FWP 1 d338034dfwp.htm GOLD INVESTOR FEBRUARY 2017

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February 16, 2017

Gold Investor February 2017 Do something! Dr Alan Greenspan on stagflation, indebtedness, despair and the role of gold Talking Turkey Smart investing Europe in sight Making better use of Asset protection Gold in an the nation’s wealth in a high-risk world electoral year

Gold Investor | February 2017 Contents Foreword 3 Maximising gold’s 15 The global role of gold monetary value Gold has long been prized In the news 4 as a means of preserving wealth from generation to Gold market news generation. But it can play a from around the much greater role in society, world as Erkan Kilimci, Deputy Governor at the Central Bank of the Republic of Smart investing in a 5 Turkey, explains. high-risk world Timely expansion in Turkey 18 Celia Dallas of global investment firm Cambridge Associates outlines optimal investment strategies Borsa Istanbul is taking substantial steps to enhance its for 2017, focused on improved efficiency, enhanced standing in the global gold market. Chairman Himmet returns and downside protection. Karadag explains his ambitions, as gold plays an increasing role in Turkey’s wealth and regional status. European uncertainty: 8 a catalyst for gold Advancing Islamic Finance 19 through gold The gold price is frequently The Shari’ah Standard associated with events in is designed to bring the the US. But this year could benefits of gold as an be different. Suki Cooper asset class to Muslim of Standard Chartered Bank investors worldwide. suggests rising political Dr Mark Mobius, uncertainty across Europe Executive Chairman, could prompt renewed Templeton Emerging interest in gold. Markets Group, explains the significance of the The ultimate insurance policy 11 new Standard. Dr Alan Greenspan, Gold beyond the US dollar former Chairman of the 21 Federal Reserve, reveals Gold is traditionally priced in dollars and assessed his deep concerns in relation to the US currency. But, as Juan Carlos about socio-economic Artigas of the World Gold Council explains, 90% of prospects in the physical demand comes from outside the US. For these developed world and investors, local currency prices are much more relevant. suggests fundamental And they can differ considerably from the dollar price. change is needed to restore political balance and sovereign Key gold market statistics indebtedness. 24 Gold Investor | February 2017 2

Foreword The global role of gold Growing fears about the future have benefited gold, which Aram Shishmanian ended last year more than 8% higher and has risen in the first few weeks of 2017 as well. But what does the rest of Chief Executive Officer this year hold? World Gold Council In this edition of Gold Investor, we explore the role of gold in the current environment from the perspective of US and European institutions; Middle Eastern investors, and central bankers, including Dr Alan Greenspan, Chairman of the US Federal Reserve from 1987 to 2006. Dr Greenspan believes there is a growing risk of stagflation across the developed world, as stagnant economic growth combines with rising inflation. Suggesting that significant Welcome to the winter edition increases in inflation will ultimately drive the gold price, he says: “Investment in gold now is for insurance. It’s not of Gold Investor. From a geopolitical for short-term gain, but for long-term protection.” perspective, 2016 was one of the (See page 11). most tumultuous years in the Central bankers in aggregate have been net buyers of gold for almost a decade, not least the Central Bank of the recent past. The Brexit vote, Donald Republic of Turkey, which allocates 13% to 15% of its Trump’s Presidential victory and a total reserves to gold. As Deputy Governor Erkan Kilimci explains: “It is one of the safest assets a nation can hold.” rise in anti-establishment feeling But Turkey is also using gold to drive economic growth, have had a profound impact not just encouraging citizens to monetise their gold and bring hidden wealth back into the economy. (See page 15). on politics but also on markets. Among institutional investors, there is mounting disquiet about the value of mainstream financial markets against a background of political and economic turbulence. Celia Dallas, Chief Investment Strategist at global investment firm Cambridge Associates, suggests that diversification is key in a high-risk climate where many “safe” assets are expensive and US equities have already enjoyed an eight-year bull run. (See page 5). Suki Cooper, Precious Metals Analyst at Standard Chartered Bank, is particularly concerned about the climate across the Eurozone, suggesting: “Significant upside risk lurks in 2017, and it sits outside the US: namely, the potential shocks stemming from the shifting political plates in Europe.” (See page 8). We are keen to hear your views about our publication so please email goldinvestor@gold.org. We hope you enjoy the read. Aram Shishmanian The World Gold Council is the market development organisation for the gold industry. Working with world-class organisations across the supply chain, we stimulate demand, develop innovative uses of gold and take new products to market. As the global authority on gold, we offer comprehensive analysis of the industry, giving decision makers unparalleled information and insight into the drivers of gold demand. Gold Investor | February 2017 3

In the news Chinese gold reserves Enhanced unchanged transparency from The People’s Bank of China reported unchanged the Bank of England gold reserves in January 2017, at 1842.6 tonnes. The Bank have added to their gold holdings The Bank of England is, for the first time, regularly since they started monthly reporting in publishing monthly data revealing the July 2015, but this is the third consecutive month amount of gold it holds on behalf of other that their position has remained unchanged. central banks. As a leading custodian of gold, with one of the largest vaults in the world, the Bank of England’s decision is highly significant. Not only will it enhance the transparency of the Bank’s own gold operations; it will also support the drive towards greater transparency across the gold market. The data reveals the total weight of gold held within the Bank of England’s vaults and includes five years of historical data. Gold demand hits four year high. Global gold demand rose 2% in 2016 to reach 4,309 tonnes, the highest level since 2013, according to the World Gold Council’s latest Gold Demand Trends report. This was largely driven by inflows into gold-backed Exchange Traded Funds (ETFs) of 532 tonnes, the second-highest year on record, as investors responded to concerns over future monetary policy, geopolitical Testing times for gold uncertainty and negative interest rates. in India The shock announcement from Indian Prime Minister Narendra Modi that the country’s two highest-denomination banknotes would cease to be legal tender rocked the gold market in the last few months of 2016 and the short-term outlook remains unsettled. Longer term trends remain positive however, driven by rising incomes, a fast-growing middle class and a number of positive domestic policy measures. Gold Investor | February 2017 4

