Capital Gold Group Report: U.S. RECESSION FAVORABLE FOR GOLD - A DOLLAR & INFLATION HEDGE
NEW YORK (MarketWatch) -- Macro economic data and the U.S. Federal Reserve Bank's swift loosening in monetary policy underline the risk that the U.S. economy is on the brink of, or already in, recession. Not surprisingly, consumers are distinctly less confident now than they were just one quarter ago and leading indicators suggest that worse is to come.
There are obvious winners and losers in terms of asset performance in a recession.
Cyclical stocks, such as car manufacturers and homebuilders, as well as
financial stocks tend to under perform as consumption is cut back and
bank lending slows.
But it is not
true of all stocks. "Defensive" stocks like biotechs or foodstuffs
whose markets are largely unaffected by the economic cycle tend to
perform well. So do fixed-income assets, as interest rates are lowered
in a bid to boost consumer demand. Commodities, on the other hand, tend
to under perform as slower economic growth reduces demand for the
metals and energy used in the production of cyclical goods or in the
provision of services.
During the recession that followed the high-tech bust,
the Dow Jones Industrial Average index and Reuters/Jefferies CRB
Commodities Index fell by 0.3% and 8.4% respectively, while U.S.
10-year bond futures rose by 1.9% and the NASSAQ Biotech index rose by
23.4%. But what about gold: how is the yellow metal likely to fare if
the economy falls into recession?
AN INDEPENDENT ASSET
Gold moves independently from the economic cycle. It's not difficult to
understand why when one considers the diversity of its supply and
demand base, the ultimate determinants of price movements.
Commodities typically
fall during a recession, as noted, as the raw materials used in the
production of non-essential goods and services declines. However,
demand for gold as an intermediate good is relatively small in
comparison to many other commodities. Last year, just 14% of gold
demand came from the industrial sector (mainly electronics). This is in
stark contrast to base metals and even other precious metals, where the
vast majority of demand comes from industry. As a result, gold is much
less vulnerable to the vagaries of the economic cycle. That said,
demand for gold in electronics is likely to fall if the economy falls
into recession as consumer spending on non-essential electronics goods
declines.
A U.S. recession would
undoubtedly have negative implications for gold jewelry demand in
America, as consumer spending slows. However, this negative implication
could be at least partially offset by the higher share of gold jewelry
in the retail market. Moreover, gold is much less vulnerable than other
jewelry materials, such as diamonds or platinum, to a U.S. recession as
far more demand for gold comes from outside of the U.S. -- 70% of
diamond jewelry demand comes from the U.S. market, compared with just
10% for gold.
The final source of
demand comes from investors. Investors buy gold for many reasons. Chief
among these are gold's inflation and dollar-hedging properties, both of
which have been proven over long periods of time. How a recession
affects investment demand would depend, in part, on how inflation and
the dollar react.
The brewing recession
has so far been positive for gold on both fronts. The dollar has
continued its downward trajectory, while inflation has (unusually)
headed higher. U.S. consumer prices increased at an annual rate of 4.0%
in February this year, up from 2.4% just a year earlier. If these
trends continue, investment demand for gold as an inflation and dollar
hedge is likely to remain strong. And if the recession deepens concerns
over the health of the U.S. banking sector, demand for gold as a safe
haven asset is also likely to remain robust.
On the supply side,
there are three main sources of gold supply: mine production, official
sector sales and scrap or recycled gold. Mine production is by far the
largest element, accounting for 70% of total supply last year. Changes
in annual mine supply bear no relation to changes in U.S. or even
global GDP growth. The upward trend in mine production that was
underway in the late 1980s was not arrested by the 1990 recession (the
U.S. economy suffered an outright contraction, while world GDP growth
slowed to 1.6% from 2.9% the previous year). Nor was the downtrend in
mining output that began in 2001 reversed by the sharp acceleration in
world growth that followed.
Mine production is
influenced by very specific factors, such as the level of exploration
spending, the success or otherwise in discovering new gold deposits and
the cost of extraction (some new discoveries may not be economically
viable). Lead times in gold mining are often very long. It can take
years to re-open a closed mine, let alone find and mine new reserves.
Central bank decisions
to buy or sell gold (they remain net sellers) are also usually
strategic in nature, rather than reactive to the economic cycle. The
decision to buy or sell gold is often made years in advance and then
carried out over a period of years. In Switzerland, for example, the
proposition to sell gold (the first gold sales program) was first
recommended by a group of experts in 1997. However, the actual sales
program did not commence until May 2000, with the sales then taking
place over a period of five years.
Scrap supply is
influenced by many factors, perhaps the most important being price and
price volatility, but recessions and periods of economic distress have
also had an impact. The most dramatic example is when Korea was pushed
into recession during the 1998 Asian currency crisis; its scrap supply
increased by almost 200 tonnes as the government bought gold from the
local populace in exchange for won-denominated bonds. It then sold the
gold on the international market in order to raise the dollars
necessary to avoid defaulting on its external debt.
In summary, a U.S.
recession does not have negative implications for the gold price thanks
to the unique drivers of gold demand and supply. The only element of
demand likely to be affected by a recession is investment demand, but
that in turn will depend on the "type" of recession. So far, the
brewing recession has been positive for gold, as it has been
accompanied by a rise in inflation and a falling dollar, which has
boosted demand for gold as a dollar and inflation hedge.
Capital Gold Group, gold group, gold, gold prices, gold news, gold coins, gold bullion, gold IRA, IRA gold
