Gold has traditionally been known as a safe haven asset and people are asking why it’s trending down in the midst of chaos. In times of uncertainly, money has veered towards gold, the Swiss Franc, U.S. Treasuries and the Yen in Japan. Trade wars are brewing, emerging-markets are collapsing and currencies are volatile, so why isn’t gold running up? Increasing geopolitical risk and economic uncertainty should be bullish for the yellow metal. Gold bugs are scratching their heads wondering why time tested rules of thumb are off the mark this year. According to the research department at West Capital International, the key to understanding bullion’s current slide lies in busting the following five myths:
MYTH: INFLATION DRIVES GOLD
When inflation rises, purchasing power drops, and investors should turn to hard assets like gold as a store of value. But inflation-adjusted yields are rising and the price of gold is in a slump. The fact is that the main economic driver of the price of gold is the U.S. Dollar, not interest rates. The price of gold has one of the strongest inverse correlations to the Dollar Spot rate of all tradable assets. The reason is simple: gold, like other commodities, is priced in Dollars. When the Dollar strengthens, so does its purchasing power, which means that less Dollars are required to purchase an equivalent amount of a basket of goods. This relationship applies to all commodities but the inverse correlation with gold is the strongest.
MYTH: RESERVES PROTECT AGAINST LIQUIDITY CRISES
The ability of central banks to avert financial crises by selling gold has been questioned in recent years. There was a time when a country could sell its gold reserves and succeed in fending off external liquidity problems. As a result, episodes of financial instability, particularly in emerging markets and lately even southern Europe, have spooked markets. In reality, monetary authorities can’t just dump all their gold. Prices would crash and often holdings are not in fact available for direct sale.
MYTH: GOLD AND THE DOW MOVE IN OPPOSITE DIRECTIONS
As a safe haven asset, gold should theoretically go up when markets are volatile. Over the last decade, statistics have shown to long term inverse correlation between bullion and equities. In fact, the correlation to the NASDAQ and the Dow has been less than 0.03. Essentially negligible. Regression plotting of movements in the S&P 500 versus bullion spot prices look like they were fired by a drunk with a shotgun. Today’s reality is that institutions control the markets, and portfolio managers minimize risk exposure through diversification of unrelated assets and derivative-based hedging techniques.
MYTH: ETFs DON’T MATTER
Gold ETFs (exchange-traded funds) have a far greater impact on the market than most investors realize. In terms of physical gold alone, the equivalent of two-thirds of all gold mined in 2017 is held in ETF-owned vaults. Bloomberg reports that the ETFs they track hold over 2,100 tons, valued at $80 billion US. In each of the last ten years, bullion-backed ETF holdings and the spot gold price have moved in the same direction. Flow tends to follow performance, especially with precious metals so levels of passive allocation will move in the same direction as bullion prices. The reverse also holds true – the tail is now wagging the dog. For purposes of clarity, West Capital Intl. is not advising for or against ETCs, the message here is to pay attention to ETF holding if you want to know where spot prices are going.
MYTH: IRRELAVENCE OF PHYSICAL MARKET FOR GOLD
Another incorrect assumption is demand for the physical metal is immaterial and that demand for gold comes from its value as a tradable asset, with prices reacting to global financial markets. Consumers of thephysical metal, like coin and jewelry buyers, may not control the market but they certainly have a measurable effect. Western investors underestimate the demand for physical gold in India and other eastern countries. Since they are based in Tokyo, West Capital Intl. sees the other side of the coin. Buyers of the physical metal don’t drive the market, but they generate sufficient demand to provide a floor when prices drop. China and India are the largest gold consumers and during the first half of this year, Indian Imports are significantly from where they were last year. Demand so far from this key marginal buyer is the lowest it’s been in over a decade.
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