Smart investing and the role of gold Celia Dallas 1 Chief Investment Strategist In your view, what are the biggest Cambridge Associates risks that investors face in 2017? Investors face a wide range of geopolitical and macroeconomic risks that are well recognised, from prospects for disintegration of the European Union to a hard landing in China, to trade wars and military conflicts. In such an environment, investors may be tempted to de-risk portfolios and/or concentrate in a few assets Celia Dallas is Chief Investment they perceive to be safe. However, much of what is regarded as safe today is expensive, with low prospective Strategist at global investment returns. Investors need to resist such temptations, along with the temptation to invest only in what has worked firm Cambridge Associates. Here, in recent years. she outlines optimal investment Eight years into a bull market in US equities, during which strategies for 2017 and the role the S&P 500 compounded at about 14% annually, and a 70% US equity/30% bond index portfolio returned that gold can play in the current an annual 11%, many investors are ready to give up on environment. diversification and active management. Investors are increasingly asking why not index to US equities or a simple stock/bond portfolio? Investors that do so run the risk of missing the bend in the road by focusing their gaze on the rearview mirror. Diversification will continue to prevent investors from owning too much of the worst performing assets, which are often the best recent performers. 2 And what are the biggest In the current opportunities? environment of We are emphasising pursuit of value-oriented strategies swelled central bank and selective private investments. balance sheets and Even as markets have responded aggressively to the initial stages of interest rate normalisation and a relating competitive currency economy by rewarding value stocks and cyclicals, a devaluations, we continuation of these economic trends would see these markets move considerably higher relative to more regard gold as a useful defensive peers. This trend has a lot more room to run addition to portfolios. before it becomes overextended, but we would caution that, within the US market, value stocks are already quite pricey. In addition, we continue to find attractive managers across the private investment spectrum, discovering better return prospects outside the mainstream. Gold Investor | February 2017 5

Smart investing and the role of gold Investors that index to US equities or a simple stock/bond 3 portfolio run the risk In your view, what are the key of missing the bend in attributes that gold brings to the road by focusing a portfolio? their gaze on the Gold’s unique characteristic as a store of value over rearview mirror. long time horizons can be a double-edged sword. This characteristic is beneficial in periods of economic contraction accompanied by currency depreciation, but under the assumption that gold prices track inflation over the long term, its expected real return is 0%. This can present a high hurdle for inclusion in portfolios. Gold’s 4 diversification characteristics must be strong enough to be additive to portfolios seeking to earn 5% or 6% in excess of inflation. What are the biggest hurdles In the current environment of swelled central bank balance that asset owners face when sheets and competitive currency devaluations, we regard introducing a new investment/ gold as a useful addition to portfolios. While high-quality sovereign bonds can be additive during many stressful asset class to their portfolios economic environments, they fall short during periods and how do they usually when inflation expectations (and nominal yields) are rising. Should an investor’s reference currency decline in overcome them? such a bust, gold would be uniquely qualified to perform well. Investors could instead own a basket of unhedged Introducing new ideas to investors requires an upfront sovereign bonds in other currencies to protect against this educational process to make sure all committee members, risk; however, the risk that currencies broadly depreciate family members, and relevant stakeholders understand the relative to gold in today’s environment makes gold a rationale and implications of such strategies before they are superior form of protection against this risk. implemented. Investors should understand and become comfortable with return patterns so that they are able to In addition, gold may benefit if real interest rates fall, withstand inevitable periods of underperformance. even as nominal yields rise; a distinct possibility in an environment where central banks, hesitant to tighten The education process does not stop after the investment monetary policy, may fall “behind the curve.” However, is made. It cannot be said enough times that investor gold investors must accept that gold prices should be risk tolerance is not static, but instead shifts with asset expected to fall to the degree that real yields rise and/ prices. If history is a guide, investors embracing “long-or central banks tighten or are less easy than the markets term” investment strategies today will be inclined to expect. Of course, we would expect that risk-oriented quickly jettison them when they inevitably enter a cycle assets comprising most of investment portfolios would of underperformance relative to more familiar perform well under such conditions. investment strategies. Gold Investor | February 2017 6

Smart investing and the role of gold 5 6 Long-term asset owners have As investors increase risk in their had to deliver returns through a portfolios, what kind of strategies prolonged period of historically do you recommend for them to low interest rates. How have they manage this risk? re-adjusted their portfolios to meet We caution investors against increasing risk today. It is their liabilities and investment getting late in the economic cycle and investors have quite a bit of geopolitical and macroeconomic uncertainty to objectives? digest in the year ahead. At the same time, over-allocating can be problematic in a low return environment when it will Every investor we work with faces unique circumstances be difficult to maintain the purchasing power of long-term that need to be clearly defined before constructing the investment portfolios after spending. portfolio. However, in general, investors have been seeking to improve portfolio efficiency to maintain an appropriate Investors should evaluate portfolios’ ability to weather a risk profile while improving return prospects. Such efforts variety of stress environments to gauge the amount of have focused on cutting back sovereign bond exposure, liquidity they need. These range from the more familiar while increasing allocations to other diversifying assets and periods experienced in recent decades, when sovereign private investments. bonds served as solid defence to equity-oriented portfolios, to the risk that economic contraction could be accompanied When investors revisit their approach to diversification, by rising inflation expectations; an environment that they can open the door to holding smaller allocations is detrimental to both stocks and bonds. Additional to low-yielding bonds, while preserving the risk profile considerations relate to the potential for debt covenants to of portfolios. We believe that it is possible to build a be violated or credit ratings to deteriorate. Such a stress-smarter, more diversified growth portfolio by allocating test analysis should be conducted holistically, not just to diversified, attractively valued sources of beta and/or focused on resources inside the long-term investment pool. by allocating to best-in-class managers in strategies with high alpha potential, but lower beta exposure (for example, The primary functions of de-risking portfolios for pensions long/short, absolute return, arbitrage, trend following, and are to reduce interest rate risk and credit risk, and to track market-neutral hedge funds). This strategy is particularly the movement of the liability (expected future payouts) as helpful to pension plan sponsors for whom the trade-off closely as possible. We emphasise downside protection between holding duration-matched bonds and maintaining in order to avoid investing in bonds that default or get sufficient expected returns to reduce funded status deficits downgraded and cause slippage in the funded status has never been higher. during times of market stress. We also construct de-risking portfolios that account for the interaction effect between Finally, investors with the capacity to increase illiquidity growth assets and liability hedging assets. have been seeking out higher returns through allocating more to private investments, including private credit funds seeking to take advantage of regulatory change and banking disintermediation. Beyond asset allocation, investors should carefully review spending and costs as another means for increasing the likelihood of preserving purchasing power during this challenging low-yield environment. Gold may benefit if real interest rates fall, even as nominal yields rise. Gold Investor | February 2017 7

