Sir William Petty, an English economist, scientist and philosopher, who served under Oliver Cromwell, as well as King Charles II and King James II, narrated that gold as wealth “…all the times at all the places” (Petty, 1690)
It is 1979 and Harry “Rabbit” Angstrom, the hero of John Updike’s series of novels, is explaining to his wife why he has just spent more than $11,000 on 30 gold krugerrands… “The beauty of gold is, it loves bad news,” he says (Economist, 26th Feb 2009)
The global financial crisis of 2008 has significantly increased uncertainty in the financial system; it has also shaken investors’ faith in financial institutions. The current scenario has also created a need to look beyond conventional investment avenues such as the stock, currency, and fixed income markets, with the primary motive of safeguarding one’s wealth. Interestingly, the price behavior of gold has been reassuring during this era of financial uncertainty. Thus, it is timely for us to empirically analyse gold as an alternative avenue for investment and as a safeguard to wealth.
Financial Role of Gold in the Past
Historically, gold has been unique due to its monetary role. Human civilisations have used the precious metal to save their wealth, make economic transactions, among other things. In simple words, gold has fulfilled all requirements to act as money. After the invention of paper money, currency values were tied to gold, giving the yellow metal a special status in the monetary system. However, in the early 1970s, with the fall of the Bretton Woods fixed exchange rate system, currency values were no longer fixed to gold, and has remained so till today. Subsequently, gold has been treated like any other commodity. Though the financial role of gold has changed over the time, uncertainties and crisis episodes in financial markets require investors to consider the potential of gold as an alternative of wealth preservation.
Volatile Asian Financial Markets
In situations where investors’ trust in the financial system is weak, the real sector acts as a cushion of stability and trustworthiness. Gold is an appropriate asset for consideration due to its universal acceptance and inherent intrinsic value. How does the safety feature of gold apply to Asian financial markets?
Asian financial markets have been very volatile. Huge currency depreciations against the US dollar have been observed over the time particularly during the Asian financial crisis of 1997 and the global financial crisis of 2008. With large variations in currency values and stocks, Asian markets and investors are searching for safe paths to investment.
Transformation in Asian Gold Demand
Asia constitutes a large share of gold demand. For instance, gold demand from India and Pakistan both constituted 26.02% of total world gold demand in 2015. Previously, the Asian gold demand was dominantly consumption-oriented (for example, as jewelry) rather than investment-oriented. However, now the pattern of Asian gold demand is transforming from consumption to investment. One motive for this change is the underdeveloped hedging mechanisms in Asian financial markets.
Safety Features of Gold and the Asian Currency and Stock Markets
With emerging investment demand for gold, Asian financial markets can benefit from gold safety features that may bring further stability in the financial system. This may also discourage currency market manipulations that has been an issue in export-promoting economies. This may also smooth the way to more market-based mechanisms with less intervention from regulators. What is the gold safety outlook compared to currency and stock markets in Asia?
Our recent research examined the performance of gold safety features against currency and stock markets covering twelve important Asian economies, namely, China, Hong Kong, Japan, South Korea, Taiwan, India, Pakistan, Indonesia, Malaysia, Philippines, Singapore, and Thailand. The findings show that gold provides more safety against currency than stocks.
From an investor’s point of view, this means that if one faces uncertainty in the currency market, investment in gold can provide her/him safety. On the other hand, if one is facing uncertainty in the stock market, she/he will get some benefit by investing in gold. Nonetheless, this will be largely a diversification decision. In finance, diversification is used to avoid risk. In a nutshell, diversification advocates that we “do not put all our eggs in one basket”. In other words, investors may introduce gold in their investment portfolios to get diversification and wealth value protection benefits.
From a policymaker’s point of view, this means a re-evaluation of trade and exchange rate policies for the economy. Most Asian economies are export-based and it can be beneficial for them to promote exports through depreciation in currency value. However, this can promote high gold price and may increase gold demand as a value protection avenue against currency. Therefore, a balance of policies may be more beneficial to ensure economic stability.
For any system to succeed, trust is one of the crucial elements. Unfortunately, the current financial system has lost that trust especially after the 2008 global financial crisis as the aftershocks are still being felt till today. Interest is now on finding or creating safe and trustworthy financial avenues. On this note, the real sector has always been resilient in safeguarding the people trust. Therefore, being one of the many real sector avenues, gold’s relevance and revival is something to watch out for.
With few exceptions, the majority of Asian financial markets are still in the developing stage with a lack of developed risk mitigating mechanisms. Severe fluctuations and uncertainty in the Asian currency and stock markets are promoting gold demand as an alternative investment and value protection avenue. The current outlook shows that gold safety feature is performing well against fluctuating Asian exchange rates. However, this safety feature is not as effective against volatile Asian stock markets. Nonetheless, gold can provide diversification benefits for portfolios of currencies and stocks. Thus, investors can consider gold as an investment option, while policymakers need to work out a better policy mix to foster stability in the financial system.
By: Izlin Ismail and Muhammad Aftab, Department of Finance and Banking, Faculty of Business and Accountancy, University of Malaya
Aftab, M., Shah, S. Z. A., Ismail, I. (2017), “Does gold act as a hedge or a safe haven against equity and currency in Asia?”, Global Business Review, Vol. 20. Forthcoming.
Hillier, D., Draper, P. and Faff, R. (2006), “Do precious metals shine? An investment perspective”, Financial Analysts Journal, Vol. 62, pp. 98-106.
Petty, W. (1690), Political Arithmetick, McMaster University Archive for the History of Economic Thought, Available at: http://ideas.repec.org /b/ hay/hetboo/petty1690.html.
 Functions of money: as a unit of account, medium of exchange and store of value.