To gold cling all? Stefan Scheurer, Senior Analyst, Capital Market Analysis, Allianz Global Investors

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1 This material is for reference only. The content is not allowed to be extracted or further distributed. Market Insights To gold cling all? Navigation Series 09/2011 Stefan Scheurer, Senior Analyst, Capital Market Analysis, Allianz Global Investors Has gold reached its new record high merely thanks to its reputation as a "safe haven" or is there more behind this development? What is it about this precious metal that still holds investors' interests? And: How is supply and demand developing? Toward gold throng all, to gold cling all" as Johann Wolfgang von Goethe put it and it seems as though he was right. Since the very beginnings of civilization gold has been highly prized as a scarce commodity. It is, for example, used as an international means of payment. Some countries, like the USA, for example, even linked their currency directly to gold between 1870 and the First World War. Although this era of gold is over, central banks still have reserves of this precious metal in their vaults. During turbulent times on the stock exchanges, in particular, gold is considered to be a "refuge currency", a "safe haven" for investments, as was confirmed recently during the crisis on financial markets. Fig. 1: Gold price performance Source: Datastream, Allianz Global Investors Capital Market Analysis, as of August 2011 Gold as a "safe haven"? Again and again investors head for the "safe haven" of gold. That was what happened, for example, in the 1970s when the first oil crisis set in (1973) and gold was able to fulfil its role as a "safe haven" for investments. From1973 to 1974, the price of a troy ounce increased from USD65 to almost USD200, while during the same period, global equity markets crashed by 35 %. 1

2 In the following years, the price of gold rose to an interim peak of just under USD850. It was only as a result of the crisis on financial markets that this level had to be revised to a price of over USD1,000 and during the European Union (EU) debt crisis to nearly USD2,000. Once again, gold seemingly proved to be a "safe haven". Whereas global equity markets crashed by 56% between the beginning of the financial crisis in June 2007 and March 2009, the price of gold increased in the same period from around USD670 to almost USD1,000. But is it really just the momentary psychological impact of investors that has lifted the precious metal to its new record level. What is it about gold that still holds investors' interests? Demand for gold as a luxury and industrial commodity The example of India: The 1.2 billion inhabitants of the country consider the precious metal to be a cultural symbol of purity and prosperity. Demand is correspondingly high, especially during the annual wedding season (March to October). Internationally, almost 70 % of global demand for gold comes from Asia and the Middle East, and the sub-continent of India is the world's biggest importer of gold. India accounts for just under a third of global demand, ahead of China (approx. 22 %) and the USA (approx. 7 %). 2 The interesting thing here is that China has developed a taste for this precious metal over recent years. Demand has risen constantly from almost 10 % in 2006 to the level cited above of close on 22 % in 2011: Evidence that a growing global population and increasing prosperity in the threshold countries is likely to lead to increased demand in the future. Fig. 2: Where does the gold demand come from? The jewellery industry remains the largest buyer of gold. In 2010, this sector accounted for just under 51 % of the total demand of 4,000 tonnes. However, this trend is declining. Whereas in 2000 the jewellery industry bought 84 % of global gold output, the share has fallen constantly to a level of 51 % in Of the remaining 49 %, 12 % was used by the dental and industrial sectors (e.g. electronics). During the financial crisis, however, demand for gold bullion and coins in particular increased (from 4 % in the year 2000 to approx. 29 % in 2010), as well as for other forms of investment. 2

3 Fig. 3: Development in gold demand (in tonnes) The US Federal Reserve has by far the largest gold reserves (8,134 tonnes or nearly 27 % of global reserves). In second and third place stand the German Bundesbank (3,401 tonnes = approx. 11 %) and the International Monetary Fund (2,814 tonnes = around 9 %). It is worth mentioning here, too, that since 2003 China has increased its gold reserves from approx. 600 tonnes to 1,054 tonnes, equivalent to almost 4 % of the world's gold reserves, putting it in sixth place. However, in relation to their currency reserves, China's gold stock is still very small. This means that, as China diversifies its currency reserves, we can expect additional demand for the precious metal in future (Source: World Gold Council, as of July 2011). Fig. 4: Official global gold reserves (in tonnes) Fig. 5: Share of gold in total currency reserves 3

