Gold investment statistics commentary Quarterly statistics commentary Q2 2012 Download this document (0.2 MB) from world gold council http://www.gold.org/investment/research/regular_reports/investment_statistics_commentary/ Overview This commentary summarises gold's price performance in various currencies, its volatility statistics and correlation to other assets in the quarter. It provides macroeconomic context to the investment statistics files published at the end of each quarter and highlights emerging themes relevant to gold's future development. Review: key macroeconomic themes during Q2 2012 Gold prices declined in most currencies during the second quarter with the exception of the euro, Swiss franc and Indian rupee, in part due to a strong US dollar. Despite a 3.8% decline in Q2 to US$1,598.50/oz on the London PM fix, gold was up 4.4% during the first half of the year. Volatility remained elevated amidst a busy event-risk period. However, gold generally outperformed risk assets. Global inflation eases but underlying trends supportive for gold: A substantial drop in energy and some agricultural commodities during the period has eased inflation pressures in many parts of the world and put downward pressure on gold prices. Reassessing "risk-free" assets: Even assets traditionally considered safe are under pressure. German Bunds interest rates climbed in June. The Swiss franc, yen and US Treasuries are also facing issues – challenging their role as assets of last resort. Despite pressures on the price of gold, its lack of credit risk, its liquidity and hedging characteristics has made gold an attractive vehicle for long-term wealth preservation. Outlook: emerging macroeconomic themes in H2 2012 Deflationary concerns in some countries provide room for further fiscal and monetary stimulus. This may lead to a further debasement of currencies through unconventional monetary policy and an increased risk of future inflation. These factors should provide support for future gold investment . The underlying structural issues that affect the euro zone remain unresolved, despite advances in the formation of more comprehensive burden-sharing mechanisms. In such an environment of uncertainty and higher market volatility, gold will continue to be an asset that investors use to diversify risk and preserve capital. The flight to the US dollar as a safe-haven in the first half of 2012 could be reversed. The US debt ceiling debate in Q3 and federal elections in November, followed by the necessity to confront a US$1.3tn budget deficit will prove challenging to the US dollar. With most currencies under pressure in one form or another, gold is likely to provide a hedging mechanism for investors. Chart 1: Performance of gold (US$/oz) price and volatility during Q2 2012 Chart 1: Performance of gold (US$/oz) price and volatility during Q2 2012 - click to enlarge Table 1: Summary of major market events during Q2 2012 Table 1: Summary of major market events during Q2 2012 Table 2: Performance of gold with respect to various currencies Table 2: Performance of gold with respect to various currencies - click to enlarge Global inflation falls but underlying trends supportive for gold A global growth slowdown with consumer retrenchment and steeply falling energy prices (Chart 2) has led to a slowdown in inflation (also referred to as “disinflation”) in major economies at rates reminiscent of the early days of the financial crisis in 2009. While inflation in many major economies has been falling (Chart 3), the potential for more extreme inflation-related environments looms large. On one hand, deflationary (negative inflation) risks are increasing. These risks provide legroom for further government stimulus measures to fuel economic growth which, on the other hand, increases longer-term inflation concerns. Further, a reactivation of economic activity in emerging markets coupled with extreme outcomes of deflation or high inflation should provide support for gold demand going forward. Chart 2: Oil and industrial commodity prices and Chart 3: Headline CPI inflation has dipped in 2012 Chart 2 and Chart 3 - click to enlarge The ongoing euro area crisis has dented consumer and business confidence while increasing fiscal restraint and lending reticence by banks. The contagion outside the region is also increasingly visible. Leading indicators of growth suggest that Europe is in recession, with Germany, the stalwart of stable growth, also succumbing (Chart 4). While consumer price indices in Europe have yet to fall considerably, economic activity indicators suggest that they will do so. The European Central Bank (ECB), perennially one of the most hawkish central banks, recently declared that “inflation expectations remain well anchored and there is no inflation risk in any euro-area country”. 