9/7/2013: Gold Price, Gold/Oil Price and What's the Fundamental Difference?

Here's a chart from @freegolds on oil-gold price co-movements:

The point is - as raised here: http://www.sciencedirect.com/science/article/pii/S1057521912001226

Main points of our research:

For the US data: "… our results discussed above indicate that the oil market does not in general act as a safe haven for stocks. However, we find that oil in fact acts as a safe haven during specific periods, such as around 1990, which is presumably related to the first Gulf War and recently, after the 2007-2009 financial crisis (the “credit crunch”). Moreover, the role of oil following the most recent crisis seems to be continuing. Similarly, oil acted as a safe haven for bonds after the 1987 stock market crash and also, after 2000, which is presumably related to the crash in technology and telecommunications stock on the NASDAQ. These results seem to create a pattern for the role of oil that has not been reported before."

"… we find specific periods in which gold market acts as a safe haven. In particular, for equities, we detect evidence for this after 1990, again presumably related to the war, and also, for the recent credit crunch. The role of gold as the anti-dollar is further confirmed in this analysis, also. Gold can be considered a safe haven for dollar in most of the last decade."

For the UK data: "Our main finding perhaps is that we continue to observe a significant role for the oil market as a safe haven when short time periods are targeted in our rolling regression analysis…  In particular, oil acts as a safe haven for the UK stocks around 2001-2002, which coincide with the technology stocks collapse, and as well as around 2007- 2008, which coincide with another crash in stock values during the “credit crunch”. Moreover, oil is a safe haven for the UK bonds also around 2001-2002 period."

"On the other hand, gold cannot be considered a safe haven for the UK stocks during these equity markets turmoil periods, which should be of interest to market participants."

"Gold, however, continues to play its role as a safe haven against paper currencies with regards to the Sterling, also. Hence, our findings indicate that the attributes of gold in this regards are not confined to the US dollar. We find that gold is a safe haven for Sterling around 1998, which was a period of turmoil in financial markets due to the collapse of the hedge fund LTMC; around, 2001, again a period of turmoil due to collapse in technology stocks as mentioned above; and further around 2007-2008, which is of course the recent global financial crisis."

The core issue the chart above raises is that simplified worldview of gold (or any other asset class) as a pure 'absolute return' play. Instead, every asset should be considered in the context of total portfolio of assets being held, including risk-adjusted returns the asset offers and hedging and safe haven properties it affords.

13/12/2012: Some thoughts on gold

Tonight's Prime Time program covering gold is undoubtedly one of the rare occurrences that this asset class got some hearing in the Irish mainstream media. Which is the good news.

Not to dispute the issues as raised in the program, here are some of my own thoughts on the question of whether or not gold prices today represent a bubble.

A simple answer to this question, in my opinion, is that we do not know.

Short-term and even medium-term pricing of gold (in any currency) is driven by a number of factors (fundamentals), all of which are hard to capture, model and value.

For example, currency valuations forward suggest that gold is unlikely to experience a sharp and protracted correction in the US dollar terms, if you believe the Fed QE4 is likely to persist over time. In euro terms, potential for devaluation of the euro implies pressure to the upside to the gold price. Yen price is also likely to play longer-term continued devaluation scenario. Things are less certain when it comes to Pound Sterling price… and so on. Here's just one discussion on one of the above effects: http://soberlook.com/2012/12/precious-metals-hit-by-evans-rule.html?utm_source=dlvr.it&utm_medium=twitter

Another example: drivers for prices on demand side that include rather volatile regulatory conditions in the major gold demand growth markets, such as China and India.

In short, things are much more brutally complex than the PrimeTime programme allowed for.

The reason for this complexity is that gold acts simultaneously (as an asset) in several structural ways:
1) as a simple bi-lateral long term hedge for inflation, equities and currency valuations
2) as a medium term (albeit not entirely persistent) hedge for some asset classes (e.g. equities)
3) as a short term speculative instrument to some investors
4) as a backing for numerous and large volume ETFs
5) as a benchmark backing for numerous and relatively large volume synthetic ETFs
6) as a store of value
7) as a risk management tool for complex structured portfolios
8) as a bilateral safe haven against equities and bonds, political and economic risks, systemic financial markets risks, etc.

These relationships can be unstable over time, can require long time horizon for materialization and are 'paid for' by assuming higher short term volatility in the price of gold. That's right - while PrimeTime contributors spoke about gold price 'correcting' or 'bubble bursting' none seemed to be aware of the fact that if you want to get something you want (hedging and safe have properties being desirable to investors), you should be prepared to pay for it (price volatility seems to be a good candidate for such cost of purchase).

