Gold has not been performing well in recent days. The commodity saw its greatest two day fall in thirty years on Friday and Monday. Some investors, including some hedge funds, are reaping great rewards from the shift, but many investors have seen holdings shed large amounts of value. The lesson, described in a report from GMO is that a change is needed in the way we think about gold as an investment.

Here at Valuewalk, we’ve been warning about the risks of the drive toward gold for some time. The analysts at GMO have similarly been warning against the use of the metal as a currency hedge for a long time. The first line of the  latest report carries the most import “The notion of gold as a hedge against systematic risks is flawed.”

The analysts, Amit Bhartia and Matt Seto, argue that the biggest factor in price finding for gold is not the actions of central banks in the developed world, it is consumers in emerging markets. According to the report 79 percent of the demand for gold between 2000 and 2010 was from that sector.

In the last decade the impact of emerging markets on the price of gold has been unequivocally positive. There is no reason to think that that trend could go on forever, and there is, in fact, reason to believe that the positive impact may lessen going forward, building pressure for a price adjustment. The chart above demonstrates the fall in demand for gold in India, which came as a result of lower economic growth.

The economies of India and China, which are responsible for a large swathe of world gold demand, are coming under increased pressure. China may, in fact, be due for a serious economic crisis, and India’s growth rate has halved in recent years to 4-5 percent. Falling demand in emerging markets has a huge impact on the world gold market.

The bottom line is that gold is not an insurance policy. Its value is not determined, for the most part, by the actions of developed world investors and developed world central banks. It is vulnerable to the vagaries of economic growth in China and India, as well as other emerging markets.

The structural problems faced by both the Indian and Chinese economies right now has increased the risk factor for investments in gold. Investors should re-evaluate their attitude to gold. It is not a hedge against economic problems and inflation in the developed world, it is more directly a pro-cyclical exposure to emerging markets.

For any investors wondering where to go with their gold holding after the recent price instabilities it is important to listen to the assertions of the GMO analysts, “the concept of gold’s role as an insurance policy needs to be narrowed significantly.”

GMO White Paper on Gold Myths by