1 Switzerland has also been affected, with its consumer price index (CPI) falling for eight consecutive months. The Swiss economy is still in relatively good shape, but persistent currency strength and deflation will raise fears of postponed spending. Chart 4: Euro-area slowdown: bank lending, German factory orders, Eurozone IP Chart 4: Euro-area slowdown: bank lending, German factory orders, Eurozone IP - click to enlarge The slowdown in Europe has spilled over to the US and the UK, and has affected demand from emerging markets. From China and India to Brazil and Russia, the effects of the global slowdown are evident through both domestic growth and local prices. Notably, India currently faces a bout of stagflation (high inflation coupled with slower economic growth) as supply-side factors and currency weakness have supported sticky inflation. It is not a simple task to estimate how long this higher inflation environment will last. However, prices should stabilise as consumer demand slows, as has occurred in other countries. Falling prices can put downward pressure on gold prices, on the back of its role as an inflation hedge. However, this simplification does not capture the full depth of the situation. As shown in “ The impact of inflation and deflation in the case for gold ” by Oxford Economics, gold is useful to investors in various economic scenarios, not only during high inflation periods. The research found that while deflation leads to a rise in the US dollar – a potential headwind for gold – it maintained that the destructive impact of deflation on traditional assets was likely to outweigh the US dollar effect and provide a boost to gold. In fact, the analysis showed that gold would outperform equities and housing in a deflationary scenario. Additionally, a disinflationary (and ultimately deflationary) environment provides central banks with more room to manoeuvre on stimulus. For example, on 5 July, the Bank of England (BoE), People’s Bank of China and the ECB acted in unison by announcing accommodative measures in response to weak economic numbers.2 These accommodative measures should fuel the risk of consumer price inflation further down the line while providing a temporary boost both to asset prices and capital flows to emerging markets. Further, the apparent dependency on central bank support for an ailing global economy highlights its chronic weakness. The combined weight of uncertainty and hope of central bank action will maintain higher asset price volatility. Therefore, while inflationary pressures may be receding in various regions, there are underlying trends to suggest that deflation risk has increased. This challenging environment tends to be conducive to gold investment. In addition, the current lower level of inflation has cleared the path for further monetary and fiscal easing. The scope for further quantitative easing and fiscal support will raise future inflationary risks but might also catalyse global growth – painting a backdrop that is typically supportive of gold demand. Reassessing “risk-free” assets Over the past year, two national bond markets have provided shelter from turbulence in global risk assets: US Treasuries and German Bunds (Chart 5). Additionally, the US dollar, the Japanese yen and the Swiss franc have benefited from de-risking flows. These positions have allowed investors to preserve capital while risk assets have floundered (performance measures in various currencies can be found in the investment statistics ). However, being an asset of last resort is not without consequences. In particular, the investors seeking more “safe” assets must also recognise that the ever-increasing supply of both currency and debt deplete the value of these assets. Furthermore, as declining yields approach zero, they create very skewed pay-off structures with much more downside risk. Unlike currencies and bonds, gold does not carry a liability, thus a rise in its value has no detrimental effect on other parties. Moreover, gold is a highly liquid asset – often times used as a de-facto currency – which forms an integral part of the monetary system. Therefore, while gold has been negatively impacted by a stronger US dollar this year, it remains an important alternative to investors seeking to preserve capital over the longer time horizon. Charts 5-6: Depletion of safe-havens Charts 5-6: Depletion of safe-havens- click to enlarge The euro crisis has highlighted the depth and breadth of the problems facing the global economy. Financial market integration and fiscal irresponsibility across the globe have left investors with few choices for capital preservation. In fact, the Bank of International Settlements (BIS) – often referred to as the central bank for central banks – in its most recent annual report included commentary devoted to the topic of Sovereigns’ loss of their “risk-free” status and the implications for financial markets. 