Gold had its best performance since 2010, rising by 18.4% in US dollar terms last year. It outperformed major global bond and emerging market stock benchmarks over that period.
In addition, gold reached record highs in most major currencies except the US dollar and Swiss franc.
Gold rose most between early June and early September as uncertainty increased and interest rates fell.
But investors’ appetite for gold was apparent throughout the year, as seen by strong ETF flows, robust central bank demand and an increase in COMEX net longs positioning.
High risks and low rates on the horizon
The Gold Council expects that many of the global dynamics seeded over the past few years will remain generally supportive for gold in 2020.
In particular, the Council believes that:
- Financial and geopolitical uncertainty combined with low interest rates will likely bolster gold investment demand
- Net gold purchases by central banks will likely remain robust even if they are lower than the record highs seen in recent quarters
- Momentum and speculative positioning may keep gold price volatility elevated
- And that gold price volatility, as well as expectations of weaker economic growth, may result in softer consumer demand near term but structural economic reforms in India and China will support demand in the long term
A supportive environment for gold investment
Looking ahead, the Gold Council believes investors – including central banks – will face an increasing set of geopolitical concerns, while many pre-existing ones will likely be pushed back rather than being resolved.
In addition, the very low level of interest rates worldwide will likely keep stock prices high and valuations at extreme levels.
And although investors may not step away from risk assets, anecdotal evidence suggests they are increasing exposure to safe-haven assets like gold to hedge their portfolios.
One of the key drivers of gold, especially in the short and medium term, is the opportunity cost of holding it relative to other assets, such as short-dated bonds.
Unlike bonds, gold does not pay interest or dividends because it does not have credit risk. This perceived lack of yield can deter some investors.
But in an environment where a quarter of developed market sovereign debt is trading with negative nominal rates – and once adjusted for inflation, the Council’s analysis suggests that a whopping 90% is trading with negative real rates – the Council believes the opportunity cost of gold almost goes away, even providing what can be seen as a positive “cost of carry” relative to bonds.
This is further evidenced by the strong positive correlation between the amount of debt and price of gold over the past four years. To some degree this illustrates the erosion of confidence in fiat currencies due to monetary intervention.
And the low rate environment is unlikely to change any time soon. Many central banks – the highest number since the global financial crisis – are cutting rates, expanding or implementing quantitative easing and, in some instances, doing both.
In fact, gold has historically performed well in the 12-to-24-month period following policy shifts from tightening to “on-hold” or “easing” – the environment in which we currently find ourselves.
And, historically, when real rates have been negative, gold’s average monthly returns have been twice as high as the long-term average.
Even slightly positive real interest rates may not push gold prices down.
Effectively, the Council’s analysis shows that it has only been in periods with significantly higher real interest rates – an unlikely outcome given the current market conditions – that gold returns have been negative.
Gold volatility may rise
As the gold price significantly rose in 2019 so did volatility, but, similarly to other assets, it remains well below its long-term trend. The Council does not anticipate a reduction in gold volatility near term.
Should the economic and political environment deteriorate, it may even rise, especially as gold volatility historically exhibits a positive skew in such circumstances, tending to increase as stocks pull back.
Weak economic growth may affect consumers
Market surveys indicate that most economists expect growth in 2020 for most countries, with a few forecasting contractions in major economies by 2021 or 2022.
However, median forecasts also show an expectation of softer global economic growth relative to 2019.
This, combined with gold price volatility at or above current levels, may discourage jewellery consumers and cause technology demand to soften.
Budgets of Chinese consumers are shrinking and their habits changing
The slowdown in China’s economy growth and rising staples’ prices have been squeezing consumers’ budgets. And while ostensible progress in trade negotiations with the US may restore some confidence, uncertainty lingers.
With tighter budgets and higher expenditure on staple goods consumers will likely limit their consumption of luxury items, putting pressure on China’s jewellery demand.
Concern about the global economy has spurred the increase in gold price as central banks adopt a more dovish tone and the FED cutting interest rates.
