Geopolitical tensions, other factors to boost gold demand this year

“In 2016, investors around the world returned in large numbers to the gold market as a combination of macroeconomic drivers and pent up demand kept interest in gold high.

“As we start the new year, there are some concerns that dollar strength may limit gold’s appeal. We believe that, on the contrary, gold will remain highly relevant as a strategic portfolio component,” the WGC said in a statement published on Friday.

In 2016, the gold price rose close to 10% in US dollar terms and amassed multiyear record inflows through physically-backed gold exchange-traded funds (ETFs), making it one of the best performing assets last year, despite a post-US election pullback.

Further, the price gained more than 5% since the US Federal Reserve increased rates in mid-December.

With political risk rising, particularly in Europe, the US and the UK, gold will, as a high-quality, liquid asset, benefit from safe haven inflows.

Former Bank of England reserves chief manager John Nugée pointed out that elections in the Netherlands, France and Germany would happen “against a backdrop of continued citizen unrest, fuelled by the ongoing uneven distribution of economic welfare.”

In addition, Britain must negotiate its exit from the European Union. While the UK economy is still expanding, the pound fell sharply following the referendum decision and continues to weaken every time the markets sense that there is an increased chance of a “hard” Brexit.

In the US, there are positive expectations about some of the economic proposals of President-elect Donald Trump and his team, but there are also concerns. The US dollar has gained ground since Trump swept to victory last November, but uncertainty is rife.

Chief US economist Jim O’Sullivan saw “a meaningful risk that negotiations on trade will turn belligerent" and suggested that “confidence in markets could be affected by geopolitical tensions triggered by the new administration”.

Gold is especially effective as a safe haven during times of systemic crisis, when investors tend to withdraw from risk assets. As they pull back, gold’s correlation to stocks becomes progressively more negative and its price tends to increase.

In 2016, gold-backed ETFs increased their collective holdings by 536 t, or $21.7-billion, the highest since 2009.

And while US-listed gold-backed ETFs saw a 40%-plus reduction in their gold holdings in the fourth quarter of 2016 – relative to the three previous quarters – UK-, Asian-, and Continental Europe-listed ETFs fell by just 14%, 9% and 1%, respectively.

In all, Europe and Asia accounted for 57% of total ETF flows last year. “We expect that gold investment demand is likely to remain firm,” the WGC said.

The metal is also becoming more mainstream, as ETFs made gold accessible to millions of investors, primarily in the West, over the past decade; but other markets continue to expand too.

China has seen dramatic growth in recent years through gold accumulation plans and physically settled gold contracts in the Shanghai Gold Exchange.

Innovation is evident across all markets, but at the end of last year one development stood out. The Accounting and Auditing Organisation of Islamic Financial Institutions, with support from the WGC, launched the Shari’ah Standard for Gold, opening up the Muslim world to gold investment.

This could potentially propel gold demand across many Muslim markets from Malaysia, the United Arab Emirates and Saudi Arabia, where Islamic finance is well established, to countries such as Indonesia and Pakistan, which are pushing for Islamic finance to play a greater role in their economic infrastructure.