4 Scarce supply Gold is a real asset and therefore supplies are limited. Whereas historically South Africa has always been the world's largest producer of gold (272 tonnes), China took over this role in 2007 (276 tonnes). In general, it is becoming increasingly difficult and expensive to open new gold mines. Just take a look at this example: The deepest mine is 3,800 metres below the earth's surface and 30 tonnes of rock have to be moved to extract one troy ounce of gold - enormous costs for the mining companies, especially since output will continue to decrease in the future. What is more, only 63 % of overall supply of this precious metal is satisfied by newly extracted gold, 29 % from recycled gold and 8 % from the central bank reserves (Source: World Gold Council, as of July 2011). Gold as a way of optimising portfolios? Fig. 6: Correlation of gold price compared with other asset classes Source: Datastream, Allianz Global Investors Capital Market Analysis, Period: Q Q1 2011, as of July 2011 A look in the rear mirror shows us that gold could be a good way of optimizing the portfolio, both from the point of view of yield as well as diversification. Whereas equities have suffered considerable losses during these times of crisis, gold can be described as the "scare currency" or the "refuge currency" (cf. Fig. 6). The degree of correlation between various returns on securities is represented as a correlation coefficient (r) which ranges over a scale of between -1 to +1. For, example: there has been a high synchronicity (r = 0.85) between gold and other commodities since There is no direct correlation on the other hand between gold and equities (r = 0.12 and 0.17). Looked at from an historical perspective, the addition of gold to a portfolio has reduced the overall risk. The positive correlation with inflation is also of interest. Whenever inflation in the Group of Seven nations rose in the past, 3 the gold price also saw a positive parallel rise (r = 0.62). Gold may also play on its strengths in future in either of two extreme scenarios, be it high inflation or high deflation: 1. In times of inflation, i.e. when your money is worth less because of rising prices: If there is a risk of rising consumer prices, gold is generally considered to be a good protection against inflation thanks to its "real value". As a result the gold price will probably rise whereas purchasing power falls (cf. Fig. 7). 4

5 2. In times of long-lasting deflation which is usually accompanied by a recession: gold is normally considered a "safe haven" by investors in order to hedge against a recession or depression (key word: ( scare currency ). The intrinsic value of this real asset stands in the foreground. Fig. 7: Gold: Scare currency and protection against inflation Allianz Global Investors Capital Market Analysis, as of August 2011 Source: Datastream, Fig. 8: Historical volatility of gold Source: Datastream, Allianz Global Investors Capital Market Analysis, as of August 2011 Even if the strengths of gold come into play when it is added to a portfolio, viewed in isolation it still bears risks. Although the gold price is less volatile than the price of other commodities, as Fig. 8 shows, this is not necessarily always the case when compared with equities. The historical monthly volatility of gold over the last five years is approximately 19 %. Other physical metals have a much higher historical volatility, silver, for example (approx. 36 %), copper (approx. 37 %) or nickel (approx. 46 %) (Source: Datastream). And yet, compared with equities, gold has demonstrated the same historical range of volatility of around 22 % which shows that gold is also subject to price fluctuations and is not necessarily more stable. Exchange rate considerations should not be forgotten either (cf. Fig. 9). 5

6 Fig. 9: Gold price (inverted) compared with the USD/EUR exchange rate Investors Capital Market Analysis, as of August 2011 Source: Allianz Datastream, Global Not all cling to gold but nevertheless, from the point of view of diversification, it should be taken into consideration when making investment decisions. Although, of course, figures from the past are no reliable indicator of future performance. Data origin if not otherwise noted: Thomson Financial Datastream. Data as of August In comparison with the Morgan Stanley Capital International World Total Return Index, in USD; past performance is no reliable indicator for future returns. 2. All demand related figures are drawn from World Gold Council, as of July The Group of Seven are: Canada, France, Germany, Italy, Japan, United Kingdom, United States. Information herein is based on sources we believe to be accurate and reliable as at the date it was made. We reserve the right to revise any information herein at any time without notice. No offer or solicitation to buy or sell securities, nor investment advice or recommendation is made herein. In making investment decisions, investors should not rely solely on this material but should seek independent professional advice. Investment involves risks, in particular, risks associated with investment in emerging and less developed markets. Past performance is not indicative of future performance. Investors should read the fund prospectus for further details, including the risk factors, before investing. This material has not been reviewed by the SFC in Hong Kong and the Monetary Authority of Singapore, and is published for information only, and where used in mainland China, only as supporting materials to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations. 6 Issued by Allianz Global Investors Hong Kong Limited (Singapore office: Allianz Global Investors Singapore Limited (Co. Reg. No Z)).