In the first quarter of 2021, strengthening consumer demand mitigated the impact of ETF outflows. This demonstrates the dual nature of gold as demand comes from both retail and institutional investment, both with different drivers. Consumer demand, which tends to be concentrated in Asian markets, the United States and Germany, is more pro-cyclical. When economies are doing well, consumers buy more gold or consume technology that uses gold.
Institutional investors have different drivers – when the economic situation is uncertain institutional investors may take an interest in gold as it is seen as a risk mitigator and safe-haven asset. The first half of this year demonstrated how gold’s diverse sources of demand and supply interact. The gold price dropped by over 6 percent in the first six months, as gains during most of Q2 were offset by pullbacks since June.
Gold’s price also underperformed in most key currencies except for the Japanese yen and the Turkish lira, which weakened against the US dollar. This was driven primarily by higher interest rates and interest rate expectations, including a more hawkish-than-expected statement by the US Fed. Looking ahead, interest rates will likely remain a major driver of gold in the short and medium term.
In the longer term though, the potential effects of the expansionary monetary and fiscal policies we have seen worldwide could prompt a renewed interest in gold. These effects may include inflation, currency debasement, and higher risk-on asset exposure.
What makes gold a strategic asset?
Gold has unique and diverse sources of demand: as a central bank reserve asset, jewellery, as a component in technology and industrial applications, and as an investment (in both the retail and institutional markets). This diversity of demand means it could behave differently to other assets and therefore is a potential diversifier. But it is also coveted as a possible source of returns, for its liquidity (over $US237 billion, $320 billion, of gold was traded every day on average last year), and for its potential impact on portfolio performance.
These strategic motivations also ring true in Australia. As a major producer country (Australia was the third largest producer of gold in 2020 after China and Russia), the Australian dollar (AUD) has a different relationship to gold than the US dollar. However, gold (in AUD) has outperformed most broad-based portfolio components over the last two decades, including Australian sovereign bonds and Australian equities.
The big issue: sustainability
Another major issue is sustainability. Investors worldwide – including here in Australia – are applying a sharper focus on issues of sustainability. The gold mining community has undertaken a lot of good work. A recent report highlighted the actions taken by leading gold mining companies as part of global efforts to reach the UN Sustainable Development Goals.
Efforts have also been made to codify environmental, social and governance (ESG) practices. The Responsible Gold Mining Principles, published in 2019, collect these practices into an organising framework so that all stakeholders can understand the material ESG risks associated with gold mining; and understand how responsible gold mining companies are managing these risks and seeking to maximise opportunities for their host societies.
Finally, when it comes to climate change, work has been undertaken by the leading producers to better understand the industry’s greenhouse gas emissions, raise awareness of the efforts already underway to reduce these, and gold’s potential contribution to the development of low carbon technologies. A lot of work has been done, and a lot more is in the pipeline, to ensure that gold contributes positively to the global economy, society at large, and host communities.
As the third largest producer of gold and a major international refining centre, the gold industry will likely continue to contribute to Australia’s economic resilience.