Juan Carlos Artigas of the World Gold Council tells Tomas Hirst that he is not expecting a bubble to form.
Q. With the spot price of gold having broken its eighth record in two weeks, are there concerns that the rally may be near its peak?
A. Let me put the moves into context. Some investors may think that this is a relatively recent phenomenon without realising that the gold price has been increasing for the past nine years in a moderate manner. Primarily any sustained rise over this time-frame is due to demand and supply dynamics.
More recently gold market demand has been robust and has been driven by economic growth in developing markets, especially in China, which is important not only in the consumption of jewellery but also for direct investment.
Similarly, the positive effect that possible renminbi appreciation has had on local Chinese gold prices has been supportive. This has happened against the backdrop of continuing and possible expansion of quantitative easing by developed market central banks, including the Fed [Federal Reserve], Bank of Japan and the Bank of England, in response to slower growth. Consequentially, people have become concerned that these same strategies may produce currency debasement.
Q. What have been the reaction of central banks to the rally?
A. There has also been a culture shift from global central banks. Since the second quarter of 2009 they have moved from historical net sellers to net buyers as emerging market central banks move to hedge against risks to their other holdings.
There might have been fears that cash-strapped developed country central banks would start selling but so far the opposite has happened during the eurozone sovereign debt crisis.
European sales slowed down to near zero levels and emerging markets have been driving purchases. Europeans have decided not to reach the gold selling limits agreed in 2009 so we don’t think that massive sales are a concern. (article continues below)
Q. What is the case for private investors who have started to invest significant capital in gold markets?
A. I think that investors are coming to understand that gold is a great diversifier, helping them to manage risk as well as a hedge against inflation and currency devaluation.
Investors are trying to harness these aspects of the commodity for their portfolios, which is helping to drive the price.
Q. What would you say to fears that a bubble is emerging in the asset class?
A. Our research suggests that the recent gold rally is not reflecting signs that have been common to bubbles in asset classes in the past. When you look at the dynamics of the market in American property before the crash or dot-com companies at the start of last decade they do not bear a resemblance to what has been happening to gold over the past decade.
The gold price is consistent with its long-run average price compared to a number of other asset classes such as equity indices and commodities like oil. The supply/demand dynamics are key to understanding the price of any commodity and as long as they remain supportive, as they have, that allows us to explain the upwards movements of the gold price.
The gold market is an interesting asset class as it behaves differently to most other markets, and is even unlike most other commodity markets. Historically you have had three sources of supply; mine supply, recycled gold and traditionally central bank sales.
As I mentioned one of the most interesting developments is that central banks that have traditionally been net sellers and therefore on the supply side of the equation have become net buyers and shifted onto the demand side.
Q. Is the rally vulnerable to a turnaround in economic conditions if the global recovery proves more robust than consensus expectations?
A. The economic conditions on the demand side are interesting. You have jewellery on the one hand, industrial demand and you also have investment. These three demand sources may not always work with one another and sometimes one can be pushing demand while the others are adding supply.
When you get into a period of economic stress the aspects of demand that are more linked to the business cycle are the ones that are mainly impacted. But while people may not have as much income to spend on luxury goods, for example, they may be looking for areas to preserve wealth and gold is going to be one of those options.
The various supply and demand characteristics produces what I like to call an intrinsically diversified market for gold as the factors do not necessarily react to the same economic events at the same time.
Q. Are there any concerns of a shock on the supply side?
A. For the past 10 years the level of mine supply has been lower than in 2001. On a tonnage basis it hasn’t moved much over that period, although it increased a little in 2009 against 2008 levels.
Q. So is your opinion prices do not reflect over-optimism or panic causing a short-term spike?
A. Relative to other commodities, a lot of the transactions that take place in the gold market are linked to spot prices. So gold does not necessarily behave in the same way as those that have larger futures markets.
The biggest component of the price movement in gold markets is driven by the purchase and sales of bullion in one form or another. This makes it unique among commodities as you get to see fundamental dynamics much more clearly.
More and more investors are starting to understand the market better. Before 2007 when we were in a stronger market, investors had a lot of options that they were looking at which, after the recession, proved to have a lot of underlying risks that they had not seen.
Those options are still available but investors have come to see that there are risks in investing in those types of assets. This has highlighted the importance to risk management and wealth preservation in portfolio building.
Gold should be used as a long-term strategic allocation in a portfolio. When an investor gets into the gold market I think they should start to see the benefits of reducing tail-risk and help towards wealth preservation.