Whole world is faced by huge uncertainty caused by Covid-19
Although various instruments are available to hedge portfolios against unexpected events or so-called “tail risks”, my analysis from December 1995 to the close on Friday indicates that by adding physical gold to a portfolio tracking the MSCI World Index in terms of US dollars or even the JSE All Share Index can reduce the volatility or risk by nearly 50percent without sacrificing returns.
The Global Financial Crisis in 2008/09 led to the realisation of gold’s role to reduce risk.
Before the implosion of equity markets in 2008 the ratio of gold to the MSCI Emerging market Index in terms of US dollars ranged between 0.6 times to 1.
Since then, the ratio varied between 1 and 1.9, where the highs coincided with high volatilities in US stock markets as measured by the CBOE volatility index or VIX.
The supply and demand chains of the global market in physical gold have been and still are severely disrupted by the coronavirus.
It is apparent that jewellery demand for gold is a wealth thing - demand is high when stock markets are booming and gold is under pressure.
India and mainland China are the main players in that market.
The hard lockdown in China with the outbreak of the coronavirus saw jewellery demand in mainland China contracting by 65percent in the first quarter of this year, compared to the same period last year, while India’s offtake tumbled by 40percent.
Although China’s demand probably picked up in the June quarter, it is likely to be offset by the lockdowns in other countries.
Speculative demand for gold (bars, coins and ETFs) is highly dependent on investors’ perceived risk of risk markets such as equities which are event-driven.
As mentioned before, the ratio of gold to the MSCI Emerging market Index in terms of US dollars the highs and lows of the ratio coincided with highs and lows of the CBOE volatility index or VIX.
With the huge amount of uncertainty facing the world as a result of the coronavirus, VIX is likely to remain elevated and ditto the ratio of gold to the MSCI Emerging market index in terms of US dollars which will therefore underpin speculative demand for gold.
There is, however, a real risk that speculative demand may contract by up to four hundred tons if global equity markets return to euphoric territory - yes, when VIX falls below the 20 point level from the current 35 points.
Although there was a slight pick-up in central bank purchases of gold in the first quarter, it is unlikely that there was a follow-through in the second quarter due to the higher gold price.
A major bullish factor in the gold supply/demand equation is the apparent absence or lack of recycled gold returning to the market.
In normal times the higher gold price in the first quarter would have resulted in about four hundred tons recycled gold returning to the market, but only 280 tons found its way back into the market.
It could be that the reduced mobility as a result of the lockdowns had a major impact.
But on the other hand, it can also be that the holders of the recycled gold have turned to be investors.
Since 2017 gold mining production levelled off at about 850tons per quarter and it seems that production decreased by about fifty tons in the first quarter of this year.
The most bullish factor for gold is the possible loss of mining production due to the coronavirus infection in gold producing countries.
For illustration purposes I calculated new gold supply at risk by the total number of new Covid-19 cases per gold producing country per day since end December last year times the country’s gold production in 2018.
The numbers for all the gold producing countries are aggregated per day and divided by the total number of new Covid-19 cases of all gold producing countries for that day.
Yes, gold at $2500 (R43129)per ounce is not far fetched in a world facing a huge amount of uncertainty.
Use gold to reduce the volatility or risk of your portfolio, rather than betting on gold alone.
Ryk de Klerk is analyst-at-large. Contact [email protected] His views expressed above are his own. He has a direct interest in the listed Gold ETF. You should consult your broker and/or investment adviser for advice.