Gold gave pretty flat annualized returns of 1.3% from 2013 to 2018. From May 2019 to May 2020, the precious metal rose 33% and everyone is looking up to invest in gold. However, the question is would it provide good returns if one invests now? This blog examines the reasons behind the rise of gold in recent times and whether it merits investment by a retail investor.
What has driven up gold price?
The largest holders of gold are central banks. Sovereign wealth funds, pension/hedge funds (>$30Tn in physical gold) & ETFs are other institutional investors in the yellow metal. These funds increase/decrease gold holdings depending on their “perceived” asset risk and/or to diversify in relation to other assets they hold. In 2019, Central banks around the world have purchased 374 Tons of gold, driving up its price from $1300 to $1500 per ounce till Aug. Subsequently instituitional investors took it up to its current price @$1700.
Why do Central Banks buy gold?
Central banks around the world hold reserves in a variety of assets ranging from USD, Euro, foreign debt & Gold. They buy gold to diversify their holdings and to derisk from USD in uncertain times like war, recession, trade war etc.
Who are the largest holders of gold in the world?
Total world gold production in 2018 was 3.3k Tons. Interestingly, China is the leading gold producer (404 Tons) followed by Australia (319 Ton), Russia (297 Ton), US (222 Ton) & Canada (190 Ton).
Cirque de USD??
USD is world’s reserve currency today. Gold is seen as a way to diversify from USD. But gold is denominated in USD – while US itself holds the largest gold reserve in the world & is the 4th largest producer of the shining metal. Oil is also denominated in USD, while US is the largest producer & consumer of oil.
So what’s the relationship between Gold & USD?
For the most part, Gold & USD has had an inverse correlation relationship. Historically, when USD weakens, gold rises – with the only exception being 2009-13 during Fed’s QE (Quantitative Easing), when they exhibited direct correlation, ie both increased. With Fed’s tightening of QE since 2014, USD was getting stronger – this explains the meagre 1.3% return from Gold between 2013 to 2018. However with the recent escalations in trade war conflict, covid-19 and greater economic and life loss, demand for the yellow metal has risen.
Is it then a right time to invest in gold?
In the wake of covid impact, the Fed and central banks around the world are again on the anvil of printing money. So, in the near term, gold is expected to appreciate until the uncertainties subside. But, retail investors being small fry compared to central bankers around the world, which way gold moves and what kind of returns it may deliver are largely dependent on politics, trade & macroeconomics.
Gold as an asset class does not generate income (except if you buy Sovereign Gold Bonds), so it is recommended that retail investors hold no more than 10-15% of their total networth in the yellow metal. While it has delivered 4-8% annualized returns over 10,20 & 30 year periods, it has also fallen by 35% in some years. In order to cushion the downside, it helps to limit one’s investment in the aurum to a pre-determined threshold.