European uncertainty: a catalyst for gold In recent years, the gold price has Suki Cooper been driven primarily by events Precious Metals Analyst in China, India and the US. Standard Chartered Bank But this year could be different. Suki Cooper, Precious Metals Analyst at Standard Chartered Bank, believes rising political uncertainty across Europe could prompt renewed interest in gold. Gold faces headwinds in 2017, such as potentially weak demand in China and India and the prospect of rising real US rates. But gold is not without catalysts. Unchecked US inflation, Brexit negotiations and the uncertainty surrounding Trump’s international policies could trigger another bout of hedging and safe-haven demand. Although gold is often at the mercy of US policies, they are not its sole macro driver. Significant upside risk lurks in 2017, and it sits outside the US: namely, the potential shocks stemming from the shifting political plates in Europe. Gold draws broad-based safe-haven demand in the event of systematic risk such as the great recession, and the elections across Europe this year have scope to shock markets again. Systemic risks have already materialised across Europe over the past few years but they have not been sufficient to drive resilient material demand for gold. So what makes 2017 different? Quite simply, the concern is broad based. Although gold is often at the mercy of US policies, they are not its sole macro driver. Gold Investor | February 2017 8

European uncertainty: a catalyst for gold The European Parliament in Strasbourg. Growing political risk Netherlands: First European Isolated or local events may drive local demand for gold, election to watch but events that reverberate through the global economy or The latest polls show the far-right Dutch Freedom Party those that are not easily hedged with mainstream assets (PVV) has maintained its lead since November. Support can result in a renewed search for gold. has risen to 35%, with the People’s Party for Freedom and Last year, markets had to digest Britain’s vote to leave the Democracy (VVD) in second place at 23%. VVD won the European Union (EU) and the unexpected victory of Donald election in 2012 with a 41% share, and PVV tied in third Trump in the US presidential election. This year, markets place with 15%. PVV leader, Geert Wilders, advocates a will focus on three political events: first, the general Dutch referendum on EU membership, as anti-immigration election in Netherlands; second, the presidential election in protests have risen. However, the country’s proportional France, and third, the federal election in Germany. In each representation system means a coalition government is case, gold could suffer initially, as investors seek liquidity, most likely, and other parties have expressed a desire not following increased concern that anti-EU parties could to govern with him. succeed in upcoming elections, threatening the future of the EU. Thereafter however, gold’s safe-haven appeal could shine again. A weaker euro and a stronger gold price have co-existed before. Gold could well find a catalyst in the uncertainty created by the European elections. Gold Investor | February 2017 9

European uncertainty: a catalyst for gold Gold draws broad-based safe-haven demand in the event of systematic risk and the elections across Europe have scope to shock markets again. The French National Assembly. France: Low probability of Germany: Unlikely victory for a political earthquake anti-EU party Our geopolitical analyst believes the risks are greatest Support for euro-sceptic Alternative fur Deutschland surrounding France’s election but that the probability of (AfD) has gained momentum. In the latest poll, support a surprise outcome is low. Current polls show Marine for the anti-EU party has risen to 15% but it remains Le Pen, the anti-EU leader of the Front National (FN), in third place behind Merkel’s CDU party at 32% and securing sufficient votes in the first round on 23 April, and the Social Democratic Party at 21%. Support for AfD qualifying in most scenarios for the second round run-off began to rise after Germany opened its borders to of the French presidential race. The trigger event would refugees. But support for Chancellor Angela Merkel be a victory for Le Pen in the second round on 7 May. Our has risen as most Germans polled welcomed her geopolitical analyst notes that, to win the election, the FN candidacy for the Bundestag election, which takes would need about 19mn votes in the second-round run-off, place by October 2017. around three times more than the FN’s record 6.8mn votes last year. Le Pen is looking to reassert national control, A catalyst for gold take a tougher stance on immigration and had, initially, advocated exiting the EU as well. She is now suggesting a Europe-related uncertainty is not limited to the political ‘renegotiation with Brussels’ as most voters are opposed to landscape and the future of the EU. Troubles also withdrawing from the EU. Her victory would have seismic surround its financial markets, such as concerns over implications for global political relations, as well as the the banking sector, particularly in Germany and Italy. future of the EU. Gold prices sold off initially following the collapse of Lehman Brothers in 2008, as it fulfulled its obligation as a liquid asset amid cash shortages and margin calls. Thereafter, gold attracted broad-based investor interest, expanding its universe of investors from individuals to institutions. We had a glimpse of broad-based investors returning in 2016 as perceived political risk grew. While we think it is unlikely that anti-EU parties will come to power in 2017, gold could well find a catalyst in the uncertainty created by the elections. Gold Investor | February 2017 10

