By Dr Nasser Saidi
Gold prices had been on the decline since rallying strongly after the financial crisis and peaking above the $1,800-mark in 2012. But after touching a seven-year low in early January 2016, gold has been looking up, with the bullion surging by 20 per cent and more this year.
Markets, including gold, have been volatile over the past year with investors reacting to a multiple risks. These have included expectations of United States Federal Reserve rate hikes, a slowdown in growth in emerging markets (the China growth and rebalancing effect), a weaker dollar, monetary stimulus for Europe and Japan, the Brexit conundrum and geopolitical factors including uncertainty about the outcome of US presidential elections (the Trump factor).
The fascination with gold throughout human history has much to do with its near-unique physical properties. It is durable and storable, so is used as a store of value. It is shiny and malleable and hence used in jewellery. It is conductive and hence used in high-end electronics. It is resistant to oxidation, unlike silver, and is relatively scarce.
Combined, these qualities have made it attractive as a store of value and medium of exchange through history. Indeed, until August 1971 when then President Nixon ended the international convertibility of the US dollar into gold, the international monetary system had been tied to gold. After that, fiat currencies – paper money – became the norm. But despite the breakdown of the Bretton Woods system (a monetary policy that tied currencies to gold), gold remains the main asset of central banks’ reserves, accounting for 75 per cent of US and 57 per cent of Euro area international reserves.
And despite widespread scepticism, many individuals view gold as a store of value – especially as an insurance policy against political upheavals – which provides protection when other asset prices are plunging. This gives rise to the ‘precautionary demand’ for gold bullion by central banks, fund managers and individual investors, as opposed to ‘use demand’ by various industries.
Because gold offers no yield, the lower the actual or expected returns offered by alternative investments such as bonds, the more attractive it looks.
The supply-demand nexus
As with all assets and commodities, price fluctuations result from the interaction of the forces of demand and supply. Gold demand recorded a 21 per cent increase year-on-year to 1,290 tonnes in the first quarter of 2016, making it the second largest quarter on record.
The increase was driven by huge inflows into exchange-traded funds – 364 tonnes (over 300 per cent year-on-year) – fuelled by concerns about the shifting global economic and financial landscape. This followed three quarters of uninterrupted outflows that led to a sharp decline in gold prices.