The World Gold Council (WGC) has analysed the potential performance of gold across four hypothetical scenarios provided by Oxford Economics in light of Covid-19 and ensuing economic lockdowns slashing global growth forecasts for this year.

The WGC explains that gold’s behaviour can be explained by a broad set of drivers, namely economic expansion, risk and uncertainty, opportunity cost and momentum.

Economic expansion comprises periods of growth that are supportive of jewellery, technology and long-term savings, while risk and uncertainty entails market downturns, which often boost investment demand for gold as a safe haven.

Further, opportunity costs involve levels of interest rates and strength of currencies that influence investor attitudes towards gold, while capital flows, position and price trends can ignite or dampen gold’s performance, which is a feature classified as momentum.

The council’s analysis shows that higher risk and uncertainty, combined with lower opportunity cost, will likely be supportive of gold investment demand for this year, offsetting the negative effect of lower consumer demand as economic activity contracts.

Gold’s behaviour thereafter may depend on the speed of the global economic recovery and the duration of monetary policy and fiscal stimuli.

Using its Web-based quantitative tool called Quarum, the WGC analysed the implied performance of gold across the hypothetical scenarios − swift recovery, US corporate crisis, emerging market downturn and deep recession.

In the first scenario, the world's gross domestic product is expected to contract by almost 4% this year, but while economic activity in the first half of the year was very weak, it could rebound sharply in the second half of the year.

To ensure this upward momentum, central banks might keep monetary policies loose and real interest rates close to zero through to 2024.

The WGC’s model indicates that gold’s implied returns in this scenario are positive, but decrease between 2020 and 2022 before turning negative over the following two years.

Gold’s strong return in 2020 is supported by rising market risk and uncertainty, lower opportunity costs and the momentum impact of a strong positive performance in 2019.

In contrast, gold’s positive but lower returns between 2021 and 2024 stem largely from abating market risks and moderating yields.

In the second scenario, US corporations could be severely impacted by the pandemic and drive the global economic slowdown, with its stock market falling 45% this year.

A relatively weaker dollar would keep import costs high, resulting in a larger drop in corporate profits and shaky business and investor confidence.

The WGC says that the spread between US corporate and treasury bond yields diverges significantly as the Federal Reserve’s asset purchasing programme focuses on government debt.

However, otherwise supportive government policies can promote a fast recovery, with the US stock market rising by 19% in 2021 and credit spreads narrowing quickly.

In this second scenario, gold’s strong implied return in 2020 is followed by consecutive falls over the next four years, while the five-year compounded return is still positive at 2%.

“As in the Swift recovery scenario, gold benefits strongly from a combination of heightened risk, falling asset values and lower opportunity costs in 2020.

“However, while 2021 plays out similarly in terms of ebbing risk sentiment and solid economic growth, it is the relative increase in government bond yields and tightening of credit spreads that, based on their historical relationship, negatively impacts gold most in subsequent years,” the council notes.

In terms of the emerging market downturn scenario, the WGC says the impact of Covid-19 this year can be much worse than the base case scenario, especially considering Chinese economy contractions and low commodity prices negatively affecting many other emerging markets.

However, governments around the world are likely to act swiftly by introducing accommodative monetary policy. While the world economy recovers only in 2021, central banks could keep interest rates low for a longer period.

The impact on gold in this scenario could be that it has higher returns in 2020 and 2021, while still remaining positive in 2022. The implied returns can then turn negative from 2023 onwards.

The strong returns for gold in this scenario comes on the back of uncertainty surrounding the Covid-19 outbreak for a longer period, while negative economic growth provides a counterbalance by reducing fabrication demand.

“As in the previous scenarios, risk and uncertainty reverses sharply in 2021. As credit spreads narrow and credit creation subsides, lower risk and uncertainty result in a headwind for gold in later years,” the WGC states.

Lastly, the council points out that the fourth scenario brings a deeper and longer impact of Covid-19 on the global economy, with activity remaining suppressed and multiple waves of contagion striking.

This scenario cites that global economic output could only return to pre-pandemic levels from 2023 – led by emerging markets.

In this case, central banks will need to keep interest rates low, or negative even, in many countries, for much longer; while credit spreads remain elevated through to 2024.

What will then happen to gold is that it will have robust gains up to 2023, before turning negative in 2024, resulting in an annualised implied return of about 20% over a five-year period.

The WGC says higher risk and uncertainty support gold’s performance, as in other scenarios, but its contribution is larger in 2020.

Beyond that, tightening credit spreads pose a drag on implied returns. Lower opportunity cost contributes positively to gold’s return in 2020 and is the only scenario with a positive follow-up in 2021, when short-term rates are pushed very close to zero; from 2022 to 2024 increasing interest rates create a drag on gold’s implied returns.

Lower economic growth and outright deflation reduce demand for gold from various sectors compared to other scenarios.