FX: Don’t be fooled by gold’s blistering 2016 start

Solomon Teague
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With rates near their lower-bound or hovering in negative territory around the developed world, the opportunity cost of investing in gold – which critics decry for lacking a regular income stream – has essentially vanished. Unless the fear continues to rage, the commodity’s recent spell should run out of steam as US rates creep up.

Gold suit-R-600

The year to date has been characterized by heightened risk aversion and panic, interspersed with relatively few periods of optimism.

And while Japan became the latest country offering negative interest rates on central-bank deposits this month, gold was surging: it has risen around 17% from the start of the year to its peak of around $1,260 in 2016.

Robin Bhar, metals analyst at Société Générale, says: "In recent weeks, we have seen a lot of concern about currency devaluation and further central-bank easing and that was a perfect storm for gold."

The impact of low rates is crucial, reducing the cost disadvantage that has traditionally undermined gold.

Adrian Ash, head of research at BullionVault, says: "Negative deposit rates in the eurozone and Japan are now approaching commercial storage charges on physical bullion, while Swiss Libor and the Swedish Riksbank’s deposit rate already exceed even the higher fees of gold-backed exchange traded funds (ETFs)."

The cheapest major ETF is the iShares Gold Trust, says Ash, which charges 0.25% per annum, while the biggest gold ETF is the iShares SPDR, which costs 0.40%.

"Commercial storage rates for large-bar gold are nearer 0.10%," says Ash. "Customers of BullionVault pay 0.12% per year."

Joni Teves, UBS
Joni Teves, precious metals strategist at UBS, says: "Gold’s cost of carry has been an argument against holding it, so negative interest rates in a sense evens out the playing field.

"For monetary policy easing outside the US, the near-term reaction function could be muddled by currency moves versus the dollar, but in the long run, easing should be positive for gold."

For now the impact of negative rates on gold are relatively modest because the costs are being absorbed by the banks, and have not yet been passed on to the public. However, the impact of negative rates will increase should the banks pass the cost on to consumers, says Teves.

Yet despite the falling costs of investing in gold, its investment case remains polarizing. The metal has seen strong moves in recent months amid market volatility and risk aversion since the start of the year, but many analysts believe that trend has now run its course.

SocGén’s Bhar says: "The US economy is looking pretty healthy given recent jobs data making rate rises more likely, even if we have to wait until 2H. At the very least, that is likely to cap gold performance, but more likely it is going to drive it down."



Source: BullionVault

UBS agrees gold is unlikely to continue its recent surge, predicting prices will stabilize and average $1,225 this year.

However, gold might look more attractive to non-dollar investors, especially for currencies that are weakening against the dollar.

"If we see the Bank of Japan or European Central Bank easing, gold may look attractive when purchased in yen or euros," says Bhar.

Therefore, the case for holding gold often centres on diversification, and in some cases a lack of trust in the financial system itself. Although it pays no interest, its advocates argue it offers protection from inflationary, super-loose monetary policy that erodes the value of fiat currencies.

The perception of gold as a superior store of value to national currencies is at the heart of its appeal to many investors.

BullionVault’s Ash says: "Die-hard gold investors never trust the fiat money system. Central bankers make gold bugs of us all when they try desperate experiments to claim some pretence of control over the economy or markets."

Yet gold’s worth as a store in value depends on the timeframe under consideration. It is clearly as capable of losing value as any fiat currency, regardless of central bankers’ inability to print more of the metal, as evidenced by its performance in the 1980s and 90s.

Because gold has only floated since 1971, there isn’t sufficient data out there to make a definitive case about gold’s performance as a store of value, relative to fiat currencies.

What is clear is that gold is sensitive to changes in interest rates – though more to the real inflation-adjusted rate than the nominal rate, and more to the direction of travel than the absolute level, says Ash.