Gold is back in favor

Gold has once again become a safe haven for investors. However, a return to the gold standard is a scenario that is unlikely to materialize – says Krishan Gopaul, Market Intelligence Analyst at the World Gold Council (WGC).
Gold is back in favor

Krishan Gopaul (private archives)

Obserwator Finansowy: Let’s look at the gold market. Many experts have no doubt that we are somewhere in the middle of a new “bull market”. What is the source of this relative strengthening of gold?

Krishan Gopaul: Investors have long been displeased with the negative real interest rates and the prospects of slow economic growth. So, they started looking for a “safe haven”. The uncertainty, which arose in connection with the COVID-19 pandemic, further encouraged them to invest their capital in gold. It is clearly visible, especially in Western countries, that gold is once again seen as a safe haven for money in the event of a deterioration in the macroeconomic situation.

Gold surpassed the level of USD1,920 per ounce, which has been the historical all-time high since September 2011. Over the course of the past 14 sessions at the turn of July and August 2020, the price increased in 13 sessions and this has never happened before. How long can this price rally last?

The risk of a significant economic slowdown, which was brought by the pandemic, still remains at a high level. There has also been an increase in geopolitical tensions, for instance between China and the United States. The labor markets are facing challenges which have not been seen for decades. There is also a big question mark concerning the quickly growing levels of public deficits and public debt. Bond and stock valuations are at relatively high levels. So, we really are navigating uncharted waters. This should continue to support increases in the price of gold.

Gold has been regarded as a safe investment for centuries. For many decades it has also provided protection against inflation. Will it be the case in the future, if the policy implemented by central banks leads to the emergence of high inflation?

The data indicate that this is indeed the case. Gold provides excellent protection against inflation. Let’s consider the following fact: the average annual change in the price of an ounce of gold in the USD was 10 per cent over the last 49 years, which allowed it to beat the rate of consumer inflation in the US. Importantly enough, numerous analyses — and here I can refer to the one carried out by the think tank Oxford Economics — show that gold performs well also in periods of deflation, when the interest rates are low, just like consumption and investment levels. This is because a deflationary environment generates “financial stress” among investors, which pushes them in the direction of gold. I don’t see any reasons why gold shouldn’t provide protection against inflation or deflation in the future.

The central banks in emerging markets hold gold in high esteem and are buying it. Meanwhile, the central banks of developed markets are mostly getting rid of it, with Fed as an exception. Why is there such a difference in the approach towards “the king of metals”? What actions are the central banks expected to undertake in relation to gold in the coming years?

The central banks in emerging markets have indeed been purchasing large amounts of gold in recent years. However, the banks from developed markets have not been getting rid of it. At present, they hold about 34,000 tons of gold in their vaults. Most of it is kept in vaults in Europe and North America, which is a remnant of the gold standard system. The central banks hold an average of 10 per cent of their reserves in gold, but of course this figure varies considerably, depending on the individual institution. The banks from emerging market economies typically hold much less than 10 per cent of their reserves in gold. This is the reason why they have been buying more gold in recent years. They wanted to gain better protection against geopolitical risks, negative real interest rates, potential changes in the international financial system, and the possible loss of the status of world’s reserve currency by the USD.

As we have already emphasized in the “Gold Demand Trends” report for the Q1’20, central banks will continue to keep gold in their vaults and will even purchase more. This is all the more likely considering that the pandemic increases the risk of turbulence in the economic sphere.

WGC’s data show that investment demand for gold is growing rapidly. What types of investors are exhibiting the greatest interest in purchasing gold?

Indeed, investment demand for gold has been very strong this year, mainly because of the pandemic. A lot of capital is flowing into the gold market especially from the exchange-traded funds. They currently hold record-high levels of gold in their portfolios. But this trend could be seen even before the pandemic, as investors wanted to protect themselves from the negative rates and geopolitical uncertainty.

Is it possible that in the future gold would become an important component of pension fund portfolios?

This is already happening. In recent years we’ve seen a strong trend among institutional investors — such as private investment and pension funds, insurance companies and state pension funds — to put their capital in the so-called alternative investments. They want to diversify their portfolios, moving beyond the stock and bond markets. Assets such as gold can indeed generate attractive returns, but during stock market crashes their prices can be strongly correlated with the stock market valuations, as we saw in March of 2020. Nevertheless, our analyses show that gold is a perfect supplementation of the investment portfolio, providing decent returns in the long run with high liquidity and relatively low risk.

What are WGC’s latest data on the demand for gold bars and investment coins? Could this be an investment hit of the coming years if the banking sector suffers badly after the pandemic and if there are some developments that undermine people’s confidence?

In the Q1’20, the demand for gold bars fell by 19 per cent y/y, to 150.4 tons. The demand for small bars decreased significantly, especially in Asia, which was the first region affected by the pandemic. The historically high price levels in Asian currencies have encouraged many small investors to sell, rather than to buy.

The demand for coins spiked by 36 per cent y/y, to the level of almost 77 tons. This was mainly thanks to Western investors who “remembered” about the existence of this investment category when the German economy was slowing down, and the geopolitical tensions related to Brexit were rising.

