Graham BuckIn troubled times, gold represents a haven for investors. This traditional wisdom was apparently again demonstrated a decade ago. In the wake of the global financial crisis, the price of gold rose steadily, to peak in 2011 at more than $1,900 an ounce.
However, the previous metal’s finest moment came more than three decades earlier at the start of the Eighties. Russian tanks had rolled into Afghanistan; the world was feeling the impact of the second oil price shock in six years following the Iranian Revolution, while inflation was strong and the outlook uncertain.
In January 1980, gold reached a then-record $850 an ounce (which, adjusted for inflation, represents similar buying power of around $2,730 today). It wouldn’t surpass this level until 28 years later, in January 2008 when the world’s financial system was fast deteriorating.
No need for safe havens?
Gold has performed well so far this year, but at around $1,330 an ounce the price is some way off its record high. Helped by a weaker dollar, the metal has risen by around 7% since mid-December, but last week saw recent gains trimmed as the greenback rallied.
So how strong are gold’s prospects over the remainder of 2018? Historically, the price has performed well in periods of economic uncertainty or high inflation. By contrast current economic growth is robust – and in sync around the world for the first time in more than 10 years. Inflation still relatively subdued, despite concerns of an imminent pick-up and corporate earnings this year should be strong, with US companies further helped by recently-agreed tax cuts.
Chart: GoldPrice.comIndeed, when Wall Street underwent a sharp correction early this month, there was little evidence of investors flocking either to gold or other traditional ‘safe haven’ assets. This had much to do with the fact that the favourable economic fundamentals haven’t suddenly changed, so the start of any bear market doesn’t look likely just yet.
Demand for gold
Citigroup’s analysts are among those confident that gold will achieve decent, if unspectacular gains in 2018. The bank’s analysts recently upped its forecast for the year by 7% to $1,355 an ounce and its six-to-12 month price target to $1,385. In a note to clients Citigroup cited “higher inflation, solid hedging demand, a softer dollar and improving consumption in China provide a supportive environment for prices.”
That would contrast with 2017, when global demand was 7% down at 4,071.7 tonnes – an eight-year low. Investment demand fell by a quarter, reflecting lower inflows into bullion-backed exchange traded funds.
China and India are major consumers of the metal. China is the world’s largest producer of gold and the biggest market for gold bars and coins. Strong domestic demand and a growing number of young consumers saw a total of 953.3 tonnes sold during 2017 and that steady growth is likely to continue.
India, where demand had fallen off in 2016, recovered last year with 726.9 tonnes sold. This was despite a 24% year-on-year drop in the third quarter, following the country’s introduction of a Goods & Services Tax (GST) and tough anti- money laundering (AML) legislation directed at jewellery retail transactions.
Laad Bazar, Hyderabad. India, a major gold consumer, is seeing renewed growth in demand: Wikimedia CommonsFour growth drivers
Not surprisingly, the World Gold Council was bullish in its recent annual outlook for gold’s performance in 2018. “Over the long run, income growth has been the most important driver of gold demand,” said the WGC’s chief market strategist, John Reade. “And we believe the outlook here is encouraging.”
The industry’s market development organisation cited four key market trends to support its optimism:
Synchronised global economic growth in 2018
The economies of both China and India are set for a strong year with real gains in both corporate earnings and personal incomes. This means robust demand for gold jewellery and technology that uses gold in industries ranging from aerospace to healthcare.
Rising interest rates
Three further US rate hikes are expected this year from the Federal Reserve, while other central banks are likely to follow the Fed’s lead in edging rates higher or easing off expansionary policies such as quantitative easing (QE). After the calm of recent years, market volatility is likely to increase again and make gold a more attractive asset.
Frothy asset prices
Despite the correction three weeks ago, equity markets in the US and elsewhere remain near record highs and investors have been seeking other risks for additional returns. This has “fuelled rampant asset price growth elsewhere”, reports the WGC. With analysts and investors cautious on how much additional risk to take on, the odds on a correction in global financial markets are shortening and increasing gold’s appeal.
Greater market transparency
The past decade has seen financial markets become more transparent and efficient, providing broader access for all types of investor. In 2017, new initiatives included trade data reporting by the London Bullion Market Association and exchange-traded contracts from the London Metal Exchange that aim to improve price transparency. India is working on a national spot exchange to streamline the market.
The case against
“Compared to stocks, gold is looking like a bargain,” said one analyst this month. The gold to S&P 500 ratio (a measure of how many ounces of gold it would take to buy the S&P 500 in any given month) is at its lowest point in 10 years. But not everyone is convinced.
Veteran investor Warren Buffett is known to have never been particularly bullish on gold – or any other precious metal. “The problem with commodities is that you are betting on what someone else would pay for them in six months,” he noted. “The commodity itself isn’t going to do anything for you.”
A celebrated study by former fixed income and commodities manager Claude Erb and finance professor Campbell Harvey found that gold is only a decent inflation hedge when measured over a period of 100 years-plus. “Over practical investment horizons, gold is an unreliable investment hedge,” they concluded.
More recently, Jason Hall of Brookfield Infrastructure Partners, which focuses on long-life assets in the utilities, transport, energy and communications sectors globally, outlined what drives his company’s investment policy.
“Instead of trying to time the market – which the experts fail to do all the time - a better approach is to invest in a business with the characteristics to provide some of what makes gold attractive – but can also do well in almost any environment,” he recommends.