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Gold is Very Much Relevant Says Goldman Sachs

(Kitco News) - Goldman Sachs says precious metals remain a “relevant asset class” sought as a safe haven in response to “fear” in developed-market economies, while purchases tend to be tied to growing wealth in emerging-market economies.

The bank released a report Tuesday, titled “Fear And Wealth,” that was not a traditional investment-bank gold forecast but assessed the factors that tend to influence demand in both developed and emerging economies. This combination of fear and wealth accounted for a greater-than-400% rise in gold prices over the two decades since the metal bottomed in the late 1990s, Goldman said.

“We believe that precious metals remain a relevant asset class in modern portfolios, despite their lack of yield,” the bank said. “They are neither a historic accident or a relic.”

The physical properties of an ideal long-term store of value -- durability, portability, divisibility and intrinsic value – explain why precious metals were initially adopted and why they remain relevant today, Goldman said.

The so-called fear factor tends to be more important in the short to medium term in developed nations, Goldman said. While real interest rates and economic expectations play a role in gold demand, so do debasement, sovereign balance-sheet, geopolitical and other market risks

“Stated more simply, we are talking about the drivers of ‘risk-on, risk-off’ behavior in markets,” Goldman said. “This factor matters so much to gold precisely because it is a safe-haven asset. Accordingly, as uncertainty increases, preferences shift towards having more gold in the portfolio, driving prices higher. Fear can spike or fall quickly, and since DM economies tend to have more wealth to reallocate as the world gets riskier, this is both a medium- to short-run driver and more one exposed to the DM growth outlook.”

The global financial crisis highlighted the purchasing that occurs based on fear, Goldman said.

“The re-emergence of structural tail risks in developed markets led to a significant rotation towards more defensive portfolios and a reassessment of central bank’s gold-selling policies. This has been manifested in higher retail and ETF [exchange-traded-fund] purchases -- still more than twice as high in 2016 as in 2006 -- and DM central banks halting all sales of gold stocks since 2009.”

Nevertheless, the bank said, with the global economy strengthening and more rate hikes expected from the U.S. Federal Reserve in 2018 and 2019, “we expect that the fear factor will moderate over the next 12 months, likely driving a moderate rotation out of gold for DM investors.”

Meanwhile, gold demand in emerging economies tends to rise when wealth does likewise. Rapid accumulation of gold tends to occur when per-capita gross domestic product reaches roughly $20,000 to $30,000, Goldman said.

“As more EM economies -- including China -- are set to grow to these income levels over the next few decades, the underlying long-term demand picture remains supportive of gold prices,” Goldman said. “While fear can spike or fall relatively quickly, wealth tends to accumulate slowly. This makes wealth an important, but easy to overlook in short-term forecasting, driver of gold.”

A boom in income and savings in emerging-market economies since 2000 created new consumers for gold demand, Goldman said. In fact, the bank pointed out, China’s and India’s combined share of the gold-jewelry market increased from 25% to over 60%.

China’s jewelry and investment demand is around 0.5 gram per person per year, Goldman said. “Our modeling, based on the historical experiences of 29 countries at various stages of development since the early 1990s, suggests that this is still very far from peak annual demand,” the bank said.

As for other precious metals, Goldman said silver primarily moves in response to gold prices and industrial demand.

“In the medium term, divergence between the two prices is primarily driven by changes in industrial demand for silver and to a lesser degree, silver supply. This means that silver tends to outperform gold during the expansion phase of the business cycle when industrial demand growth is strong,” the bank said.

“It should be noted however that since 2011, silver industrial demand diverged from the global business cycle due to the substitution for base metals (initiated by the 2011 silver price spike), but we expect this disconnect to be temporary.”

Meanwhile, due to less safe-haven investment demand and the potential for physically tight markets, platinum group metals tend to be priced like other industrial commodities.

“The price of a basket of PGMs must reflect the price of the incentive mine project necessary to balance the market,” Goldman said. “The ratio of individual PGM prices then has to be determined as a function of relative on-ground stocks and market balances.”

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