In addition, demand from younger consumers is shifting towards innovative jewellery pieces with fashionable designs and lighter weights – a divergence in sales of traditional and innovative products that we expect will continue in 2020.
Gold price volatility and higher taxes may deter Indian consumers
The Indian Goods and Services Tax (GST) – introduced in 2017 – rose last year across many categories.3 And gold import duty increased from 10% to 12.5%.
Until tax cuts are introduced as a credible incentive to spur economic growth – the infrastructure for which may not be available until 2021 – higher taxes are exacerbating the impact of the record high local gold price on consumption.
And while the introduction of mandatory hallmarking for gold jewellery at the beginning of the year may enhance consumer trust, this potential initial disruption should not be ignored.
In all, we believe consumer and gold trade sentiment may remain soft through 2020.
Economic reforms may improve long-term demand
Both China and India are implementing economic reforms geared towards strengthening growth and internal consumption. In China, the “belt and road” initiative should also strengthen its regional role and reduce dependence on the West.
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In India, policy reforms designed to bring transparency and an orderly trade structure to many sectors of the economy are expected to improve confidence, remove inefficiencies and promote growth.
The Council expect these factors to be a long-term positive for gold demand although their effects may take time to become apparent.
Valuing gold through demand and supply
Gold does not conform to most of the common valuation frameworks used for stocks or bonds. Without a coupon or dividend, typical discounted cash flow models fail. And there are no expected earnings or book-to-value ratios either.
Its dual nature as a consumer good and an investment means that jewellery demand can be boosted by economic growth even if investment demand may fall amid lower uncertainty or higher interest rates. These seeming contradictions can pose challenges, but they can make gold an effective strategic asset.
In fact, the Council’s research shows that valuing gold is intuitive.
Its equilibrium price is determined by the intersection of demand and supply.
Gold’s performance can be explained by four broad sets of drivers:
- Economic expansion: periods of growth are very supportive of jewellery, technology and long-term savings
- Market downturns often boost investment demand for gold as a haven
- Opportunity cost: the price of competing assets, especially bonds, currencies, and to a lesser degree, other assets, influence investor attitudes towards gold
- Momentum: capital flows, positioning and price trends can ignite or dampen gold's performance
Generally positive implied performance for 2020
Gold rallied by 4% in December 2019, increasing by an additional 6% by 7 January 2020.
While the Council believes that there are various reasons for this move, tensions in the Middle East linked to the US-Iran confrontation ultimately pushed the price to an almost seven-year high in early January.
Subsequent comments by President Trump aimed to ease concerns, pushing the price down to the US$1,560/oz-US$1,550/oz level as of 10 January 2020.
Yet, the commodity remains still 2.6% higher relative to the end of 2019.
The council expect that investor positioning related to this specific event will likely influence gold’s performance in the near term. But over the medium term, broader financial and geopolitical uncertainty and developments in monetary policy will play a more important role.
For example, using Qaurum, the Council analysed the performance as implied by four different hypothetical macro-economic scenarios provided by Oxford Economics.
- a global deceleration
- a US-led recession
- a more pronounced slowdown in China
- an economic improvement in emerging markets
The result of the analysis suggests that, in general, gold may see a positive performance in 2020.
While some of the scenarios – with the exception of an economic upturn in emerging markets – could result in lower consumer demand, its dampening effect on price performance will likely be offset by potentially robust investment demand on the back of deteriorating credit conditions and stable to lower interest rates.
It is important to note, however, that this is not a comprehensive list of possible scenarios. Instead, they reflect key investor concerns as per Oxford Economics’ Global Risk Survey.
Therefore, hypothetically, improving market sentiment – for example, a reduction on perceptions of risk, a lower likelihood of further rate cuts by the Fed or other major central banks, or tighter monetary policy through means other than rate cuts – could put downward pressure on gold’s price performance relative to the scenarios currently available on Goldhub.com.