Understanding Gold

Abstract

Gold has a reputation as a safe-haven asset-useful in times of economic turmoil or inflation. However, perceptions can differ from reality. We examine the investment characteristics of gold and assess its reliability as a hedging asset. We also explore the reasons that the gold price is so high today by detailing the role of the financialization of gold as well as the push among many countries to de-dollarize. We also argue that a second demand shock that could be on the same scale as ETF introduction looms on the horizon with potential changes in Basel III regulations that would allow commercial banks to hold gold for regulatory purposes as a high-quality liquid asset. It is inconsistent that central banks hold gold as a major reserve asset-yet commercial banks cannot. Finally, using the framework of Erb and Harvey (2013), we show that based on historical analysis, when gold hits all-time highs, the subsequent multi-year returns are low or negative. This needs to be weighed against both gold hedging ability, i.e., hedging assets have low expected returns, and the possibility of increased demand from de-dollarizing countries, institutional investors and commercial banks.

Keywords: Gold, Golden Constant, Real Gold, Overshoot, Inflation, De-Dollarization, ETF Flows Hedging, Risk Management, Central Banks, Emerging Markets

JEL Classification: G10, G11, G12, G14, G15, G18, G21, G22, G23, G28