No matter what happens in the short- to medium- term, gold is likely to remain the sole vehicle for the store of value and risk hedging over the long-term. It did so over the last 5,000 years or so and it will most likely continue doing so in years ahead. This property of gold is well established in the literature and is hardly controversial.

There is one caveat to it - due to instrumentation via ETFs, there are some early (and for now econometrically fragile) signs emerging that some of gold's hedging properties might be changing. More research on this is needed, however and only time will tell, so in line with PrimeTime, let's stay on the RTE side of Complexity Avoidance Bias on that one.

There is an excellent summary on what we know and what we don't know about gold by Brian M. Lucey available here:  http://ssrn.com/abstract=1908650 .

Last year I gave a presentation at the Science Gallery on some properties of gold, which is posted here: http://trueeconomics.blogspot.ie/2011/08/20082011-yielding-to-fear-or-managing.html .

Not to make this post a lengthy one, let me summarize my own view of gold as an asset class:

1. In my view, gold can be a long-term asset protection from the risk of expropriation, inflation, devaluations, and tail risks on political and economic newsflow side etc.
2. To me, gold is not a speculative (capital gains) instrument for the short-term and it should not be acquired in a concentrated fashion - buying in one go large allocations. Gold should be bought over longer period to allow for price-averaging to reduce exposure to gold price volatility.
3. Gold allocation should be relatively stable as a proportion of invested wealth - different rules apply, but 5-10% is a reasonable one in my view.
4. Of course, any investment portfolio (with or without gold) should strive to deliver maximum diversification across asset classes, assets geographies etc.

Disclosure: I have no financial interest in or any commercial engagement with any organization engaged in selling gold. Until December 1, 2012 I used to be a non-executive member of the investment committee of GoldCore Ltd and was never engaged on their behalf in any marketing or provision of advice to any of their current or potential clients.

19/7/2012: Q2 report from the World Gold Council

Q2 analysis of the trends and drivers for gold prices from the World Gold Council is worth a read (here) for a number of reasons. Here are two, from my point of view:

Point 1: Per Gold Council: "Gold prices declined in most currencies during the second quarter with the exception of the euro, Swiss franc and Indian rupee, in part due to a strong US dollar. Despite a 3.8% decline in Q2 to US$1,598.50/oz on the London PM fix, gold was up 4.4% during the first half of the year. Volatility remained elevated amidst a busy event-risk period. However, gold generally outperformed risk assets."

Chart and table alongside:

Table explaining events in the chart above:

Table summarizing Q/Q performance of gold prices in various currencies.

"Gold’s correlation to equities and other risk assets fell towards long-run average levels in Q2 helping portfolio diversification. Gold’s increased correlation to equities in Q1 was an indirect effect related to a weaker global economy coupled with a stronger US dollar."

Tow charts to compare on the above:

So things are reverting to historical levels - just what I drew as a conclusion from the gold coins markets data.

Point 2: More importantly, the theme is that of the 'depletion of traditional safe havens': 

"Over the past year, two national bond markets have provided shelter from turbulence in global risk assets: US Treasuries and German Bunds. Additionally, the US dollar, the Japanese yen and the Swiss franc have benefited from de-risking flows... However, being an asset of last resort is not without consequences. In particular, the investors seeking more “safe” assets must also recognise that the ever-increasing supply of both currency and debt deplete the value of these assets. Furthermore, as declining yields approach zero, they create very skewed pay-off structures with much more downside risk."

In other words, these risk-free returns for safe havens start to look like return-free risks once price upside is virtually exhausted either by persistent policy interventions or by natural exhaustion of the asymptotic valuations (in the case of US Treasuries - zero yield bound on prices).

Good luck fitting zero yields into pricing equation for Treasuries, folks...

20/08/2011: Yielding to Fear or Managing Wealth

Here's a copy of my presentation from August 18th in the Science Gallery covering some of my views on gold (announcement here). All disclosures were made in the announcement and at the beginning of my presentation - do not accept this as either an advice to take any investment action - as usual. You can click on individual slides to enlarge.

27/01/2011: Gold - an interesting chart

Few interesting charts on gold for 2010 - all courtesy of the GoldCore.

The above, of course, highlights the relative power of gold as risk-diversification instrument. Gold price volatility was 16% on an annualised basis in 2010 which is consistent with long-term trend. At the same time, volatility on S&P GSCI daily returns was 21% annualized. Given that GSCI is a broad commodities index, 's worth taking a look at relative returns: Gold price rose by 29% in 2010, S&P GSCI rose 20%, S&P 500 +13%, MSCI World ex US Index +6% in USD terms, Barclays US Treasuries Agg +6%. Now, note that the only less volatile commodity instrument is non-storable livestock.

If you want an in-depth view of hedging and flight-to-safety properties of gold - go here. Alternatively, for a more popular view: see the video here.