Gold: The ultimate insurance policy Dr Alan Greenspan was Chairman Alan Greenspan of the Federal Reserve from 1987 to Chairman of the Federal 2006 and has advised government Reserve from 1987 to 2006 agencies, investment banks, and hedge funds ever since. Here, he reveals his deep concerns about economic prospects in the developed world, his view on gold’s important role in the monetary system and his belief in gold as the ultimate 1 insurance policy. In recent months, concerns about stagflation have been rising. Do you believe that these concerns are legitimate? We have been through a protracted period of stagnant productivity growth, particularly in the developed world, driven largely by the aging of the ‘baby boom’ generation. Social benefits (entitlements in the US) are crowding out gross domestic savings, the primary source for funding investment, dollar for dollar. The decline in gross domestic savings as a share of GDP has suppressed gross non-residential capital investment. It is the lessened investment that has suppressed the growth in output per hour globally. Output per hour has been growing at approximately 1⁄2% annually in the US and other developed countries over the past five years, compared with an earlier growth rate closer to 2%. That is a huge difference, which is reflected proportionately in the gross domestic product and in people’s standard of living. As productivity growth slows down, the whole economic system slows down. That has provoked despair and a consequent rise in economic populism from Brexit to Trump. Populism is not a philosophy or a concept, like socialism or capitalism, for example. Rather it is a cry of pain, where people are saying: Do something. Help! At the same time, the risk of inflation is beginning to rise. In the United States, the unemployment rate is below 5%, which has put upward pressure on wages and unit costs generally. Demand is picking up, as manifested by the recent marked, broad increase in the money supply, which is stoking inflationary pressures. To date, wage increases have largely been absorbed by employers, but, if costs are moving up, prices ultimately have to follow suit. If you impose inflation on stagnation, you get stagflation. The Federal Reserve’s gold vault. Gold Investor | February 2017 11

Gold: The ultimate insurance policy 2 3 As inflation pressures grow, do Over the past year, we have you anticipate a renewed interest witnessed Brexit, Trump’s election in gold? victory, and a decisive increase in Significant increases in inflation will ultimately increase the anti-establishment politics. How price of gold. Investment in gold now is insurance. It’s not do you think that central banks for short-term gain, but for long-term protection. and monetary policy will adjust to I view gold as the primary global currency. It is the only currency, along with silver, that does not require a counter- this new environment? party signature. Gold, however, has always been far more valuable per ounce than silver. No one refuses gold as The only example we have is what happened in the 1970s, payment to discharge an obligation. Credit instruments and when we last experienced stagflation and there were flat currency depend on the credit worthiness of a counter- real concerns about inflation spiraling out of control. Paul party. Gold, along with silver, is one of the only currencies Volcker was brought in as chairman of the Federal Reserve, that has an intrinsic value. It has always been that way. No and he raised the Federal Fund rate to 20% to stem the one questions its value, and it has always been a valuable erosion. It was a very destabilising period and by far the commodity, first coined in Asia Minor in 600 BC. most effective monetary policy in the history of the Federal Reserve. I hope that we don’t have to repeat that exercise to stabilise the system. But it remains an open question. The European Central Bank (ECB) has greater problems than the Federal Reserve. The asset side of the ECB’s balance sheet is larger than ever before, having grown steadily since Mario Draghi said he would do whatever it took to preserve the euro. And I have grave concerns about the future of the Euro itself. Northern Europe has, in effect, I view gold as been funding the deficits of the South; that cannot continue indefinitely. The eurozone is not working. the primary In the UK, meanwhile, it remains unclear how Brexit will global currency. be resolved. Japan and China remain mired in problems as well. So, it is very difficult to find any large economy that is reasonably solid, and it is extremely hard to predict how central banks will respond. Gold Investor | February 2017 12

Gold: The ultimate insurance policy 4 Although gold is not an official Today there is a currency, it plays an important role widespread view that in the monetary system. What role the 19th century gold do you think gold should play in standard didn’t work. the new geopolitical environment? I think that’s like The gold standard was operating at its peak in the late wearing the wrong size 19th and early 20th centuries, a period of extraordinary shoes and saying the global prosperity, characterised by firming productivity growth and very little inflation. shoes are uncomfortable! But today, there is a widespread view that the 19th century gold standard didn’t work. I think that’s like wearing the wrong size shoes and saying the shoes are uncomfortable! It wasn’t the gold standard that failed; it was politics. World War I disabled the fixed exchange rate parities and no country wanted to be exposed to the humiliation of having a lesser exchange rate against the US dollar than it enjoyed in 1913. Britain, for example, chose to return to the gold standard Today, going back on to the gold standard would be in 1925 at the same exchange rate it had in 1913 relative perceived as an act of desperation. But if the gold standard to the US dollar (US$4.86 per pound sterling). That was a were in place today we would not have reached the monumental error by Winston Churchill, then Chancellor of situation in which we now find ourselves. We cannot afford the Exchequer. It induced a severe deflation for Britain in to spend on infrastructure in the way that we should. The the late 1920s, and the Bank of England had to default in US sorely needs it, and it would pay for itself eventually in 1931. It wasn’t the gold standard that wasn’t functioning; the form of a better economic environment (infrastructure). it was these pre-war parities that didn’t work. All wanted But few of such benefits would be reflected in private cash to return to pre-war exchange rate parities, which, given flow to repay debt. Much such infrastructure would have to the different degree of war and economic destruction be funded with government debt. We are already in danger from country to country, rendered this desire, in general, of seeing the ratio of federal debt to GDP edging toward wholly unrealistic. triple digits. We would never have reached this position of extreme indebtedness were we on the gold standard, because the gold standard is a way of ensuring that fiscal policy never gets out of line. Significant increases in inflation will ultimately increase the price of gold. Investment in gold now is insurance. It’s not for short-term gain, but for long-term protection. Gold Investor | February 2017 13

