Negative rates could ‘structurally increase’ gold demand

Gold futures are set to end March with a big quarterly gain, but the precious metal may soon find added support via a spike in demand from investors and central banks alike, according to an industry organization.

Gold futures GCM6, +0.47% were up 0.5% at $1,235.20 an ounce early Thursday’s settlement at $1,228.60 an ounce, leaving the yellow metal on track for a quarterly rise of around 16.5%.

Over the longer term, negative interest-rate policies for some of the world’s key central banks, including the Bank of Japan and European Central Bank, could change the way investors think about risk, a potential boon for gold bulls, according to a World Gold Council report released Thursday.

–Over the long run, negative interest-rate policies, or NIRP, “may result in structurally higher demand for gold from central banks and investors alike,” the report said.

Negative nominal rates are unprecedented, but the WGC said a look back at the times in history that have seen negative real rates shows that gold returns tend to be “twice as high as the long-term average.” A real rate is the nominal interest rate minus the inflation rate.

And while “falling rates are generally linked to higher gold prices,” rising rates aren’t always linked to lower prices, it said.

“Investors…now need to assess the risk-reward of investing in assets with negative return expectations,” and that “may fundamentally alter what it means to manage portfolio risk,” the WGC said.

According to the report, demand for gold as a portfolio asset will “structurally increase” because NIRP:
•reduces the opportunity cost of holding gold
•limits the pool of assets some investors/managers would invest in
•erodes confidence in fiat currencies due to the threat of currency wars and monetary interventions
•further increases uncertainty and market volatility as central banks run out of effective policy options to combat inflation/deflation and/or spur growth.

Low interest rates reduce the opportunity cost of holding gold. That means under negative-interest rates, it “costs little, if anything” to hold gold, according to the WGC.

Gold purchases by central banks are likely to climb to record amounts this year and beyond, “as foreign reserve managers all over the world continue to grapple with the challenges of native nominal interest rates,” the WGC said.

“The prolonged presence of low (and now even negative) rates has fundamentally altered the way investors should think about risk and may result in a broader use of assets like gold to manage their portfolios more effectively and preserve their wealth over the long run,” the report said.

By Myra P. Saefong

Published: Mar 31, 2016 8:29 a.m. ET