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Gold: Still a safe haven asset in times of crisis

As a high-quality, liquid asset, gold performs especially well during times of systemic crisis, helping investors preserve capital.

The unprecedented health crisis resulting from the COVID-19 pandemic which has led to widespread travel restrictions, the complete shutdown of numerous sectors, and higher volatility in financial markets than was experienced during the 2008/2009 global financial crisis – all point towards a highly likely global recession.

This article first appeared in Mining Review Africa Issue 5, 2020
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While the deceleration in economic growth is expected to impact consumer demand and result in price fluctuation, investor response to economic volatility will be supportive of gold investment demand as a safe haven in the longer term. CHANTELLE KOTZE writes.

Despite the price volatility experienced in March, it remains one of the best performing asset classes this year, with strong investment through gold-backed exchange-traded funds (ETFs), says World Gold Council head of research Juan Carlos Artigas.

In Q1, 2020, ETFs added 298 t, or net inflows of US$23 billion, across all regions – the highest quarterly amount ever in absolute US dollar terms and the largest tonnage additions since 2016.

Anecdotal evidence from the US Mint has also shown continued demand in physical bar and coin purchases.

“These are clear signs that investors are adding gold to their portfolios to protect against and hedge vulnerability during these times,” says Artigas.

On the other hand, the deceleration in economic growth and price volatility is expected to impact on gold consumer demand, with early indications of softening consumer demand emerging from China.

“Historically, however, investment flows in periods of uncertainty tend to offset weakness in consumer markets,” says Artigas.

Uncertainty drives investment demand

The World Gold Council’s 2020 outlook, released in January 2020, predicted that market risk, low interest rates and weak economic growth would drive demand in 2020.

While these fundamentals remain true, the magnitude of these have significantly increased, owing to the extent of the impact of COVID-19 and the extents of economic deceleration.

Several Central Banks around the world have lowered their rates to counter the fallout from the coronavirus pandemic on commercial banks, the economy and borrowers.

This trend has in turn reduced the opportunity cost of holding compared with that of stocks or bonds, and has driven investors that would not usually invest to add gold to their investment portfolios as an additional hedge, says Artigas.

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In terms of Central Bank gold purchases, data from the International Monetary Fund (IMF) in March, showed that Central Banks and supranational organisations, such as the IMF and the Bank of International Settlements, currently hold almost 34 000 t as reserve assets (17% of total above ground stocks), having been consistent net buyers of gold.

These buyers have collectively added approximately 4 720 t between the end of 2007 and the end of 2019.

While there has been a structural change in Central Bank demand over the past 10 to 15 years as developed market Central Banks have slowed down their net sales and emerging markets increased their net purchases, IMF data indicated an uptick purchased from Central Banks in January and February 2020, following December’s five-month low.

The World Gold Council puts the primary reason for recent gold buying down to heightened economic and political risks, low negative interest rates and the rebalancing of allocations.

While Artigas says that some Central Banks may decelerate their level of purchases, others may use gold as a way to minimise some of the volatility in their own foreign reserves as a high-quality, liquid asset during this time of uncertainty.

Volatility leads to asset sell off

Like most asset classes, gold is being affected by the unprecedented economic and financial market conditions in play around the globe.

According to World Gold Council chief market strategist John Reade, it was not the only asset to experience a sell off, with massive liquidations across all assets, including equities and bonds.

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Gold however, was likely being 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 is a high-quality and highly liquid asset, trading over $260 billion per day in March.

“This is entirely consistent with behaviour we have seen during periods of other major unexpected events, when volatility spikes to extreme levels, including the 2008/2009 global financial crisis, directly after the collapse of Lehman Brothers, when a very similar pattern of asset sales took place,” says Reade.

“Despite the sell-off that took place at the beginning of March, the price has since recovered and settled down into a more stable range it does however remain very difficult to predict whether this asset sale will continue.

“I am hopeful that the gold purchases that have taken place might have deterred others from selling their gold for liquidity purposes going forward,” adds Reade.

Future demand and supply fundamentals

While gold has remained relevant throughout the centuries, there has been an evolution in how investors interact with the metal and how they access it.

The significant improvements made to financial asset structures has facilitated new ways for investors to invest increasing demand in the metal, says Artigas.

These trends are expected to continue in future as further developments are made to the ways in which investors can access it.

While consumer demand, particularly its use in jewellery, is influenced by generational shifts and differing perceptions between older and younger generations, there is a new consumer market gaining momentum in which gold is required.

Artigas says that future demand is expected to arise from its use in technological applications, such as electronics and green technologies.

On the supply side, mines have been able to steadily increase production over the past few decades. The trend in 2019 deviated from this with the first drop in gold production in almost a decade, albeit only a slight drop.

This is a reflection of the fall of the gold price that took place 2012/2013 which resulted in many new projects being shelved while companies tried to survive at a lower gold price.

This latest trend in lower gold production may be an early indicator that gold production may drop slightly or remain flat over the next few years and potentially longer, says Reade.

While there might not be enough new mine gold production to keep up with demand, Reade is confident that when the price of gold increases owing to demand outweighing supply, existing gold will come back to the market for recycling.

Despite a period of underperformance in gold from 2013 to mid-2019, which left investors questioning whether gold was a sensible investment asset, the past 12 months have proven its ability as safe haven asset, says Reade.

While the World Gold Council argues that gold should always form part of an investment portfolio and not just for safe haven reasons, it is a clear asset investment, particularly during declining expectations for the global economy.

Investors and Central Banks in particular continue to see value in gold during these times, because gold has been a source of returns, is a great diversifier of portfolios and because it enhances the risk adjusted returns of a portfolio.

Chantelle Kotze
Chantelle Kotze is a Johannesburg-based media professional. She is a contributor at Mining Review Africa (Clarion Events - Africa) and has created content for the media brand over the past 6 years.