Gold ETFs are often described as an inflation hedge but recent academic research suggests the precious metal is more dependent on emerging market demand, particularly from central banks that hold less gold than their counterparts in developed countries.
“Assuming that gold moved in lockstep with the CPI, the implied price would be about $780 an ounce, according to Duke University Professor Campbell R. Harvey and his collaborator, Claude B. Erb,” Bloomberg News reports.
Gold is trading back above $1,600 an ounce as traders speculate on the odds of further monetary easing before next week’s Federal Reserve meeting. [Gold ETFs Eye Fed, Europe]
Since the gold bull market started in about 2001, prices have risen more than sevenfold.
“If gold is an inflation hedge, then on average its real return should be zero,” Erb and Harvey wrote, according to the Bloomberg report. Instead, returns from 2000 through March of this year averaged 13% a year on an inflation-adjusted basis.
Gold ETFs such as SPDR Gold Shares (GLD - News), iShares Gold Trust (IAU - News) and ETFS Physical Swiss Gold Shares (SGOL - News) have likely fueled the metal’s rise since they have made it easier for more investors to buy gold.
“Global ETF investor positions have continued to trend up in both gold and silver, reflecting the fact that long term price supports such as negative real interest rates, currency debasement and sovereign/financial sector default risk, and rising emerging market/central bank demand remain embedded in the 2012 outlook,” ETF Securities said in a report earlier this year. [Measuring the Impact of Gold ETFs]
Harvey and Erb wrote that emerging markets can support gold because the precious metal represents a smaller part of central bank reserves than developed nations.
Foreign central banks are “one of the more intriguing sources of incremental demand for gold,” says ConvergEx Group strategist Nicholas Colas. [Strategist: Why Gold ETFs Still Make Sense]
“Among emerging economies, for example, central banks are actively buying gold to add to their reserves. The trend is most noticeable in Russia and India, but increasingly in China as well. Press accounts placed China’s net gold purchases in 2011 at over 200 tons, doubling its position in one year,” he said in a recent report.
“And gold is clearly playing a role at the central bank level in these countries’ efforts to hedge such price increases,” Colas noted. “There is a popular saying on Wall Street – ‘Don’t fight the Fed.’ Why fight the Chinese, Russian and Indian central banks on gold? Like the Fed, they have much deeper pockets than you.”
SPDR Gold Shares
Full disclosure: Tom Lydon’s clients own GLD.