GMO in its latest whitepaper argues that gold has been proven to be a poor hedging or insurance tool. They also seek to dispel other notions regarding the precious metal in the April white paper.
The notion of gold as a hedge against systemic risks is flawed. We believe that the concept of gold’s role as an insurance policy needs to be narrowed significantly.
Last year we argued that relying on conventional wisdom to analyze gold price movements is naive. Conventional
wisdom would lead us to believe that gold price movements are driven solely by the actions of developed markets’ central banks. We believe this view is misinformed and that the available data does not support it.
In that paper, we argued instead that the key driver of the significant rise in gold prices since 2000 has been the emerging markets consumer. Between 2000 and 2010, consumers in emerging markets accounted for 79% of total demand. Conversely, ETF purchases accounted for only 7.5% of demand and central banks in aggregate were net sellers.
This expanded framework demonstrates that gold is also positively exposed to pro-cyclical factors in the emerging markets. Moreover, given the cyclical challenges gold’s key consumers may be facing, the value of gold as insurance should be questioned.
Over the past 13 years, the impact of emerging markets on gold prices was unequivocally positive: emerging markets drove gold prices higher. However, this has not always been the case through history and, we believe, will not always be the case going forward. Emerging markets can be both a positive and a negative driver.
The impact of the Asian financial crisis is instructive. As the economies in the region fell into recession, the purchasing power of consumers in Southeast Asia declined commensurately. Thailand, Indonesia, and Korea all became net sellers of gold, albeit briefly (see Exhibit 1). In line with the drop in demand and the drop in the regional stock markets, gold prices fell 25% (see Exhibit 2).