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Gold price volatility, asset class correlations, and Central Bank demand.

Why has the gold price been so volatile? Perhaps the answer is that as a liquid asset, gold may have been used to raise cash, not least because it was one of the few assets with positive returns this year. Gold was up 10% ytd in early March.

There is a historical precedent for the “liquidity-driven” decline in the price of gold that occurred in mid March. The correlation between gold and equities is generally negative. In other words gold is usually a good hedge. However, during periods of disorderly selling when equity market volatility spikes to extreme levels both can sell off together, as also occurred during the 2008-2009 financial crisis.

This argument is supported by the fact that the much of the selling of gold appears to have been via derivatives markets. According to the World Gold Council* net long positioning in COMEX futures – usually linked to speculative trading – was high prior to gold’s March pullback. Additionally, leveraged investors may have been forced to sell positions to meet margin requirements as the price fell through technical levels.

Despite significant selling of gold-backed ETFs in mid-March, inflows were positive overall in the month. Investors added US$3.6bn to gold-backed ETFs in March contributing to a total inflow of US$11.5bn ytd, according to the World Gold Council, helping to explain the price recovery in recent days.

Gold’s performance is intertwined with its unique nature as a consumer good and investment asset. The key issue is whether during the current period of uncertainty investment flows can offset weakness in consumer markets (think of the quantity of gold jewellery that is usually sold at airports).

Ballooning budget deficits, negative real rates and debasement of currencies will present structural challenges to asset managers, pension funds and central banks, and will be a longer term compelling argument in favour of gold.

We expect central banks to remain net gold buyers overall, partly for reasons related to the weaponisation of the US dollar that we have discussed previously. The Central Banks of Russia, China, and Turkey have all been notable buyers in the last two years. The political reasons for this buying are unlikely to change in the near term.

Finally, don’t underestimate the impact that very low (or even negative) interest rates in the US might have on central bank’s reserves portfolios. It was the onset of negative rates in Europe that undermined the Euro currency share of global FX reserves. In the current constellation, the zero yield on gold might look like a relative winner.


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