Gold-backed ETFs exhibited particularly low volatility in 2017 with prices so far remaining stable into 2018.

Matthew Turner, precious metals analyst at Macquarie.

Low volatility

Matthew Turner, precious metals analyst at Macquarie, suggests the historically low volatility in the gold market may reflect fundamental changes which could be here to stay.

“At first glance, 2017 seemed an eventful year – the first year of President Trump, elections in France and Germany, Brexit, tensions in North Korea, changes to Chinese leadership. But gold barely moved: price volatility was at its lowest in more than 20 years,” said Turner.

To illustrate his point, Turner notes there wasn’t a single day-on-day move in the price of gold in excess of 2.5% during the whole year, a statistic not seen since 1996.

Clearly daily price moves matter less to long-term investors than short-term traders; however, Macquarie notes that volatility of the precious metal has also been low on a monthly basis. Gold’s 2% monthly average price move in 2017 was also the lowest since 1996.

In the ETF space, the UBS Gold ETF (AUUSI SW), which invests in physical gold and tracks the LBMA Gold Price Index, has seen its rolling one-year volatility fall from 17.1% at mid-July 2016 to just 9.3% as of the end of June.

Source: ETF Strategy.

Mirroring the fall in gold price volatility, ETFs tracking the equities of gold producing firms have also shown declining levels of volatility which have pushed even lower in 2018 despite volatility in the broader equity market spiking upwards from February.

The rolling one-year volatility of the iShares Gold Producers UCITS ETF (IAUP LN) was 42.7% at the start of 2017 but has steadily dropped to 18.1%, as of the end of June. The $460m fund tracks the S&P Commodity Producers Index and has a TER of 0.55%.

So what is going on?

Turner believes the most obvious explanation would simply be that for all the noise, 2017 wasn’t that exciting a year.

“President Trump made it through his first year largely unscathed, European politics caused fewer upsets than expected, and even when issues arose, they were largely overshadowed by the improving economy,” he said. “One academic attempt to measure this – the economic policy uncertainty index (EPU) – peaked at the start of the year but fell sharply thereafter. The real increase in the EPU came in 2016 – the year of Brexit and Trump’s election – and gold volatility did rise in response.”

Nevertheless, the trend in gold volatility has been mostly lower since 2008.

Turner commented, “We see two broad explanations: shifts in the wider macro-economic and financial environment and shifts in gold’s internal fundamentals.

Turner’s first explanation stems from the realisation that many other asset prices, including equities, have experienced falling volatility. Indeed, over the past 90 years, 1964 is the only year that S&P 500 volatility was this low.

“Various reasons have been put forward for this, many relating to central bank policy,” said Turner. “Interest rates, inflation and growth have all been very stable. Furthermore, if investors have come to believe that central banks will respond to falling equity prices by easing monetary policy, then any dip is likely to be viewed as a buying opportunity, thus reducing price swings.”

Turner’s second explanation stems from the realisation that not all assets have experienced falling volatility, noting that crude oil’s price volatility, for example, fell between the GFC and 2013, but has since jumped significantly between 2014 and 2016.

Turner asks, is it possible that gold, by contrast, has experienced certain changes that have reduced its volatility fundamentally?

Turner believes that the average daily change in the gold price of 0.8% over the past ten years (low when compared to aluminium’s 1%, copper’s 1.2%, oil and silver’s 1.4%, and nickel’s 1.5%) partly reflects gold’s high traded volume compared to underlying supply and demand, particularly since the introduction of ETFs.

“But the nature of that underlying supply and demand is even more important,” says Turners. “It is characterised by high elasticity and plentiful stocks, which means that any supply/demand imbalances do not require large price shifts to correct.”

Turner believes these attributes may have become even more prominent in recent years.

So what insights can investors gain from these underlying trends? Looking ahead, Turner believes one point seems to stand out.

“Gold’s extremely low volatility in 2017 was driven by many factors, both short-term and long-term, physical and financial,” said Turner. “That reduces the chance of a sharp reversal. Some factors are clearly coming to an end, such as low interest rates, but others, such as price-sensitive demand, remain strong.

“Gold has so far remained immune to turbulent markets in 2018 – indeed on some measures, such as the trading range, it has been less volatile than at any time since the early 1970’s when it was fixed to the US dollar. For many investors, that will be exactly what they want from it. But you can have too much of a good thing.”