Wednesday, August 7, 2013

What Drives Gold Prices- Interest Rates and Risk Control

Via the World Gold Council

What can be inferred from gold’s relationship to US real rates?

While returning to a more normal US interest rate environment should have implications for gold
investment – especially in Western markets – these may not be as negative as some market
commentators expect. In fact, our analysis shows that gold’s attributes appear favourable in a
moderate real rate environment compared to either negative or high rate environments:

•     In a moderate rate environment (with real rates ranging between 0% and 4%), returns for gold
are in line with the long-term average of an annualised 6 – 7%.

•     Rising rates are worse for gold than falling rates, but still provide annualised returns well in
excess of a conservative 0% long-term inflation-adjusted return estimate often used to show
gold as a core portfolio asset.

•     Gold’s volatility is significantly lower in a moderate real rate environment. While rising real rates
are associated with increased volatility, it is only marginally higher than the long-run average.

•     The correlation between gold and global equities in a moderate real rate environment is close to
zero, which forms part of the basis for gold’s diversification properties.

•     High rate environments (with real rates exceeding 4%) are least favourable towards gold in
terms of returns, but volatility and correlations remain moderate relative to other assets.
Finally, a re-estimation of the gold price model developed for the World Gold Council by Oxford
Economics suggests that the gold price and US real rate relationship is weaker than in the past.
This is likely due to the effect of the increasing relevance of emerging market demand for gold and
consequently the influence of their local macro-economic factors in determining its price.

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