2013 has seen a renewal of risk appetite and with that has come concern about the outlook for gold. A recent World Gold Council (WGC) commentary notes that the metal ended 2012 on a bittersweet note, but adds that the metal’s ability to put a 12th notch in its string of annual gains reflects underlying drivers. Overall, the organization’s report brushes away pessimism about gold and outlines the metal’s potential in the current environment.
The WGC report does not deny that the gold market has faced challenges and experienced weakness. It notes that during the fourth quarter of 2012, gold prices declined in many currencies, including the dollar, euro, yuan and rupee. Across the currencies, gold fell an average of 6.2 percent.
Gold volatility was at one of the lowest quarterly levels seen in nearly a decade. Market transaction volumes, already low throughout 2012, were even lower in Q4 relative to the rest of the year. And during that period, when market participants were active, selling pressure dominated, as per the WGC.
Last year, many insisted that loose monetary policy would stoke fears and drive demand for the yellow metal, but according to the WGC, these measures had the opposite effect.
“[T]he combined efforts of the Fed, European Central Bank (ECB) and Bank of Japan (BOJ) to underwrite markets with promises of unlimited monetary support served to quell nervousness, as did the results of the US elections,” the organization said.
Now, midway through the first quarter of a new year, gold prices are struggling to gain momentum as investors display renewed appetite for risk and declining interest in safe havens. Some are concerned that gold will struggle to find a role in this environment, but the WGC isn’t so sure.
Equities and gold demand
Recently, global equities have rallied as investors pour money into risk assets. The WGC report notes that strength in these markets may be seen well into 2013. While many view investors shifting from bonds to equities as a disadvantage for gold, the report states that general risk aversion does not preclude prudent risk management and portfolio diversification. In fact, the reduction of safe-haven bond exposure provides an opportunity for gold to play a larger role in value preservation.
Emerging markets are the largest consumers of gold and many have improving economies. Additionally, their central banks have continued showing support for the gold market, while strength in their equity markets is fueling domestic sentiment, creating a positive feedback loop. The WGC report states that the role of such sentiment should not be underestimated.
China is one nation that is experiencing economic improvement. Debates over the possibility of a hard landing for the country have subsided. Now, following wide-scale improvement in areas such as equities, trade, manufacturing and services, the WGC believes that the resumption of growth is on the cards. Even so, the organization’s report points to the nation’s corrosive inflation as strongly supportive for gold demand — both for wealth creation and wealth protection.
India, another major gold consumer, continues to battle inflation and low levels of economic activity. As long as this battle continues, the WGC believes that investors are likely to remain cautious. Although demand fell last year and the government continues to implement policies that discourage gold purchases, the WGC sees the rupee as an important factor for the country’s gold demand.
The report notes that rupee volatility has been declining since October. More stable foreign exchange rates are therefore expected to provide comfort to gold investors who typically shy away from purchases when volatility is elevated.
Turning to the developed world, the WGC believes the re-election of Japan’s Liberal Democrat Party led to tough rhetoric on the economy and regional diplomatic crises. Both the expansion of unconventional monetary policy and the geopolitical tension stemming from this victory provide support for gold.
Furthermore, “[u]nlimited quantitative easing with an inflation target of 2% is a bold step for a country battling with deflation, a gross debt ratio more than twice its GDP, a 10% budget deficit, a rising exchange rate and a falling current account balance,” the WGC report states.
The marginal impact on yields already suggests that skepticism exists in the bond market. Pension funds’ demand for gold may be only a trickle now, the report notes, but if the country’s fiscal credentials deteriorate and central bank credibility comes into question, investment demand could be underpinned.
It was widely believed last year that a crisis in Europe was imminent. But the ECB came to the rescue with its commitment to make unlimited bond purchases. That led to a steep decline in peripheral countries’ bond yields and reduced exit and default fears. But the WGC report warns that markets will likely put the region’s central bank to the test. Whether the ECB will cough up the cash when funding is required remains to be seen.
The unexpected consequences of austerity must also be considered. Thus far, it appears that the negative effects have been greater than anticipated. Indicators such as rising unemployment and declining production in Germany suggest that the region’s economy is headed in the wrong direction. Overall, Europe appears far from safe ground and the WGC report warns that Eurozone concerns may reignite this year.
Then there is the US. Its appetite for gold is small compared to likes of China and India, but its influence on the market and the global economy is hefty.
The WGC believes that the US avoided the biggest threat to economic growth when it managed not to go over the fiscal cliff. And a pick up in consumer spending and corporate investment, combined with the nation’s aversion to public spending cuts, may position this nation as one of the brighter economies in 2013.
Many gold investors have made it clear that they view improvement in the US as a threat to gold, but the WGC argues in its report that that is not necessarily the case.
Positive growth, lower consumer uncertainty and greater business visibility all lend themselves to an increased propensity for discretionary spending — a driver of gold demand in the jewelry and technology sectors, which together account for over 50 percent of annual gold demand, the report states.
Furthermore, some are concerned that the US’ economic improvement will lead to interest rate hikes and bring an end to quantitative easing.
The WGC report dismisses such suggestions as nothing more than optimism, as numerous structural issues still exist.
“An end to unconventional policy and a rise in interest rates will need to very carefully orchestrated and are unlikely to occur for some time,” the report states.
Furthermore, the WGC deems it unlikely that the US will unwind its policy. That’s because the other three major economies that embarked on a similar path — Europe, the UK and Japan — are not even close making that step. The organization argues in the report that unconventional policy appears to be a concerted effort to achieve a unified, global impact and it would odd for the US to make a unilateral change.
Though growth prospects have brightened and sentiment has improved, the WGC report warns that risks remain abundant. The organization is confident in gold’s continuing role as a capital preserver during times of market stress. Investors are also reminded that demand is determined by a globally diverse set of drivers, not least of which is economic expansion, as evidenced by the massive demand from emerging markets.
Securities Disclosure: I, Michelle Smith, hold no direct investment interest in any company mentioned in this article.
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