The World Gold Council (WGC) has said it believes gold will become even more relevant this year owing to “its proven record” for delivering returns, its low correlation to major asset classes, its liquidity and its risk-adjusted returns.
Looking ahead, the council expects gold demand to benefit from the interplay of market risk and economic growth, with key dynamics, such as financial market instability, monetary policy, the dollar and structural economic reforms, likely to influence the precious metal’s performance in 2019.
This forecast comes on the back of the commodity having faced significant headwinds for most of 2018. A strong dollar, rate hikes by the US Federal Reserve (the Fed) coupled with accommodative policy from other central banks and a US economy buoyed by tax cuts, fueled positive investor sentiment and pushed US stock prices higher through the start of October.
However, as geopolitical and macroeconomic risks increased, emerging market stocks pulled back and developed market stocks eventually followed.
This resulted in short-covering in gold, with its price ending the year near $1 280/oz, outperforming most global assets. This is a 1% decline year-on-year, the council said in a report, published on Thursday.
In the new year, meanwhile, the WGC expects growing market uncertainty and the expansion of protectionist economic policies to make gold increasingly attractive as a hedge.
While gold may face headwinds from higher interest rates and dollar strength, the council believes these effects will be limited as a result of the Fed having signalled a more neutral stance.
Structural economic reforms in key markets will continue to support the demand for gold in jewellery, technology and as a means of savings, the WGC said.
Globally, there were net positive flows into gold-backed exchange-traded funds in 2018. However, North American funds suffered significant outflows in the second and third quarters, with this trend only reversing in the fourth quarter as risks began to intensify.
As a result, the WGC believes that global investors will, this year, continue to favour gold as an effective diversifier and hedge against systemic risk on multiple global metrics.
The council pointed out that, firstly, despite the recent market correction, many stock valuations remain elevated, especially in the US, after almost a decade of almost uninterrupted price appreciation, yet bond yields remain low.
Secondly, while European growth has recovered from the aftermath of the sovereign debt crisis it has failed to reach the level of the US economy, making it more vulnerable to shocks.
In addition, continental Europe continues to face internal turmoil, the WGC said, adding that France was grappling with social unrest, Spain was fending off secessionism and dealing with a fragile political alliance, and Italy's populist government continued to highlight the inherent instability of the monetary union.
Thirdly, the council highlighted that more and more governments around the world seem to be embracing protectionist policies as a counter movement after decades of globalisation.
“And while many of these policies can have a temporary positive effect, there are longer-term consequences that investors will likely grapple with in the coming years; for example, higher inflation.”
They are also expected to have a negative effect on long-term growth, the council added. And although investors have, so far, taken some of the trade war rhetoric as posturing, it is not without risk to restrict the flow of capital, goods and labour.
Combined, these trends have increased the risk of recession, the WGC warned.
While market risk will likely remain high, two factors, namely higher interest rates and dollar strength, could limit gold’s upside, the council pointed out.
It explained that higher US interest rates alone are not enough to deter investors from buying gold, as seen between 2004 and 2007 or 2016 and the early part of 2018. And while higher interest rates, combined with a strong dollar, can dampen gold’s performance, there are reasons to believe the upward trend of the dollar may be losing steam.
Firstly, the council mentioned that the dollar DXY Index, which measures the relative direction of the dollar against a basket of key currencies, has already appreciated by almost 10% from its 2008 lows.
A similar trend in 2016 was followed by a significant correction.
Secondly, the WGC noted that the positive effect of higher US rates on the dollar would diminish as the Fed policy stance becomes neutral, especially since the recent dollar strength was fuelled in part by the more accommodative monetary policy maintained by other central banks.
Thirdly, the Donald Trump administration has often voiced frustration about competitive disadvantage caused by a strong dollar, the council said, adding that emerging market central banks continue to diversify their exposure to the dollar.
Meanwhile, the WGC believes emerging markets, which make up 70% of gold consumer demand, are very relevant to the long-term performance of gold. And among these, India and China stand out owing to the implementation of necessary economic changes to promote growth and secure their relevance in the global landscape.
India has been active in modernising its economy, reducing barriers to commerce and promoting fiscal compliance. India’s economy is expected to grow by 7.5% in 2018 and 2019, outpacing most global economies and showing resilience to geopolitical uncertainty, the council stated.
“Given its unequivocal link to wealth and economic expansion, we believe gold is well poised to benefit from these initiatives. We also believe that gold jewellery demand will strengthen in 2019 if sentiment is positive, while increasing marginally should uncertainty remain,” the council elaborated.
Similarly, it added that efforts to promote economic growth in western markets are expected to result in positive consumer demand.
Looking ahead, the council further mentioned that gold’s performance in the near term is heavily influenced by the perceptions of risk, the direction of the dollar and the impact of structural economic reforms.
“As it stands, we believe these factors likely will continue to make gold attractive”.
In the longer term, the WGC believes gold will be supported by the development of the middle class in emerging markets, its role as an asset of last resort and the ever-expanding use of gold in technological applications.
In addition, central banks continue to buy gold to diversify their foreign reserves and counterbalance fiat currency risk, particularly as emerging market central banks tend to have high allocations of US treasuries.
Generally, there are four attributes that make gold a valuable strategic asset. It is a source of return, has a low correlation to major asset classes in both expansionary and recessionary periods, it is as liquid as other financial securities and it has a history of improved portfolio risk-adjusted returns.
In addition, gold speculative positioning in futures markets remains low by historical standards after hitting record lows in the final months of 2018, the council said in its report.
Further, net combined speculative positions, which go back further, are negative for the first time since December 2001, the WGC added, explaining that large net short positions have historically created buying opportunities for strategic investors, as such positions are prone to short-covering, adding momentum to rallies in the gold price.