While the WGC says inflation risks are still the strongest fundamental on gold prices, central bank policy and gold purchases are a growing force on price direction.
In the World Gold Council’s just-released quarterly Investment Statistics Commentary for the third quarter, the nonprofit association of the world's leading gold mining companies clearly shifts the focus of what’s moving the yellow metal’s price more and more toward central banks.
For the WGC, the various ways central banks are employing “unconventional monetary policies” are playing a bigger and bigger role in affecting the price of gold.
First, let’s take a step back from watching the daily or weekly movements of the metal to review.
Gold prices, while fairly flat during the beginning of the third quarter, rose steadily during the last part of the quarter. That climb resulted in an 11.1 percent increase in closing price when compared to the previous quarter.
However, when you look at the average price for each quarter, the increase was only 2.6 percent quarter-over-quarter. Volatility dropped during the quarter and gold’s correlation to other assets didn’t change much compared with the previous quarter either.
From a global gold investor’s perspective, most of the big news came from central banks hinting at or announcing plans to extend or expand their “unconventional monetary policy” (which the WGC uses to mean pretty much anything other than interest-rate manipulation).
Since policy meetings weren’t scheduled until the later half of the third quarter, many investors held off making decisions until after they could read the defense, so to speak, seeing what the central banks were actually going to do. At the same time, data available on central bank purchases shows that many countries continue to add to their gold reserves.
In July and August, Korea added 16 tonnes, Russia added 18.7 tonnes and Turkey gorged on 51.3 tonnes. (September data won’t be available until next month.)
By September, the central banks of Europe, Japan and the United States had all committed to further stimulus. China started a new infrastructure-spending program to the tune of $158 billion, and India promised to lower barriers to foreign investment.
The WGC notes, “Weakening economic data had finally spurred a concerted reaction by central banks, leading to a sharp rally in asset prices as the long wait for further easing came to an end.”
While many investors are looking at these actions as a bad omen for global economics, flooding the world with excess currency, one way or another, it’s seen as good news for gold investors. Bernard Sin, head of currency and metal trading at refiner MKS in Geneva noted back in September, “Gold is given a boost on the back of anything that is a form of quantitative easing.”
Expanding on that core premise, John Reade, senior vice president at Paulson & Co., said in an article in Bloomberg on Thursday, “There is no doubt the expectation or the announcement of QE4 or QE infinitive has been positive for gold and I would expect gold will do well in this environment where central banks will continue to print and where monetary policy is still in an extraordinary condition.”
It’s an interesting shift in the conversation about gold. While much of the popular press on gold in the past few years has focused on either “end of the world”-type fatalistic buyers, or the pure inflation hedge, more of the discussion is now directly about the role of central banks, in many ways (not just inflationary).
Easing monetary policy pushes gold prices up as a response to perceptions about increased inflation risk (and thus, the declining value of a dollar). But the WGC posits that, while inflation risk is the largest motivating factor, unconventional monetary policy also has additional effects that move gold as well, and they are:
1) Currency impact
2) Support of assets prices
3) Response to low interest rates
The amount of money in the economy is clearly related to the rate of inflation — too much money chasing too few goods equals rising prices. So far, it looks like the policies have increased the monetary base without increasing the monetary supply in most countries. However, the WGC notes that monetary supplies are likely to increase over the long term, possibly leading to higher inflation.
Right now, the WGC notes, “While the inflation needle has yet to move, there appears to be a willingness to tolerate a higher rate of inflation in the future to ensure the sustainability of fragile economic growth.” The WGC points out that this is likely positive for gold investment.
In the current economic environment, strengthening the economy often means boosting exports, and that, in turn means many countries want a weaker currency. These policies aimed at tweaking currency strength to increase exports also have an impact on gold prices.
Since gold is typically priced with reference to U.S. dollars, investment in the metal can provide a hedge against an investor’s concern about a U.S. “weak dollar” policy.
Looking at the strength of the U.S. dollar itself, it may be in trouble. Peter Schiff said during IndexUniverse’s Inside Commodities conference this month, “The closest thing I know to being a sure thing is that the U.S. dollar is going to depreciate. Faced with a weakening outlook, gold and other precious metals are a perfect hedge against the loss of purchasing power.”
Support Of Asset Prices
One interesting idea from the WGC analysis is that central banks are essentially gold buyers of last resort—if the price of gold halved, they would gobble it up as fast as they could.
By purchasing bonds, central banks have shown that they will also step in, such as they did with buying AIG bonds, to support the price of other assets. (In the case of AIG, the Fed managed quite a tidy profit when the last of the assets were sold off back in August.) The Word Gold Council puts it this way—“The willingness of central banks to engage in protective strategies provides an implicit ‘put’ option—an implied guarantee to prevent precipitous falls in asset prices.”
Given the propensity of emerging markets central banks to continue hoarding gold at current prices, the idea that there’s an implied put here makes a ton (pardon the pun) of sense.
Low Interest Rates
One motivation for unconventional monetary policy is the belief that households will increase spending in times of low interest rates. But, given low interest rates, households will have to save even more money to pay for future expenditures like retirement and college, because their savings are not growing as quickly.
The WGC suggests these low interest rates will likely cause a shift from traditional savings to investment in real assets that will “provide long term and real security.” Additionally, Western investors may look to emerging markets for investment purposes because the relatively higher real rates are attractive and the risk-adjusted returns “appear more favorable.”
This flow of capital from developed markets to emerging markets impacts wealth creation, and wealth creation drives gold demand in those emerging countries, where gold-buying as a store of wealth is often culturally embedded far more strongly than in the industrialized world.
WGC: Gold Is Good
In the end, it is no surprise that the World Gold Council is bullish on gold’s long-term strategic investment picture. “The backdrop of negative real yields, a slow recovery and a likely continuation of expansionary monetary policies—with all the risks these present—provides further support to the long-term strategic investment case for gold.”
(A quick note: The Investment Statistics Commentary replaces the Gold Investment Digest that was released by the World Gold Council until the second quarter of last year. Investment data is published monthly and is now organized by country. It covers price performance, exchange rate effects, correlations and volatility of gold and other assets. All other data on investment (amount and breakdown by type) is covered in the Gold Demand Trends report. The Investment Statistics Commentary is released quarterly and focuses on the economic, financial and gold market influences on gold performance.)