Gold: The ultimate insurance policy 5 6 Do you think that fiscal policy Against a background of ultra-low should be adjusted to aid monetary and negative interest rates, many policy decisions? reserve managers have been I think the reverse is true. Fiscal policy is much more large buyers of gold. In your view, fundamental policy. Monetary policy does not have the what role does gold play as a same potency. And if fiscal policy is sound, then monetary policy becomes reasonably easy to implement. The very reserve asset? worst situation for a central banker is an unstable fiscal system, such as we are experiencing today. When I was Chair of the Federal Reserve I used to testify before US Congressman Ron Paul, who was a very strong The central issue is that the degree of government advocate of gold. We had some interesting discussions. expenditure growth, largely entitlements, is destabilising I told him that US monetary policy tried to follow signals the financial system. The retirement age of 65 has changed that a gold standard would have created. That is sound only slightly since President Roosevelt introduced it in monetary policy even with a fiat currency. In that regard, 1935, even though longevity has increased substantially I told him that even if we had gone back to the gold since then. So, the first thing we have to do is raise the standard, policy would not have changed all that much. retirement age. That could cut expenditure appreciably. I also believe that regulatory capital requirements for banks and financial intermediaries need to be much higher than they are currently. Looking back, every crisis of recent generations has been a monetary crisis. The non-financial part of the US economy was in good shape before 2008, for example. It was the collapse of the financial system that brought down the non-financial part of the economy. If you build up enough capital in the financial system, the chances The very worst situation of serial, contagious default are much decreased. If we raised capital requirements for commercial banks, for a central banker for example, from the current average rate of around is an unstable fiscal 11% to 20% or 30% of assets, bankers would argue system, such as we are that they could not make profitable loans under such circumstances. Office of the Controller of the Currency experiencing today. data dating back to 1869 suggests otherwise. These data demonstrate that the rate of bank net income to equity capital has ranged between 5% and 10% for almost all the years of the data’s history, irrespective of the level of equity capital to assets. This suggests we could phase in higher capital requirements overtime without decreasing the effectiveness of the financial system. To be sure there would likely be some contraction in lending, but, arguably, those loans should, in all likelihood, never have been made in the first place. Gold Investor | February 2017 14

Maximising gold’s monetary value Gold has long been prized as a Erkan Kilimci national asset, preserving wealth Deputy Governor from generation to generation. But it Central Bank of the can play a much greater economic Republic of Turkey and social role, as Erkan Kilimci, Deputy Governor at the Central Bank of the Republic of Turkey, explains. The Central Bank of the Republic of Turkey. Gold Investor | February 2017 15

Maximising gold’s monetary value The role of the Central Banker has become increasingly Monetising gold challenging in recent years. On the one hand, we formulate monetary policy. On the other hand, we ensure that However, we think that gold can play a much broader role national reserves are properly managed. So we are primarily in a country’s economic wealth, particularly for nations with responsible for setting ultra-low and often negative interest a long tradition of gold investment. rates. But we also need to deal with the consequences as The Turkish domestic economy, for example, is home to reserve managers. between 5,000 and 6,000 tonnes of gold, worth around In Turkey, we believe that gold can play a role in both areas. US$200 billion. Much of that wealth lies hidden within domestic households, where its economic contribution As reserve managers, we are mandated to follow three is negligible. basic principles: safety, liquidity and returns. In an era of persistent economic fragility, these principles need to be That is why the Central Bank of the Republic of Turkey analysed in forensic detail. We cannot just continue to do (CBRT) introduced the Reserve Option Mechanism, under what we once did, because the environment has changed which banks can use gold as part of the required reserves and there is no early recovery in sight. Quantitative easing that they deposit with us. We introduced the policy in 2011, has reduced liquidity and means that many government giving banks an option to deposit up to 30% of their total bonds are producing negative yields. Under this scenario, required reserves in the form of gold. The measure has had old assumptions about which assets are highly liquid and considerable success, boosting our reserves by more than risk-free need to be reassessed – and it is here that gold 450 tonnes. comes into its own. In addition, last autumn we went further, increasing the proportion of the permissible gold reserve option to 35%, on condition that the extra 5% comes from wrought or As gold has no credit risk, scrap gold from Turkish residents. We also allowed banks it is one of the safest assets a to submit gold in the form ? of 1kg bars (kilobars) that can be stored at the Borsa Istanbul. We then applied a 1:1 nation can hold. co-efficient to this gold, which effectively makes it four times cheaper for banks to use gold as their required reserves versus the Turkish lira. Broadly speaking, reserve assets represent a nation’s This year, we introduced another mechanism, under wealth accumulated over many years. As gold has no credit which domestic banks will not only be able to post gold as risk, it is one of the safest assets a nation can hold. It is required reserves; but we will also be able to buy recycled also one of the most liquid assets available so it plays an gold from them, at price fixed by the Borsa ? Istanbul and incredibly useful part in a central bank portfolio. stored at the Exchange in kilobars. This means that if a I believe that we have neglected the importance of gold in bank has already deposited 35% of its required reserves as recent years. As an asset, it has certain unique features, gold, it can sell up to 5% of that gold to the Central Bank not just because it is safe and liquid, but also because and post fresh gold with us. it is valued and in demand across the world. So today, I think we need to revisit this treasured asset and try to Why have we taken all these understand why it has always been held in such esteem measures? and its role within a diversified portfolio. Of course, asset allocation is dynamic and market Quite simply, to make better use of the nation’s gold. dependent, but in Turkey we allocate 13% to 15% of our In Turkey, there is a long tradition of gold investment. Gold total reserves to gold. And we firmly believe that long- is used for wedding gifts and many women belong to gold term asset holders should also overweight gold in their saving circles, organised within family homes on a monthly portfolios, particularly against a backdrop of economic basis. These traditions have allowed thousands of tonnes and political uncertainty. of gold to build up in our economic system but they are unrecognised and their owners earn no return from them. Gold Investor | February 2017 16

