, but as long as there is higher risk and low opportunity cost, the investment demand will sustain.
Do you have data on how gold prices performed during the great depression in 1929-30?
Yes, we do. When we look back at that period, gold and dollar were linked, as gold standard was followed by countries back then. The US government devalued the value of the dollar relative to gold prices in that period. The performance of gold in that period is, therefore, not comparable to the gold prices today.
But our study shows that if we see the trend over the last century, all currencies have been devaluing in relation to gold.
Besides the GDP contraction impacting consumer demand, do you also see a structural decline in gold consumer demand due to changing habits in India and China?
We did a consumer research survey of 18,000 people around the world, across generations, from different segments and so on. There are attitudes changing across generations, but we also found opportunities for the gold market.
There are conversations about how millennials prefer experiences, but what we do not know is whether their preference changes as they grow older, and that is something we are trying to find out — if their views on financial assets, savings change as they grow older.
But interestingly, gold still remains relevant in India, across generations, more than the other parts of the world, according to our survey.