Emerging Markets and Gold

Drawing from the work of Bhartia and Seto in the article titled "Present and Emerging Risks to the Gold Trade" (found here) and "Emerging Consumers Drive Gold Prices: Who Knew?" (found here) it is claimed that the driver for the price of gold since 2000 has been the emerging economies. 

From our perspective, we have struggled to jump on board the explanation that India and China, or emerging markets, are the primary contributing influence on the rise in the price of gold.  In our experience, when the small players (in any market) are piling in on a particular trade, it is worth examining the elements that are making it possible.

What stands out the most in our review of Bhartia and Seto’s work is the following comment:

“The impact of the Asian financial crisis is instructive. As the economies in the region fell into recession, the purchasing power of consumers in Southeast Asia declined commensurately. Thailand, Indonesia, and Korea all became netsellers of gold, albeit briefly (see Exhibit 1). In line with the drop in demand and the drop in the regional stock markets, gold prices fell 25% (see Exhibit 2).”

This is an instance where it appears that correlation of a select period of time has fit the argument more than explained the reasons why the price of gold has increased.  Unfortunately, this examination overlooks or omits the performance of the same regional stock markets from 1980 to 1993, a period that reflected massive gains in the respective emerging stock markets even as the price of gold crashed or was unchanged from the peak in 1980 to 1993, and ultimately to 2000. As an example:

• The Thai Set Stock Index increased 16 times (16x) from 1980 to the 1993 peak (found here) & (confirmed here) In the same time frame (1980-1993), gold declined -61%.
• In the case of the KOSPI or Korean stock index, it increased 11 times (11x) from 1980 to the 1993 peak (chart here). In the same time frame (1980-1993), gold declined -61%.
• In the case of the Indonesian stock market, it increased 6 times (6x) from 1982 to 1992/1993 (chart here).  In the same timeframe, gold was unchanged.

Our belief is that the overall rise in the stock market reflects a general increase in economic wealth of the country.  Unfortunately, Bhartia and Seto cannot demonstrate that the emerging market consumer demand to push the price of gold higher in a period when the emerging economies grew from 1980 to 1993.  Nor could they demonstrate that currency collapse and a crashing economy had enough impact to move the price of gold higher.

If Bhartia and Seto are correct that emerging markets are moving the price of gold higher today, then the ability and opportunity, due to significant economic growth, to buy gold should have increased enough to move the needle in a positive direction from 1980 to 1993.  Unfortunately, when countries normally associated with a long tradition for appreciating the value of gold and/or high savings rate experienced substantial economic wealth, the price of gold did not increase.  In fact, from 1980 to 1993, the price of gold declined substantially. Also, as the respective currencies were on the brink of collapse in 1996 and 1997, gold managed to decline -37%.

The economic law of demand suggests that as prices go higher, demand will decline.  That has not been the case in emerging economies when it comes to gold, as demonstrated by Bhartia and Seto.  Worse still, when  emerging markets are piling into a trade (any trade), it may mean that the easy money has been made, in the short term.

Rather than considering emerging markets as leaders of a movement towards better investment decisions, we should be reassessing the role of that investment and its ability to generate reasonable risk-reward outcomes.