In Understanding Gold, Claude B. Erb and Campbell R. Harvey study gold’s enduring popularity as a safe-haven asset and distinction common narratives with empirical proof. Whereas gold has preserved buying energy over millennia—what the authors name the “golden fixed”—this doesn’t translate into dependable short- or medium-term inflation hedging. Gold’s volatility is corresponding to equities, whereas inflation itself is way extra secure, making gold an unreliable hedge over typical investor horizons. The important thing perception is that gold’s actual long-run return is roughly zero, which is exactly what one ought to anticipate from a hedging asset reasonably than a progress asset.
The paper reveals that gold’s actual worth tends to mean-revert over time, and that intervals following real-price extremes have traditionally been related to low or unfavorable multi-year returns. This creates what the authors time period the “golden dilemma”: gold is most tasty exactly when its anticipated returns are lowest. However, gold’s low correlation with equities has made it a helpful portfolio diversifier, and historic drawdown evaluation demonstrates that gold typically performs effectively—or not less than much less poorly—throughout fairness market stress, albeit not completely or universally.
A serious contribution of the paper is its evaluation of why gold costs are exceptionally excessive at present. The authors spotlight the “financialization” of gold, particularly following the launch of gold-backed ETFs in 2004, which eliminated institutional constraints and created structurally increased demand. ETF flows are strongly positively correlated with gold returns, suggesting momentum-driven and hedging-related demand reasonably than valuation self-discipline. In parallel, geopolitical forces—notably the weaponization of the U.S. greenback by way of sanctions—have accelerated central financial institution gold accumulation as a part of broader de-dollarization efforts, most notably by China and Russia.
Trying forward, the authors argue that further demand shocks should still lie forward. One potential catalyst is regulatory: if gold have been ever categorized as a Tier 1 Excessive High quality Liquid Asset below Basel III, business banks might maintain it for liquidity functions, unlocking demand on a scale corresponding to—or bigger than—the ETF revolution. Nonetheless, traders mustn’t confuse rising demand with excessive anticipated returns. Gold’s position stays that of insurance coverage: helpful for diversification and disaster safety, however traditionally related to low actual returns after worth peaks. The paper finally urges traders to view gold with realism reasonably than reverence.
Authors: Claude B. Erb and Campbell R. Harvey
Title: Understanding Gold
Hyperlink: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5525138
Summary:
Gold has a popularity as a safe-haven asset-useful in occasions of financial turmoil or inflation. Nonetheless, perceptions can differ from actuality. We study the funding traits of gold and assess its reliability as a hedging asset. We additionally discover the explanations that the gold worth is so excessive at present by detailing the position of the financialization of gold in addition to the push amongst many international locations to de-dollarize. We additionally argue {that a} second demand shock that could possibly be on the identical scale as ETF introduction looms on the horizon with potential adjustments in Basel III laws that will permit business banks to carry gold for regulatory functions as a high-quality liquid asset. It’s inconsistent that central banks maintain gold as a serious reserve asset-yet business banks can not. Lastly, utilizing the framework of Erb and Harvey (2013), we present that primarily based on historic evaluation, when gold hits all-time highs, the next multi-year returns are low or unfavorable. This must be weighed in opposition to each gold hedging means, i.e., hedging belongings have low anticipated returns, and the potential of elevated demand from de-dollarizing international locations, institutional traders and business banks.
As all the time, we current a number of fascinating figures and tables:
Notable quotations from the tutorial analysis paper:
“Gold has held its worth over the past 2,500 years. Its buying energy has not modified a lot. Erb and Harvey (2013) shared a historic instance from Roman navy payrolls. The annual wage of a Roman centurion within the reign of Augustus was 38.58 ounces of gold.3 Primarily based on gold’s common worth over the previous yr, that’s about what a U.S. Military captain, main, or lieutenant colonel earns at present.4Gold’s constant buying energy over the millennia led Roy Jastram (1977) to suggest the “golden fixed.” For nearly all belongings, return has two parts: compensation for inflation and actual return. If gold has held its worth, its worth has moved with inflation. That suggests that gold’s actual return has been zero and that gold has been a profitable inflation hedge for the previous 2,000-plus years.In fact, no real-world investor has a 2,000-year horizon. Over shorter intervals, gold might be an unreliable hedge for one easy cause: It’s a risky asset. Exhibit 1 reveals gold has about the identical volatility because the S&P 500.
However what about much less extreme crises, for instance, fairness market drawdowns? How does gold examine to lengthy put choices, lengthy bonds, and different hedging methods? We checked out gold’s efficiency in 11 main inventory market drawdowns relative to Treasury bonds and S&P 500 places taken 5% out of the cash. As Exhibit 5 reveals, the worth of gold rose in eight of the 11 drawdowns and fell by lower than the S&P 500 within the three others. Gold did present some diversification profit and could possibly be a helpful hedge in opposition to present inventory market volatility.
Exhibit 20 reveals that the U.S. holds 22.4% of world reserves, nearly 2.5 occasions as a lot as second-place Germany. All euro-area international locations and the European Central Financial institution (ECB), mixed maintain 29.7%. Whereas reserve ranges are fascinating, adjustments in reserves are what probably strikes costs.
Exhibit 21 reveals the biggest adjustments in gold holdings. Panel A covers 2002 to 2025 and Panel B appears on the final 10 years. There’s a massive overlap in purchasers, with China and Russia the important thing consumers. Over the past 10 years, they’ve added roughly 2,500 tons between them. India and Poland are additionally lively consumers, however nowhere close to China and Russia.
The demand shock perspective hinges on whether or not “this time is totally different.” Has a structural change rendered the previous mannequin out of date? It’s all the time tempting to consider so when occasions really feel totally different. However, as now we have stated earlier than, each time is totally different. The query is whether or not the circumstances are totally different sufficient. Can we make the case, by means of financial reasoning, that the mannequin has modified? In Exhibit 35, the shift is mirrored in a change of intercept. The slope of the 2 strains is sort of similar.”
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