3 Developments in the euro-area crisis during Q2 2012 have led markets towards the realisation that most outcomes in this ongoing saga will be painful not just for the peripheral countries, but also to core economies – particularly Germany. Whether through its contributions to the European Financial Stability Facility (EFSF) and the European Stability Mechanism or through its potential liabilities for losses in its banking system, Germany appears to be on the brink of sharing the burden of the peripheral countries’ woes, which may run the risk of affecting its credit rating. A brief but sharp drop in German and the troubled peripheral government bonds, alarmed some investors during the second quarter. Although other factors may have been at play,4 it highlighted the fact that whatever the outcome in the euro area saga, Germany’s liabilities are large and likely to increase as a result of greater burden sharing. Further, the EU summit agreements reached on 28 June, which contributed to an across-the-board positive reaction by markets have, at the very least, exceeded reluctant but necessary concessions made by Germany. While this may finally put Europe on a path towards a unified solution, it also increases the pressure on the Bund’s “asset of last resort” status. US Treasuries have provided investors with consistent returns so far this year. However, while yields are at, or close to, record lows – reflecting their safe-haven status – the Treasury market faces significant risks. Investors are bracing for another round of debt-ceiling negotiations; during 2011, those drew a negative outlook warning from Standard and Poor’s rating agency. In addition, as the US presidential elections loom, a decision on how to deal with the “fiscal cliff” will have to be made to avert a sizeable drag on growth. As the US holds the world’s reserve currency and has a resilient and dynamic economy, questions over its debt sustainability may be unwarranted. However, interest rates risks lie increasingly to the upside to the detriment of risk averse investors, especially in a negative real yield environment. In Japan, safe-haven flows to the yen have resulted in a spate of interventions by authorities over the last 18 months to quell the rise in the currency, with their 1 June 2012 statement denouncing currency market volatility and declaring a readiness to continue their policy. Interventions during 2011, which incurred large volume spikes, had the desired immediate effect of weakening the yen, though have yet to significantly dent the upward trend. A stronger yen fuels continued deflation and a fall in export competitiveness has seen the Japanese economy experience the deepest contraction since the 1930s. The yen may provide a safe-haven for many investors but can also be recognised as a drag to the Japanese economy. In addition, Switzerland, which exports more than half of its goods and services to its neighbours in Europe, has been dealt a double blow with its currency being considered a “safe-haven”. Persistent disinflation and strong currency flows prompted the central bank to intervene and peg the currency to the euro. For Swiss investors, gold performed better than might have been expected due to the aforementioned pegging. Investors increasingly look for alternative assets to preserve capital in the face of a potential depletion of safe-haven assets. Gold’s intrinsic characteristics such as lack of credit and counterparty risk, coupled with a deep and liquid market, can provide long-term protection to investors’ capital. Correlation between gold and risk assets falls toward long-term averages Gold’s role as a diversifier was scrutinised during Q1 2012 as correlations increased; however, its correlation to equities and commodities fell closer to long-term averages during Q2. Global growth slowed during the period as a slew of economic numbers suggests that the US recovery is stalling, China’s growth is waning and that the euro area is slipping into recession. Each of these contributed to gold’s lower correlation to equities. Gold maintained a higher than average correlation with global bonds as a by-product of a strong US dollar. In a continuation of its recent trend, gold’s negative correlation to the US dollar remained significantly stronger than its long-term average. This was partly caused by investors flocking to US Treasuries and selling their portfolio holdings, including gold. Gold was not the only asset that was affected by the dollar, as shown in Chart 8; most assets had a stronger inverse correlation to the dollar. US Treasuries, on the other hand, had a strong positive correlation to the dollar – suggesting that interest in dollars is based on safe-haven flight rather than a particularly bullish view on US prospects for growth. Charts 7-8: Correlation to global assets, gold v US dollar Charts 7-8: Correlation