Erste Asset Management

Gold with traces of rust

Gold with traces of rust
Gold with traces of rust
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Hardly anyone can escape the fascination that the element with the atomic number 79 in the periodic table exudes: the wonderful glow, the exuberant value. But on a more rational front: what is the economic function of gold, and how does it perform socially and environmentally?

What’s the long-term rate of return of gold?

Due to the gold coverage that used to be commonplace for currencies for a long time – especially for the US dollar – the gold price used to experience only little volatility. For the first 30 years of the 20th century, it was hovering around USD 200 per ounce.

The Bretton Woods regime set an ounce of gold at USD 35 (N.B. Bretton Woods implemented gold as lead currency and fixed exchange rates relative to other currencies). Accordingly, the gold price chart was more or less flat – until 1973. At that point, the divergent economic development of the various economies made a continued pegging of the exchange rates untenable. This resulted in a weak US dollar and the increase of the gold price above USD 100 in the same year.

In 1980, the gold price recorded a new high of USD 850, driven by political crises, among other things (Iran, Afghanistan). In the following years, however, the price would decline to the earlier level of 1979. The financial and economic crisis set off another upward trend.

On 6 September 2011, gold set its all-time-high at USD 1,920.49 per ounce at the New York NYMEX. This was followed by a correction to currently (December 2019) close to USD 1,500.

How successful would an investment in gold have been over the years? The average return over the past ten years (December 2009 to December 2019) has been 2.7% (in USD).

Over the past 50 years, gold has earned the investor an annual 7.8%. And Great-Granddad’s gold coin from 1919 has yielded close to 4.4% p.a. By comparison, an investment in equities (S&P 500) has yielded almost 11% p.a. in the past ten years and an annual 6% over the past 100 years.

However, there have also been periods where gold was superior to equities and saved the investor from significant losses. This was particularly true for times of crises and hyperinflation. Gold as material asset protects against inflation (as do equities, by the way).

What are the drivers of the gold price?

The direct determinant of any good is the relationship of supply and demand. These, in turn, are driven by fundamental forces, overlaid with psychological “white noise”.

In case of gold, this is complemented by a strongly political element that may come in the form of historically existing purchase and selling restrictions (especially for private individuals), price fixing by central banks or others. For gold, the fundamental value drivers seem to be of subordinated relevance, which does not come as a surprise, given that the utility value of gold is of a secondary nature.

What are the environmental consequences of gold production?

Throughout human history, an estimated 190,000 tonnes of gold have been produced, and about 3,000 tonnes are added on top of that every year. Important large-scale production methods are the amalgam process that uses mercury and cyanide extraction.

Both processes are highly problematic from an environmental point of view and poison soil, water bodies, and living creatures, and they often do so in particularly sensitive habitats.

The amount of rock that has to be moved is enormous and generally increases due to the decreasing gold content in the newly developed deposits from one mine to the next. Sometimes the gold content is as low as one gram per tonne of rock. This means an average wedding ring requires 10 to 20 tonnes (!) of rock to be moved. Gold production is energy-intensive and accordingly detrimental to the climate. Much of the damage only emerges after the mine has been closed down (e.g. acid mine damage). The responsibilities in this context are unclear.

On the upside, gold has a high recycling ratio of close to 100%. By the way: the gold required for technology and medicine could be covered by recycling without a problem (about 30% of global supply). No primary gold would have to be produced.

What are the social effects of gold?

The increasing exhaustion of the depositories in the first world has led to the rising significance of gold production in Latin America, Africa, Asia, and the former Soviet Union. More than 40,000 tonnes of gold have so far been mined from the world’s biggest depository, discovered in 1886, i.e. the Witwatersrand goldfield.

The currently most important gold-producing countries are China, Russia, Australia, the USA, Canada, Indonesia, Peru, South Africa, Mexico, and Ghana. Due to the political and legal framework in many of these countries, the social balance sheet of gold production is suboptimal: infringement with worker and human rights, conflicts with indigenous people, corruption, health hazards, and many casualties in the mines.

Whole swaths of land in developing and emerging countries are paying a high environmental and social price, while the majority of the economic value-added benefits international mining companies: Barrick Gold, Goldcorp und Kinross Gold from Canada, Newmont Mining from the USA, and AngloGold Ashanti from South Africa are among the leading quoted gold miners.

In addition to the negative effects of mining and smelting – which are also valid for other metals to some degree – gold also has to grapple with its character of being considered a luxury good.  Jewellery and gold items account for half of the gold supply, an estimated third is held by investors, and a tenth is held by central banks.

Only a small part is used in electronics and medicine on the basis of its actual utility value. Other metals such as silver or zinc are regraded from a more rational perspective, are used purposefully, and play an important role in a future scenario that builds on renewable energy and e-mobility.

Can gold be a sustainable investment?

The sustainability research agency rfu was commissioned to find the most sustainable gold mining shares in 2012. The base universe consisted of about 200 companies, but only a handful of justifiable titles ended up in the sustainable universe.

Some of their traits are that they work without the use of cyanide and only operate in regions with low social risk such as Canada or Scandinavia. In 2018, rfu developed a sustainability rating process for commodities. Of the nine analysed industrial and precious metals, gold achieved the worst environmental and social performance.

On a rating scale of A+ to C-, the precious metal was positioned at C+, which put it deeply into negative terrain. A truly sustainable investment in gold is therefore practically almost impossible.

But if you do not want to do away with gold completely when it comes to the marriage proposal or the Christmas present, can rely on fair trade gold. Fair trade gold was produced from mines that are certified with regard to environmental and work standards and receives a premium of USD 2,000 per kg on top of the market price in support of the implementation of local projects.


Legal note:
Prognoses are no reliable indicator for future performance.



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