My analysis of quarterly demand trends as published by the World Gold Council indicates a very close relationship between the investment demand for gold and the ratio of the gold price (US$/oz) relative to the MSCI Emerging Market Index (US$).
Investment demand includes gold bars, gold coins, gold-backed exchange traded funds as well as purchases of gold by central banks. It is evident that investment demand for gold is largely event-driven.
For example, elevated stock market valuations preceded the European sovereign debt crisis, which led to a crisis of confidence for European businesses and economies and had the potential for a break-up of the single currency, the euro.
This crisis was the catalyst for increased investment demand from 2010 to 2012, which led to a surge in the gold price over that period, while stock markets and especially emerging markets succumbed to downward pressure.
Gold outperformed emerging markets by more than 50percent as the ratio between the price of one ounce of gold to the MSCI Emerging Market Index in US dollar rose to 1.85 from 1.22.
From 2013 the concerns over the sovereign debt crisis faded and investment demand fell sharply. This caused a sharp sell-off in gold, while emerging market equities rebounded from oversold levels and inexpensive valuations.
In the first quarter of 2016 worries about the outcome of a UK vote to leave the EU led to a spike in investment demand for gold. Although it heralded a new rising phase in the price of gold, emerging market equities began to outperform gold as stock market players became less risk-averse, while the investment demand for gold waned.
Gold’s under performance to emerging market equities came to an end in the first quarter of this year, an indication that investment demand has improved. This is backed by global gold-backed ETFs, which collectively added 47tons of gold during the first quarter, of which 22 tons were added in March alone.
It is also an indication that the global gold-backed ETFs are on track to at least equal last year’s addition of 203 tons of gold. Many market watchers continue to be disappointed with the performance of the gold price, given the global trade tensions and volatile stock markets - gold is seen as a safe haven.
Although we are used to gold being quoted in US dollars, the trading in gold is not limited to one currency alone. Gold should rather be viewed in a basket of currencies to get a clearer picture of the true price of the commodity. In doing so, the impact of strength or weakness of the greenback on the gold price is largely neutralised.
An equally weighted gold price index consisting of the gold prices in US dollars, euros, British pounds, Swiss francs, Japanese yen, Indian rupees, Chinese renminbi and Turkish lira (therefore, in all countries that are major players in the gold market) indicates that the average international price of gold in the first quarter of this year is at the previous highs achieved in the fourth quarter of 2012. In comparison, the average gold price in US dollars in the first quarter is 22percent, lower than the highs in the fourth quarter of 2012.
Evidence suggests that the jewellery demand for gold is in fact highly price-sensitive. The strong rise in the gold price at the height of the euro crisis suppressed jewellery demand, while the subsequent drop in the gold price led to increased jewellery demand.
It is, therefore, not unsurprising that the jewellery demand for gold weakened with the surge in the gold price in the first two quarters of 2016. The market got used to the higher levels, though, and jewellery demand underpinned the gold price in 2017 - at a time when investment demand waned.
It has to be said, however, that the global stock markets, and especially emerging markets, may overshoot on the upside - as it did during the 2004 to 2007 bull market.
If it happens the gold price: MSCI Emerging Market Index ratio may drop to 0.8 or 0.9points, meaning that there is a possibility that gold may under-perform emerging markets by 20percent, but I would not bet on that happening.
“Fear, Mr Bond, takes gold out of circulation and hoards it against the evil day when every tomorrow may be the evil day.” - I am Bond, James Bond by Ian Fleming
Ryk de Klerk is an independent analyst.
the views expressed here are not necessarily those of Independent Media.
- BUSINESS REPORT