One of the clear standout performers in the global investment market in 2019 was gold, which enjoyed its best year in close to a decade to finish 18.4% higher (in US dollar terms) than it did in 2018. Changing dynamics in the global geopolitical and economic spheres pushed investor gold demand higher, and these conditions are likely to remain generally supportive of gold in 2020, according to the World Gold Council. The global authority on gold published its Gold Outlook 2020 report in mid-January, which focuses on the interplay between market risk and economic growth that will drive gold demand this year. The report also introduced the council’s new web-based quantitative tool for gold investors – Qaurum. RGN’s editor finds out more in an interview with the Council’s director of investment research, Juan Carlos Artigas.
Jacob Ambrose Willson: Before we get into the Gold Outlook 2020 report, I’d like to ask you about the performance of gold in 2019. What were the key reasons behind gold enjoying its best year since 2010?
Juan Carlos Artigas: There are two major factors that are relevant in explaining gold in 2019. Firstly, the level of financial market uncertainty that investors faced. There was a steady stream of different risks popping up last year. It was a collection of various potential concerns that investors had across the world. These concerns related to trade, geopolitics, valuation of the stock market and many other things that kept investors on their toes.
In addition to that, and in part in response to the uncertain environment, central banks around the world made monetary policy more flexible, either by reducing interest rates or expanding alternative tools to monetary policy such as quantitative easing or so-called quasi-quantitative measures. All that reduced the opportunity costs of investing in gold as well as other asset classes.
Of course, once the price of gold started to rally that created a third ancillary factor which is momentum. When you start to see momentum playing in favour of gold, you will see more activity in the investment market, and that’s what happened in 2019. This was not only individual and institutional investors but also central banks adding to gold demand.
JAW: To what extent are we going to see a continuation this year of the trends that drove gold up in 2019?
JCA: We flagged in the Gold Outlook 2020 report our belief that market uncertainty is not going away this year. It’s not going to be exactly the same dynamics as 2019, although some may continue. But as we can see from the first month of the year, new concerns are materialising. Different risks are popping up on different fronts and things we are supposed to have solved in 2019 seem more likely postponed than fully resolved, so risk and uncertainty isn’t going away.
Monetary policy will remain loose. We will not necessarily see central banks cutting rates at the same rate they did last year. Some of the statements from the Fed and other banks is that they are monitoring the situation, but more likely than not (and this is a fairly consistent view across financial markets), interest rates are not likely to increase any time soon and may even continue to decrease. This provides an additional level of support for gold, particularly as an investment.
We do acknowledge in our outlook that, because of the price performance of gold and the fact that price volatility may remain at the same heightened levels we saw last year, some softness in consumer demand is expected, particularly in jewellery and retail in key markets like China and India. We saw that in the first three quarters last year and expect that trend to carry into 2020.
It is important to note that India and China have been instituting structural changes to their economies with a view to strengthening local ties and making them less reliant on trade agreements with the West. That should be more supportive of gold in the long term, but in 2020, we may see some of this softness playing on.
JAW: The World Gold Council recently released its new quantitative tool for gold investors – Qaurum. What is the main purpose of this tool?
JCA: We built Qaurum for investors to intuitively understand the interplay of gold’s drivers and how that may impact gold’s performance across different macroeconomic scenarios.
We wanted to help investors understand the drivers of gold appropriately and understand how they interact, in part because there is a dual nature to gold. It’s not just an investment and an asset to utilise in periods of risk or uncertainty, it’s also a productive asset that is used in jewellery and the production of electronics. There is a dual nature to gold and it is important for investors to understand that the interaction between these two sides is key to understanding gold’s long-term performance.
In the short term, market participants may focus on gold as an investment with interest rates or the dollar as guidance for short-term performance, but once you look at longer-term performance over a year, five years or 20 years, you start to understand the interaction between these two sides, which is key to unlocking gold’s potential.
JAW: Can you take me through the mechanics of Qaurum, in terms of how it will be used by gold investors?
JCA: Qaurum is powered by our Gold Valuation Framework (GVF). The GVF is a methodology we developed that has been academically validated. It’s based on the principle that the gold price and gold performance reflect market equilibrium. In other words, the price of gold can be appropriately explained by the dynamics of demand and supply. Demand and supply not only in the sense of purely buying jewellery or gold-backed ETFs, but also what is happening in the over-the-counter market.
Once you have a full picture of the market and how this interacts with the supply side, in particular mine supply and recycling, you can historically very well explain the behaviour of gold. Gold may not necessarily follow traditional gold valuation methods such as cash flow modelling because it doesn’t have credit risk. But that doesn’t mean that investors cannot value it. In fact, gold’s valuation is more intuitive because it goes back to the principle of demand and supply and market equilibrium. The GVF explores how you can utilise market equilibrium to establish an appropriate framework to value gold.
Qaurum is a web-based tool that utilises an econometric model based on the GVF, where investors can understand the impact of different drivers of gold and the performance of gold in three easy steps.
First, users can select a pre-populated macroeconomic environment developed by the think tank Oxford Economics. They publish quarterly different macroeconomic scenarios based on their models and their interactions and understanding of investor concerns. We take those inputs and allow investors to select the one they feel more appropriately reflects their own views.
Next, users can view how those scenarios may influence demand and supply for gold. The third step is to calculate the implied performance or change in the price of gold required to ensure that the market is in equilibrium.
The additional powerful feature in Qaurum is that we allow investors to customise their own scenario. Any scenario they see, they can modify if they have a slightly different perspective on some of the key variables driving gold. We bucketed these variables into four categories: 1) Economic expansion 2) Risk and certainty 3) Opportunity costs 4) Momentum.
Economic expansion is the positive link that economic growth has on the procyclical side of gold, in particular jewellery and technology. Risk and uncertainty and opportunity costs tend to influence more of the performance of gold in the context of investment, whether it is by individuals, institutions or central banks. Finally, momentum and trends can influence different aspects and behaviours in the market across various groups.
JAW: Finally, broadly speaking what will the World Gold Council be focusing on over the course of the year? Are there any specific areas or initiatives that will be examined in 2020?
JCA: We often look at the gold market from different perspectives and try to make sure that the market is as transparent and accessible to investors. We tend to spend time thinking about how we can interact with the industry and various regulating bodies to see how the gold market can become stronger and more accessible.
There has been quite a lot of focus on ESG and climate change in recent years and World Gold Council has been active in this area across a number of fronts. In 2019, we released our Responsible Gold Mining Principles, and continue to focus on the relevance of ESG for investment. In addition, from the perspective of research, we want to make sure that investors properly understand the drivers of gold, how it behaves and why it behaves in the way it does, so that they can feel more comfortable to make strategic decisions on gold.
We also want to help investors not only understand gold in the absolute but how it compares and interacts with other asset classes. For example, gold compared to a broad commodity basket exposure and what may be better in terms of portfolio performance. We published a paper last year comparing the two, highlighting how gold may be a better strategic asset, even if investors still maintain more tactical exposures to broader commodities.