Maximising gold’s monetary value Golden days Triple benefits The Reserve Option Mechanism encourages banks to Overall, we believe that it creates a win: win situation. monetise that hidden gold. We have deliberately refrained Individual investors win out because they are swapping from telling them how to do it, but they have produced a physical gold, which yields no return, for return-generating number of initiatives themselves. They have, for example, deposit accounts. Turkish banks win out because they are introduced monthly ‘Golden Days’ designed to follow the able to use this gold as required reserves with the Central pattern of the women’s savings circles. Gold investors are Bank, thereby boosting their own liquidity without recourse invited to bank branches, where they meet gold experts, to international borrowing. We win out because we are drink tea and are given the opportunity to open gold deposit increasing our reserves of physical gold at a time when we accounts. This particular initiative worked very well, not believe all Central Banks should be raising the proportion of least because it is so well aligned with existing traditions. gold they hold in their portfolios. And the Turkish economy benefits because gold is being transformed from a passive I believe this is a crucial factor behind the success of the asset into an active one. Reserve Option Mechanism. In our view, there is little point in introducing such a system and imposing a single Looking to the future, we have no specific target for the methodology on the banks and other stakeholders. It is amount of gold that we would like to monetise in this way far preferable to allow participants to design their own but, given there is close to US$200 billion of gold lying approach, which takes into consideration local behaviour dormant in people’s homes, we will certainly continue to and customs. support the Reserve Option Mechanism and encourage individuals and banks to bring gold into the financial system. The Mechanism has also benefited from trust at every stage of the value chain: the trust that investors have in We are also working on an initiative with some of our gold; the trust that they have in the banking system; the largest trade partners, where both sides can use either their trust that banks have in the refineries who take the recycled domestic currency or gold for payment. It is early days but gold and return it as standard bars. And, of course, the trust this scheme is another key way in which we can monetise in us, the CBRT. our gold. As one of the most creditable national institutions, people We believe that Turkey is one of the wealthier emerging trust us as the ultimate depositary of the nation’s wealth. In market countries, but much of that wealth is hidden. fact, the mechanism by which householders’ gold is turned We are determined to bring it into the open. into an international asset is a source of national pride. When we first introduced the Reserve Option Mechanism, there were concerns that it would create additional demand for gold. That has not happened. Instead, it has helped gold investors to realise that there are other ways to save and invest. When they go into a bank branch, they see the products that are on offer and the returns that they can potentially receive. So the Mechanism is bringing unbanked citizens into the finnancial system and boosting financial education. We firmly believe that long-term asset holders should overweight gold in their portfolios. Turkish bracelets made of gold coins. Gold Investor | February 2017 17

New steps to empower Turkey in the global gold market Working in partnership with the Himmet Karadağ Central Bank of the Republic of Chairman Turkey, Borsa İstanbul is expected Borsa İstanbul to play a pivotal role as Turkey cements its reputation for successful innovation in the global gold market. Borsa İstanbul Chairman Himmet Karadag explains the steps that the exchange is taking and the Gold has been regarded as one of the most important importance of the new AAOIFI investment products for generations in Turkey and Borsa Istanbul is a key player in the trade of physical gold. Looking Standard which sets specific rules ahead, we hope to become a global centre for physical for use of gold as an investment in precious metal storage. However, one point was clear: in order to fulfill our ambition, we needed to expand our Islamic Finance. vaulting capacity. To that end, we are constructing a new facility, with more than 1,600 tons of storage capacity for gold and other precious metals – around ten times larger than our current vault. The move should strengthen our partnership with the Central Bank of the Republic of Turkey (CBRT), as it continues to develop the reserve option mechanism. Borsa ?Istanbul’s vault is currently the only place where Turkish banks can safeguard gold kept as a part of their reserve requirements within Turkey. In time however, we hope to store commercial banks’ other gold reserves currently stored in London. We have been collaborating closely with the CBRT on this and, once the new facility is open in around March, efforts to bring the gold reserves from London to Istanbul will accelerate. The expansion of Borsa ?Istanbul’s vault is also timely, given the recent launch of the new Shari’ah Standard for gold, developed by the World Gold Council and the Accounting and Auditing Organisation for Islamic Financial Institutions (of which Turkey is a member). We believe that the new Standard will have a significant impact on gold demand from all sector players which shy away from conventional ?nance practices, as it is the ?rst time there has been such definitive guidance on gold products in this regard. In the short-term, we expect that this recent step will foster the creation of diversi?ed ?nancial gold products; provide investors with access to a broader range of investment options, and reduce handling and vaulting costs. In the longer term, we believe that the Standard will play an even greater role in the market: bolstering demand for gold products, reducing gold price volatility and contributing to Turkey’s standing as a regional gold hub. Borsa I?stanbul hopes to become a global centre for physical precious metals storage. Gold Investor | February 2017 18

