Most people think that gold only acts as an insurance against volatile and nervous times on either the macro-economic front or the stock market in general. This conventional thinking is actually incorrect, and the World Gold Council was able to put some numbers on some wrong perceptions of the gold price.
The correlation between GDP growth and the consumption of gold might be closer than you think, as the WGC estimates that for every one percent increase in the GDP, the demand for gold to be used in for instance jewellery increases by 5%. This makes a lot of sense as an increased GDP indicates an increased wealth per capita and thus more purchasing power. As the first part of the disposable income is being spent on basic needs (food, housing,…), any increase in wealth allows for more income to be spent on so-called luxury goods.
This is a phenomenon which is very clearly visible in both India and China. However, there are some differences between both countries as in India there seems to be some kind of linear correlation whereas in China the increased demand for gold seems to be exponential. If the income per capita in India doubles from 40,000 rupee per capita to 80,000 rupee per capita, the gold demand increases by approximately 350%. In China, however, a doubled income per capita leads to a demand for gold which is approximately five times higher.
Source: World Gold Council
You might try to dismiss this correlation by stating that there’s a big difference between emerging market countries and more ‘mature’ economic super powers. That’s correct, as in the USA the correlation is 2.3, so there definitely is a very strong correlation between the GDP and the demand for gold, even in mature markets. As market analysts are expecting a GDP growth of 3% for 2015, the gold demand in the USA will actually increase by 7% and that’s not something which could easily be ignored. And you also can’t ignore the force of compounding. Should the GDP of the USA grow by 3% per year for the next 4 years, then the demand for gold will increase by 12.55%. To make this more tangible, by the end of 2017 the annual demand for gold will increase by in excess of 600,000 ounces. If you know that the actual contribution of recycled gold has been decreasing for five years now, the fear for a lower demand for gold is unrealistic.
Source: Brilliant Earth
A second argument is that gold doesn’t offer any returns in a high-yield environment. Whilst this is a generally accepted thesis, it’s an erroneous one. In a ‘normal’ interest rate environment between 0% and 4%, the volatility of the gold price decreases tremendously, and the case could be made that in a higher yield environment gold could be used as a balance for equity weight in a portfolio, as higher interest rates usually also indicate a higher risk for the debt holder.
Even though we don’t necessarily care about the economic demand for gold, we commend the World Council to publish some hard facts. We remain convinced about the fundamental value of gold in any portfolio, either as an investment or as a hedge. If you’d for instance look at the most recent developments at the Federal Reserve where the Quantitative Easing program will be stopped, the reaction in the gold price was actually quite muted. As the real selling only started 36 hours later during the Hong Kong trading time, we have the impression this selling pressure was unrelated to the decision of the Federal Reserve (which was widely anticipated anyway).
Even though these are shaky times for all precious metals investors, we continue to consider gold and silver related investments to be an excellent long-term hedge against volatility. And so should you!
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