The enduring strategic role of gold

THE year 2020 was a record one for gold as it reached new highs on the back of institutional investment. This institutional interest in the precious metal was driven by a number of factors, not least the unprecedented economic uncertainty brought about by Covid-19.

Although we have a long way to go to fully recover from the pandemic, the global roll-out of vaccines has led to renewed economic optimism. This has supported consumer demand for gold, particularly in Asian markets, but institutional investment in gold has softened so far this year.

Gold-backed exchange traded funds (ETFs) are one way investors allocate to gold.

At the time of writing, over 3,500 tonnes of gold are held in ETF and similar structures, mainly in the United States, the United Kingdom and the rest of Europe. This is a larger holding than individual central banks (with the exception of the US Federal Reserve). Although the larger ETFs are domiciled in the West, Asia-based ETFs are growing in popularity.

Gold and real rates

The latest data from the World Gold Council (WGC) shows that, compared to last year's record inflows into ETFs, investment demand remains muted even as gold prices recover. With real rates moving further into negative territory, many are asking why gold has not rallied more.

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In early August, real government bond yields via the US 10-year TIPS yield hit all time lows. Normally, this would be positive for gold, as the opportunity cost of a gold allocation might decrease.

In recent years, we have seen a strong correlation between real rates and gold but there has, at times, been a lag. This appears to have been the case in August and if real rates hold below minus one per cent, we would not be surprised to see gold react.

August 'flash-crash'

On Aug 9, gold dropped 4 per cent over the course of just 15 minutes during Asian market trading hours. Some have referred to this as a "flash-crash" and there are a number of potential explanations for what happened.

First, on the preceding Friday, gold was down 2.3 per cent on the back of a strengthening of the US dollar and yields.

There are also some technical factors that could have had an impact, including stop-loss orders snowballing. But the key takeaway is that gold partially recovered when the US markets opened and it ended the day down 2 per cent.

Softening in gold price

At the time of writing, gold is down by 4 per cent this year, and in August it was down 0.6 per cent. There are several possible reasons for this including more positive economic data, and expectations of rising interest rates. There is also uncertainty over how transitory a period of inflation would be.

Last year was an unprecedented one for gold, so a softening in the gold price is not out of the ordinary.

Despite this year's pullback, gold's strategic role endures, and there are four main attributes to look at.

First, it can be a source of returns. Some of our recent research looked at gold's historical performance against other major asset classes popular here in Singapore.

What we found was that the long-term average returns of gold outperformed most other assets, including Singapore equities.

Secondly, gold can act as a diversifier. The benefits of diversification are widely acknowledged - but it is hard to find effective diversifiers.

Many assets become increasingly correlated as market uncertainty rises and volatility is more pronounced, driven in part by risk-on/risk-off investment decisions. As a result, many so-called diversifiers fail to protect portfolios when investors need them most.

Gold is different in that its negative correlation to risk assets generally increases as these assets sell off. This was demonstrated in the financial crisis - equities, risk assets, most commodities and real estate tumbled in value, but gold held its own and increased by 30 per cent in Singapore dollars between December 2007 and February 2009. In the more recent equity market pull-backs of 2018 and 2020, gold remained positive.

Thirdly, gold is a liquid asset. It is traded globally and average daily trading volumes between December 2010 and December 2020 exceeded S$240 billion.

Taking these factors together suggests that gold can enhance a portfolio's risk-adjusted returns and it is for these reasons that institutions and individuals have long recognised the strategic role of gold.

Singapore's role

Singapore is an important market for gold. It is a major regional gold hub and per capita gold consumer demand is the highest in Asean, and among the highest in the world.

In 2020, per capita consumer demand was more than double that of the US.

Singapore is also home to new and innovative gold products.

A combination of Singapore's expertise in fintech, supportive regulatory environment, and access to capital means it is well placed for the development of digital gold products that are transforming the gold market.

Singapore also plays a major role in the processing of gold, and is home to significant gold refining capabilities.

Institutions in Singapore have long recognised the role of gold. As such, the WGC will be holding its first Evolve Investment Summit in Asia in Singapore later this year.

As a major international wealth management hub and innovative financial centre, Singapore is likely to play a key role in the global gold market for years to come.

• The writer is regional CEO (APAC (excluding China) at the World Gold Council.