What are the Key Themes in Gold?

Wall St. Cheat Sheet

The World Gold Council, the global authority on gold and its uses, recently released its overview of the first quarter of 2012. While there are many factors affecting gold these days, the report breaks down three key themes for gold that took place in the first quarter.

It was a challenging quarter for gold due to a pullback in March, but gold prices still finished 8.6 percent higher to reach $1,662.50 by the end of the quarter. Furthermore, gold continues to perform well against all fiat currencies. The WGC explains, “The average price for the quarter was marginally higher than Q4 2011 (+0.2 percent) and 22 percent higher on a year-over-year basis, as drivers of gold demand and supply continued to support its long-term trend. This performance was echoed in all major currencies.” Gold has been on the rise in all currencies, because central banks such as the Federal Reserve, Bank of Japan, Bank of England and the European Central Bank continue to paper over their insolvency problems. On Friday, the IMF officials agreed to nearly double its lending capacity to more than $700 billion. The funds will almost certainty be used for more bailouts in the eurozone in the coming months, as nothing has truly been solved in the debt crisis.

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Volatility is no stranger to the precious metals industry and the theme of higher-than-normal price swings continued in the first quarter. The WGC reports, “Gold’s annualized volatility measured 20.4 percent during Q1, higher than the long-run average of around 16 percent. However, more importantly and consistent with its historical profile, it was skewed to the upside, registering 21.8 percent on the upside and only 16.4% on the downside.” This means that gold prices typically fell less sharply than it rose. However, commodities in general had a negative volatility skew with upside volatility of 12.21 percent and downside volatility of 13.4 percent. Although gold is often labeled as a commodity, it does not perform as one. Instead, gold performs as an asset class in its own league.

The final theme relates to gold’s ability to trade as its own asset class. The WGC finds that the long-term correlation of gold to equities remains statistically insignificant. The report states, “ Despite higher than average short-term correlations to equities and other risk assets during the quarter, gold’s performance remains independent of risk asset performance. Regression analysis shows that gold may, at times, move in the same direction as equities, but these moves are almost always related to other macro factors, such as, gold’s negative correlation to the US dollar.” The report goes on to explain that gold may have a slight short-term positive correlation with the S&P 500, the long-term correlation remains near zero. This is a key characteristic of the safe-haven metal.

Although gold prices are currently trading down about .65 percent today, equities are trading more than 1 percent lower on renewed European fears. Volatility is likely to remain this year as speculation builds on even more central bank easing. However, gold’s ability to stem losses on the downside and trade separately from equities makes it a very attractive holding for any portfolio.

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Disclosure: Long EXK, AG, HL, PHYS