to global assets, gold v US dollar - click to enlarge Looking back to Q1 2012, gold had a higher correlation to global equities, emerging markets and commodities than the long-run average; however, this correlation was not indicative of a direct economic relationship. In our Investment statistics commentary for Q1 2012 , we observed that this correlation to equities was spurious. When viewing gold’s return in relationship to a strong US dollar, the relationship between equity and gold returns decreased significantly. Consequently, gold’s increased correlation to equities was due to the indirect effect of a weaker global economy coupled with a stronger US dollar. The flight to the US dollar in the first half of 2012 could reverse in the second half of the year and will likely bring some challenges to the US dollar that could prevent continuation of the consistent inflows it has experienced so far. The US debt ceiling debate in Q3 and federal elections in November, followed by the necessity to confront a US$1.3tn budget deficit will prove challenging to the US dollar. Therefore, we expect gold’s correlation to most assets to remain low and gold to act as a currency hedge in the international monetary system, particularly against the US dollar. This will be especially prevalent if see-sawing risk aversion and fluctuations in global growth expectations persist. 1 Mario Draghi, 15 June 2012. 2 The BoE announced further quantitative easing as inflation is falling and as the euro area fallout threatens to impact British investors. In equal measure, Chinese authorities lowered the benchmark borrowing rate as they are also better placed to act with price increases slowing. Similarly, the ECB cut its benchmark borrowing rate by 0.25% to a record low of 0.75%. 3 http://www.bis.org/publ/arpdf/ar2012e.htm 4 Excessive long positioning and a ruling by Danish pension authorities enabling domestic funds to cut bond positions – of which Bunds would have been a sizeable proportion. Investment statistics commentary archive The quarterly Investment Statistics Commentary succeeded the Gold Investment Digest (GID), which was published between Q3 2006 and Q2 2011 and examined trends in price, investment markets and the macro-economy relating to gold and other assets typically found in an investor portfolio. The Commentary complements the investment statistics analysis updated on a regular basis. Investment statistics commentary Q1 2012 Full year 2011 - Download this document (0.2 MB) Gold Investment Digest - archive 2011 Q2 (PDF 2.4 MB) Q1 (PDF 2.3 MB) 2010 Q4 (PDF 2.9 MB) Q3 (PDF 1.3 MB) Q2 (PDF 1.2 MB) Q1 (PDF 1.0 MB) 2009 Q4 (PDF 1.1 MB) Q3 (PDF 1.1 MB) Q2 (PDF 0.9 MB) Q1 (PDF 0.5 MB) 2008 Q4 (PDF 0.6 MB) Q3 (PDF 0.6 MB) Q2 (PDF 0.7 MB) Q1 (PDF 0.4 MB) 2007 Q4 (PDF 0.3 MB) Q3 (PDF 0.4 MB) Q2 (PDF 0.3 MB) Q1 (PDF 0.4 MB) 2006 Q4 (PDF 0.3 MB) Q3 (PDF 0.8 MB) The World Gold Council's Gold Investment Digest (GID) examined price and volatility trends for gold and other assets typically found in an investor portfolio. It also looked at the primary macro-economic drivers behind gold’s performance and preliminary trends on demand and supply. GID was organised into four sections: Price trends – Gold price and volatility performance in multiple currencies and its relation to other global financial assets including most liquid commodities. Investment trends – Trends in the most active gold investment markets including ETFs, futures and options, and over-the counter products. Economic trends – An analysis of the most important macro-economic factors that influenced gold’s performance during the period. Gold market trends – Gold demand and supply statistics as of the last available World Gold Council Gold Demand Trends publication, and discussion on preliminary reports on recent trends and their effect on gold’s performance. Additionally, GID included a concise key data summary - financial statistics on gold and various assets including price, volatility and correlation measures. All of which, and more continue to be provided within our investment statistics files. Explanatory text... Also in this section Regular reports Gold Demand Trends Gold Demand Trends - Japanese Investment statistics commentary Commentary Q1 2012 Research summaries Featured research 日本の投資家向けレポート Thematic research Portfolio diversification For European investors For UK investors Gold and alternatives Gold and inflation Impact of inflation and deflation Investors guide to the gold market (European edition) Investitionsführer Gold (Europische Ausgabe) Gold and the dollar Wealth protection Hedging against tail risk Country case studies Gold and commodities The gold market Central banks Related Investment statistics commentary, Full Year 2011 Read more... (PDF 1.3 MB) Gold Investment Digest - archive Read more...
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