Will the demand for gold from industry and the jewelry sector grow? As you’ve mentioned, the demand for physical gold from Asia sharply declined. Is there a chance for it to recover?

It seems that in 2020 we will generally see a decline in demand for physical gold from individual investors, the jewelry sector, and industry. People in many countries have for a long time had difficulty with buying physical gold, and in many places, they still have a problem with that. Economic output is limping. The unemployment rate is rising, a growing number of small businesses are going bankrupt. The demand for gold will recover gradually, along with the return of the GDP growth rates back to normal levels.

When we look at the prices of gold expressed in the global currencies, for example, in the USD, we see that the long-term growth trend has basically been uninterrupted. Are we even able to imagine the end of this trend? What would have to happen?

I wouldn’t want to present long-term forecasts for gold or consider such scenarios. However, the long-term upward trend since the final collapse of the gold standard system in 1971 has indeed been strong and uninterrupted. This allowed gold to be as good an investment as stocks, and even better than bonds.

Is it possible to assess the intrinsic value of gold? What should be taken into account in such a model?

Gold cannot be valuated with methods that are used for the valuation of listed companies. It does not pay out dividends, and there are no revenues, so this cannot be done using the discounted cash flow method. It has no book value, it does not generate profits. However, its great advantage is that it can serve as money, and also that it doesn’t carry credit risk, that is, the risk of bankruptcy of its issuer. Gold is a unique investment asset. The demand for gold may increase both as a result of positive and negative developments in the world economy. If the economic situation in one region of the world is unfavorable, but it is good in other places, this does not have a negative effect on gold.

Due to these specific characteristics of gold, and due to the lack of revenues or dividends, gold can only be valuated intuitively. Its value is simply the result of the game of supply and demand. It is precisely the careful observation of supply and demand that gives investors a chance to anticipate price trends for gold. In order to enable better and more accurate valuation of gold, at the WGC we have developed a tool known as Qaurum, as part of the Gold Valuation Framework project. Based on quantitative methods, it allows us to forecast the changes in the price of an ounce of gold in given conditions and following the implementation of selected scenarios. We want it to contribute to the process of demythologizing gold and its features, and to help investors adapt the tactics of investing in gold to the market conditions.

Would it be possible to return to the gold standard?

At present it seems that this is a scenario with a very low likelihood of materialization. While it is true that the world has entered a period of high political and economic uncertainty, this does not mean that we are moving in the direction of the gold standard. The restoration of the gold standard system would require the societies around the world to lose confidence in paper currency. That is difficult to imagine.

The gold/silver ratio is at record-high levels. Why and how long will this situation last?

There are certain similarities between gold and silver, both in the structure of demand and supply. Of course, both are precious metals, used both in industry and in jewelry. Both are investment assets. But in reality, even though hardly anyone seems to be aware of this, at present these two metals don’t have a lot in common. As evidence, we just have to look at the low level of correlation between silver and gold since 2011. Frankly, at the WGC we don’t really have an opinion as to the future behavior of the ratio that you’ve mentioned.

Could Bitcoin or other cryptocurrency be able to serve as “digital gold” in the future? Could it replace gold as a “safe haven” protecting value against geopolitical risk or inflation?

In our opinion, cryptocurrencies are not and will not be a substitute for gold, and they don’t have any advantages over gold. The price of gold is less volatile than the prices of cryptocurrencies. The gold market is a deep, global market. Gold is an asset with a well-established position. We’re not saying that cryptocurrencies will not play any role in the global financial market. However, their behavior, even during the current crisis associated with the pandemic, shows that they cannot replace gold in its role as a “safe haven”. Investors have greater confidence in gold – it’s clear to see.

According to some sources, approximately 190,000 tons of gold have been mined thus far, and about 54,000-64,000 tons are still underground. At the current rate of extraction, these resources would last for about 20 years. Could gold resources really be exhausted within a few decades?

According to WGC’s estimates, 197,576 tons of gold have been mined as of the end of December 2019. Moreover, around two-thirds of that amount have been mined since the late 1950s. Because gold is very difficult to destroy and is not subject to corrosion, almost all the gold mined throughout the history of the world still remains above the surface of the planet in one form or another.

The data on the gold remaining underground comes from mines and mining companies. These deposits can be grouped into two types. The first are the recoverable resources, which can be mined right now due to economic reasons. The second are the deep resources, which could possibly be extracted, but the costs would be extremely high unless there are significant improvements in technology. The former category of gold deposits is indeed estimated by the US Geological Survey at about 54,000 tons.

When it comes to the deep resources, at this point it’s not easy to estimate their size. We should also keep in mind that not all of them have necessarily been identified. Besides, underground gold resources are ultimately extracted over the long term. So, in reality it is difficult to say how much gold remains under the surface of our planet. The only thing that is certain is that it is a finite amount.

Krishan Gopaul is an expert at the World Gold Council’s Market Intelligence Group.

Krishan Gopaul (private archives)


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