From time to time, Morningstar publishes articles from third party contributors under our "Perspectives" banner. Here, Philip Poole, Global Head of Macro and Investment Strategy at HSBC Global Asset Management, explains the continued allure of the ultimate safe haven and says the fundamentals are still supportive of the gold price. If you are interested in Morningstar featuring your content, please provide your details here.
All That Glitters
The stellar performance of gold in recent years has reflected its role as a safe haven in a perfect global financial storm and concerns that ultra loose monetary policy in the developed world--including so-called quantitative easing in the US and UK--would debase major currencies, particularly the US dollar in our view.
The gold price is normally determined by a combination of global real interest rates, the value of the US dollar and risk aversion (so-called ‘safe haven’ demand) plus net supply from new production and changes in stocks held by central banks. As with most commodities, demand from China and India has become much more important in shaping the gold price. Moreover, it seems that Indian buying, in particular, has extended beyond jewellery to gold as a monetary asset as part of savings. These two markets accounted for more than half of all global gold demand in 2010. The price tends to vary inversely with the strength of the US dollar, although this can break down in times of heightened risk aversion when investors tend to turn to gold and to US treasuries--and so the US dollar--as safe haven assets.
The gold price normally also reflects the stance of monetary policy. Precious metals, including gold, do not provide a running yield so their attraction tends to fall when real yields rise. In situations where inflation risks are rising or liquidity conditions are particularly loose – the recent period of quantitative easing being a classic example--gold is seen as a hedge against currency debasement and tends to find investment support.
Central Banks Want It Too
The supply of new gold production only responds to price increases with a substantial lag as it normally takes investment and time to bring new supplies on stream. In fact, production was down by almost 2% in 2010, adding to upward pressure on the gold price. Changes in central bank stocks of gold can make a bigger difference to net supply than changes in production because of the huge size of stocks relative to annual production. Central banks are the holders of the largest stock piles of gold. For many years they were net sellers of gold. They preferred to own assets that generated a running yield because the focus was on improving the rate of return on their assets.
Concern about dollar weakness and debasement from ultra loose monetary policy has helped to change this and central banks have become a source of net demand for gold not net supply. India, China and Russia have recently been buyers of gold in an effort to diversify their foreign exchange reserves away from excessive dependence on US treasuries and other US dollar-denominated assets.
Fundamentals Still Supportive
This change in central bank demand is an important structural difference in net supply and demand conditions relative to the past and it seems set to continue. Central banks in the emerging world remain keen to diversify away from the US dollar and the attraction of precious metals, including gold, is unlikely to fade anytime soon. In addition, looking to the future, in our view gold should continue to benefit from supportive private sector demand from the emerging world, particularly in view of the fact that developing economies in Asia seem set to continue to grow rapidly and real interest rates in much of the developed world are likely to remain very low for some time to come.
Chart gold's price performance here.
Disclaimer: All views expressed in this third party article are those of the author(s) alone and not necessarily those of Morningstar. Morningstar is not responsible for the comments nor will it be liable in any way for any information provided by the author.