Advancing Islamic finance through gold In 2016, AAOIFI launched the Dr Mark Mobius Shari’ah Standard on Gold, Executive Chairman developed in collaboration with the Templeton Emerging World Gold Council. The Standard Markets Group is one of the most important recent developments in Islamic finance and will bring all the benefits of gold as an asset class to Muslim investors worldwide. Dr Mark Mobius, A modern step-change Executive Chairman, Templeton The World Gold Council’s cooperation with the Accounting Emerging Markets Group, explains and Auditing Organisation for Islamic Financial Institutions why the time has now come for gold (AAOIFI) to create a Shari’ah Standard on Gold is a notable development in this regard. The new Standard will enable instruments in Islamic finance. the foundation of what could be the most significant event for Shari’ah finance in modern times. Despite challenging times recently, the Islamic finance field has experienced major growth during the last The most exciting outcome would probably be a series decade. Nevertheless, the opportunity for innovation of financial products which would appeal not only to is great, given the high interest in Islamic finance Muslims but to people of all faiths. Given its unique and by Muslims all over the world. Gold is a particularly incomparable characteristics of rarity and durability, gold noteworthy prospect given its significant history in the has for millennia been considered the best store of value Muslim world. Antiquity gold was actively mined and gold for all civilisations. Gold’s reputation for safety and stability coins were minted throughout the Middle East, while has made it a haven for many investors around the world, the gold dinar was recognised as a trading standard for particularly during the high volatility experienced in financial hundreds of years. Of course, the use of gold in Islamic markets in recent times. The fact that gold’s market art is exceptional and gold’s use in calligraphic documents behaviour is remarkably different from other asset classes has given pleasure to millions of people over the years. means that it offers an excellent diversification tool for investors. In addition, it has proven to be less volatile than Given its history and reputation, the opportunity for gold equities. Furthermore, gold carries no credit risk. in Islamic finance is clear. However, in order for this development to take place, the Islamic world needs to agree on a clear set of rules regarding the use of gold in Islamic finance. Buy gold and sit on it. That is the key to success. The new Standard will enable the foundation of what could be the most significant event for Shari’ah finance in modern times. Gold Investor | February 2017 19

Advancing Islamic finance through gold Wealth preservation Perhaps one of the most important characteristics of gold Over the long term, gold has is its liquidity. Gold is traded all over the world and a market provided investors with a bulwark for sellers and buyers can be found in large quantities. In addition, the most important argument for the use of gold against the irresponsible issuance of in Shari’ah and other kinds of finance is the fact that it has paper money by governments all been shown to be a long-term preserver of wealth. over the world. The study of paper money since the time it was first issued shows that no ?at currency has held its value for the long term. Over the long term therefore, gold has provided investors with a bulwark against the irresponsible issuance of paper money by governments all over the world. Franz Pick, a renowned expert on currencies who spent a lifetime studying money, once said: “Buy gold and sit on it. That is the key to success.” The time has come for gold instruments in Islamic finance. Mohammad Al-Amin Mosque, Beirut. Gold Investor | February 2017 20

Gold and currencies: looking at gold beyond the US dollar Gold is traditionally priced in dollars Juan Carlos Artigas and assessed in relation to the US Director currency. But, as Juan Carlos Investment Research Artigas, Director of Investment World Gold Council Research at the World Gold Council explains, 90% of physical demand comes from outside the US. For those investors, the price of gold in their local currency is much more relevant. And it can differ significantly from the The reference price of any dollar price. commodity – including gold – is Gold has played an integral role in the monetary system for less important to investors and centuries, as a unit of exchange and a monetary anchor. consumers than the price they pay While gold’s official role has evolved under the existing in their own local currency. system of floating exchange rates, it has retained several currency characteristics. For fiat currencies, however, money supply and bank balance sheets can be expanded as necessary to adjust Chart 1: Gold’s mine production growth pales in comparison to the monetary policy (Chart 1). And the value of fiat currencies money supply growth of fiat currencies since the Great Recession* is linked to whether investors believe that governments are Gold willing and able to discharge their obligations. Japan United Kingdom Gold is different because the available supply of gold United States changes little over time – growing only 2% per year through Switzerland mine production. Its geological scarcity and its role as a Canada hard currency make it a natural hedge to fiat money. In South Korea fact, over the past century, gold has vastly outperformed all Australia major currencies as a means of exchange. Brazil India As such, investors use gold as they seek the safety of China supply-constrained hard assets, especially as governments Russia implement inflationary policies. Central banks use gold -5 0 5 10 15 20 in the same way. They view it as an integral part of their Average annual growth (%) foreign reserves, providing diversification and buffering Mine production growth geopolitical and sovereign risks. relative to above-ground stocks of gold Nominal GDP growth Money supply growth *Annual growth between 2008 and 2016. For each country, the magnitude between zero and the end of the light red bar represents money supply growth. The magnitude from zero to the end of the dark red bar represents nominal GDP growth. Money supply growth in excess of GDP growth could lead to inflation and/or currency devaluation. In Japan’s case, the GDP growth is negative. Money supply growth was computed using a broad money aggregate that includes M0, M1, M2 and M3. Growth in gold supply was computed by comparing the mine production growth the available above-ground stock of gold at the end of 2007. Source: Bloomberg; GFMS, Thomson Reuters; IMF, Metals Focus; World Gold Council Gold Investor | February 2017 21

Gold and currencies: looking at gold beyond the US dollar Traditionally, gold is considered a natural hedge to the US Martin Feldstein, Professor of Economics at Harvard dollar, the world’s reserve currency. But US dollar investors University highlighted the impact of this in Project are not the only ones to benefit from gold’s currency Syndicate. He showed that the local price of oil only moves hedging qualities. An allocation to gold also provides in relation to the dollar to reflect the US currency’s move international investors with protection against falls in relative to the local currency. Similarly, we believe the price their local currency. of gold in dollars would only change to reflect the change in local demand/supply for the currency, reflected in the Quoted in US dollars, gold is change in the US dollar relative to a local currency. For example, if the dollar rises against the euro, gold becomes bought in local currency more expensive for European buyers. They, in turn, may demand less gold, putting downward pressure on the gold Investors often say that gold is ‘priced’ in US dollars and price. This is, of course, a simplification, but explains why in use this to explain the negative relationship between the practice, there is an asymmetric relationship between the two. While it is true that the gold price is often quoted in dollar and gold. dollars, it is not solely dictated by the dollar. The relationship between gold and the dollar responds to the position of the dollar as ‘the’ reserve currency and The market for gold is truly the effect of US dollar-based demand and supply on the global, with more than 90% of gold price. From the demand side, however, the reference price of any physical demand coming from Chinese consumers track the gold price in local currency in retail environments. Gold Investor | February 2017 22

