The World Gold Council’s Investment Commentary released October 27th said that as of October 20, 2014, gold prices were up 3.3% for the year “amid record low volatility”. Its year-to-date low was just below US$1,200/oz and reached a high at US$1,385/oz, WGC said. This, despite predictions from market analysts who expected lower prices, based on their evaluation of investor sentiment and their belief that stronger economic growth would be counter indicative for gold prices.

The commentary sums up its argument for gold as a valuable portfolio component for investors citing four reasons:

• Positive economic growth is supportive of gold’s long-term demand

•Rising interest rates do not necessarily push gold prices down

• Gold’s cost effectiveness makes it an attractive portfolio hedge compared to other strategies

• Constraints in mine production and decreasing gold recycling have kept the market in balance.

WGC believes that not all gold demand is counter-cyclical. “Investors recognise that in times of crisis, high quality, liquid assets such as gold are in high demand,” the commentary states. “What is less understood is that the majority of gold demand is linked to consumption and long-term savings, not to speculative investment. As an economy expands, incomes grow and gold demand increases – counterbalancing short-term investment flows. In turn, this pro-cyclical nature of consumer demand and counter-cyclical nature of investment demand make gold an effective diversifier and a valuable portfolio component.”

Earlier in the recent issue of Gold Investor, the WGC had said that “a 1% increase in global real GDP increased gold jewellery and electronic demand each by an average of 5% – holding all else equal”.

This is particularly apparent in countries like India and China, WGC noted, where demand for gold is closely co-related to increasing wealth. For example, it says, investors in China bought more than 1,200 tonnes of gold in 2013 alone – 20% more gold than the current combined gold holdings of all US-listed gold-backed ETFs.

Further, this phenomenon of the co-relation between GDP growth and gold demand is not restricted to emerging economies. “In the US”, the commentary says, “a 1% increase in real GDP lifts jewellery demand by 2.3%  –  all else being equal.”

The WGC believes that gold can remain attractive to investors at higher rates. “If rates rise, we contend, gold could sensibly replace bonds as a balance for equity risk,” the commentary opines. “With US real interest rates at historic lows, they cannot fall much further and, consequently, bond prices have limited upside. As such, bonds are unlikely to give investors the risk buffer they provided over the past 20 years when rates had further to fall.”

WGC  analysis suggests that if investors expect real returns for 10-year bonds to be approximately 4%, gold should comprise 5% of the portfolio. However, if investors expect bond real returns to remain around 0% – close to where they are now – the optimal gold holding rises from 5% to roughly 6.5%. “Historically, only when real interest rates are much higher (more than 4%), have gold prices tended to fall, while gold’s volatility and correlations increased relative to their longterm average,” the commentary says.

The commentary adds that its research makes “a compelling case” for gold as a valuable hedge: “It is cost-effective, easy to obtain, and has a wide range of applications.”

WGC is of the view that the supply side keeps the market in balance.  According to current estimates the organisation says, as costs of production spiral, mine production could start contracting over the next few years (unless production costs decrease or new deposits are found, both unlikely propositions according to the WGC).  In addition, total recycled gold has been decreasing since 2009, further constraining supply.

Finally, the WGC advises that “The most relevant way to think about gold is not in isolation but as part of a well diversified portfolio. It can help investors preserve wealth and reduce risk; it can also benefit from economic growth through consumer demand and in the form of long-term savings.”