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Gold – the hedge against risk

Snapping three years of decline, gold rose by over 8% in 2016 due to concerns fuelled by Brexit and the uncertainty over US President-elect Donald Trump’s policies. This is because people invest in gold to hedge against uncertainty in the market. Generally, gold moves in the opposite direction of the dollar and the world economy.

business Updated: Jan 05, 2017 15:24 IST
Ramanvir Grewal
Gold biscuits
Gold biscuits(File)

Snapping three years of decline, gold rose by over 8% in 2016 due to concerns fuelled by Brexit and the uncertainty over US President-elect Donald Trump’s policies.

This is because people invest in gold to hedge against uncertainty in the market. Generally, gold moves in the opposite direction of the dollar and the world economy.

But one might wonder why do people invest in gold. That is because gold, along with stocks and bonds, is considered to be a store of value as it transfers purchasing power from the present into the future.

Counters inflation, deflation

Moreover, gold is also known to neutralise the risks of inflation and deflation. As inflation goes up, so does the price of gold. According to an International Journal of Research in Management & Technology paper, in 1946, 1974, 1975, 1979, and 1980, when inflation was high in the US, the average real return on stocks, as measured by the Dow, was -12.33%, while that of gold was 130.4%.

During the the Great Depression of the 1930s, when prices were decreasing and businesses contracted, gold prices jumped.

Safe haven

People also flock to gold in times of geopolitical uncertainty as witnessed this year. According to a World Economic Forum paper, gold spot price hit a record high of $1921.17 per ounce on September 6, 2011, amid geopolitical uncertainty.

The year was marked by the Arab Spring, western military intervention in Libya, strikes in Greece, riots in the UK, and the continuing Eurozone crisis.

Limited supply

The production of new gold from mines has been declining since 2000. According to BullionVault.com, the annual gold-mining output fell from 2,573 tonnes in 2000 to 2,444 tonnes in 2007. It can take around 5-10 years to begin production at a new mine. In other words, limited gold supply means higher prices.

Dollar link

Investopedia says the US dollar is one of the world’s most important reserve currencies, and so when it falls, people rush to buy gold. When the dollar depreciated between 1998 and 2008, gold price nearly tripled, reaching the $1,000-an-ounce milestone in early 2008. The dollar declined 40% between 2002 and 2008, partly because of the widening current account deficit.

Demand high

A recent World Gold Council study found latent demand in India, China, Germany, and the US. It found that the global demand has gone from 430 tonnes in 2006 to 1,051 tonnes in 2015. Moreover, demand from China is picking up as it was illegal for individuals to own gold bullion before 2004.

Why it falls

But there are times when gold falls. Whenever the dollar goes up, bond yields rise or the economy looks up, gold prices fall.

A World Economic Forum paper says gold declined in 2013, 14, and 15. In 2013, gold prices fell 23%, the largest annual decline since 1981, due to expectations that the Federal Reserve will cut its bond-purchase programme.

It continued to fall in 2014 amid positive investment climate. In 2015, gold prices fells by over 10% as the US dollar strengthened and the bailout deal for Greece was approved.

What’s in store in 2017

According to a Nasdaq survey, gold prices may rise 13% in 2017. Analysts expect the yellow metal to go up due to a potential trade war between the US and China, tensions with Russia over the alleged hacking of the Democratic National Committee’s servers, and Brexit-fuelled turmoil in Europe. In other words, the world will continue to hold the precious metal dear.