The World Gold Council last week released its latest market update report, which covers the effect that negative interest rate policies have had on gold.
It reports that “negative interest rates double gold returns,” and advises that “investors should consider doubling their gold allocations amid negative rates.”
The report states that banks in Europe and Japan have now implemented Negative Interest Rate Policies (NIRP). The long-term effects of these policies are unknown, however, discouraging side effects have included unstable asset price inflation, swelling balance sheets and currency wars.
Amid higher market uncertainty, however, the price of gold is up by 16% year-to-date; due in part, it says, to NIRP. It explains that, historically, in periods of low rates, gold returns are typically more than double their long-term average.
“Looking forward, government bonds are likely to have a limited upside, due to their low- to negative yields and, in our view, would be less effective than gold in mitigating risk, ensuring portfolio diversification, and helping investors achieve their long-term investment objectives.”
Portfolio analysis suggests that gold allocations in a low rate environment should be more than twice their long term average.
“We believe that, over the long run, NIRP may result in structurally higher demand for gold from central banks and investors alike. As a result, we expect that demand for gold as a portfolio asset will structurally increase.
“The link between gold and interest rates happens through investment demand. Low interest rates reduce the opportunity cost of holding gold, and negative rates magnify this. Negative sovereign debt yields in Switzerland and Japan extend out to 10 years, while those in France and Germany are negative out to 5 years. Even interest rates in the US and UK are extremely low across the curve, with up to two-year debt yielding less than 1%. In real terms, the picture is even bleaker. Only yields in the UK are positive for maturities higher than three years and just a few long-term bonds yield more than 1%,” it continues.
NIRP significantly reduces the likely pool of assets that investors may hold. In the current negative nominal interest-rate environment, about 30% of high quality sovereign debt (more than US$8 trillion) is trading with a negative yield, and almost an additional 40% with yields below 1%. When yields are adjusted for inflation, the figures are even starker: 51% of sovereign debt (US$15trillion) is trading with negative real yields and only 16% yields more than 1% in real terms.
Therefore, with fewer options to invest in, the opportunity arising in gold shines.
The World Gold Council is very clear on its stance on the matter. “Unless investors are willing to accept a loss-making investment strategy, they may need to consider increasing their holdings of gold,” it warns.
“We believe this should resonate especially well with pension funds and foreign reserve managers whose investment guidelines are typically stricter and who hold a large portion of bonds in their portfolios, but it is also relevant for investors with limited tolerance for risk, as well as those who have increased their stocks holdings due to the low rate environment.”