Gold and currencies: looking at gold beyond the US dollar Non-dollar performance of gold In 2016, as the dollar Yes, the US dollar is a significant driver for gold but there strengthened, gold’s return in euro, are two additional important points to consider: first, it is not the only driver, and second, it is not always the most sterling, Indian rupee and Chinese relevant metric for investors. renminbi was higher than in The market for gold is truly global, with more than 90% of US dollars. physical demand coming from outside the US, primarily from emerging economies. For all these non-dollar buyers, it is the local price – and not the US dollar price – that matters most. In 2016, as the dollar strengthened, gold’s Recently, Solactive AG – a well-established index provider return in euro, sterling, Indian rupee and Chinese renminbi, – has developed an index to track the price of gold from to name a few, was higher than gold’s return in US dollars. a non-dollar perspective. Combining the performance of gold in a basket of non-US currencies – including the euro, the British pound, Japanese yen, Canadian dollar, Swedish Chart 2: Gold in non-dollar terms outperformed gold in dollar krona and Swiss franc – it reflects the economic effect of terms over the past decade aided by periods of dollar strength holding gold with a basket of non-US currencies. Gold’s Gold (US$/oz) and Index annual returns* return from this perspective has been, on average, 2.3% Return % higher per year than the return of gold in dollars for the past 40 ten years, driven by periods of dollar strength (Chart 2). 30 20 So, looking at gold only from a dollar perspective does not capture all the benefits that investors around the world 10 derive from adding gold to their portfolio. And from a US 0 investor’s point of view, these alternative metrics underline -10 gold’s global relevance. -20 -30 -40 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Gold (US$/oz) Long US$ Gold Index * As of 31 December 2016. Gold corresponds to the LBMA Gold Price PM. The Long US$ Gold Index corresponds to the Solactive GLD® Long USD Gold Index. For more details see: https://www.solactive.com/complex-indexing/ ?index=DE000SLA2K90. Source: Bloomberg, ICE Benchmark Administration, Solactive AG, World Gold Council Gold Investor | February 2017 23

Key gold market statistics Gold returns remain competitive compared to major financial assets Gold has been inversely correlated to stocks, high yield and Performance metrics for major global financial assets in US$* commodities over the past year 10-year average return % Weekly return correlation on key assets and gold in (US$)* 20 BarCap BarCap 1-3m T-bills US Credit** S&P 500 BarCap US HY Gold (US$/oz) 10 BarCap US Credit** BarCap 1-3m T-bills MSCI BarCap US HY 0 EAFE S&P 500 S&P -10 GSCI Key: Bubble area = S&P GS MSCI EAFE annual volatility Crude Oil 15% Brent (US$/bbl) -20 per year 30% per year S&P GSCI -30 05 10 15 20 25 -1.0 -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6 0.8 1.0 1-year return % Correlation to gold 1-year 10-year *1-year and 10-year retuns based on data ending 31 January 2017. *1-year and 10-year correlations based on weekly returns ending 27 January 2017. **BarCap US Credit includes both governmenment and high grade corporate bonds. **BarCap US Credit includes both sovereign and corporate bonds. Source: Bloomberg; World Gold Council Source: Bloomberg; World Gold Council Gold performance should be measured in more than one currency Gold trades more than many other major financial assets Annual gold returns in various currencies* Average daily trading volumes in US$* Return % German Bunds 40 Dow Jones (all stocks) 30 UK Gilts 20 Euro/yen 10 S&P 500 (all stocks) Gold** 0 US Agencies -10 JGBs -20 US$/sterling -30 US Treasuries -40 US$/yen 2001 2003 2005 2007 2009 2011 2013 2015 2017** US$/euro Gold (US$) Long US$ Gold Index Gold (CNY) Gold (INR) 0 200 400 600 800 1,000 1,200 1,400 US$bn/day * Based on the LBMA Gold Price PM except for the Long US$ Gold Index that is based on the Solactive GLD® Long USD Gold Index. The Index combines a long Stocks Bonds Currencies position in physical gold with a long position in a basket of currencies that include EUR (57.6%), JPY (13.6%) GBP (11.9%), CAD (9.1%), SEK (4.2%) and CHF (3.6%). *Based on estimated annual averages as of December 2017. For more details see: https://www.solactive.com/complex-indexing/ **Gold liquidity includes estimates on over-the-counter (OTC) transactions, and ?index=DE000SLA2K90. published statistics on futures exchanges, & gold-backed exchange-traded products. **Year-to-date as of 31 January 2017. Source: BIS; Bloomberg; German Finance Agency; Japan Securities Dealers Source: Bloomberg; ICE Benchmark Administration; Solactive AG; World Gold Council Association; LBMA; UK Debt Management Office (DMO); World Gold Council Financial gold accounts for more than a third of above Gold market larger than many major stock and bond markets ground gold stocks Market size of major global financial assets in US$* Market size (in tonnes and US$ value) for various gold sectors* S&P 500 US Treasuries Japan Jewellery TOPIX 89,775 tonnes US$ 3,610bn 47% Shanghai Composite Official sector Gold** 31,652 tonnes US$1,273bn 17% UK Gilts Bars and coins China 37,475 tonnes US$1,507bn 20% FTSE 100 ETFs and similar French OATs 2,142 tonnes US$86bn 1% German Bunds Hang Seng Other fabrication and unaccounted DAX 28,900 tonnes US$1,162bn 15% Australia 0 5,000 10,000 15,000 25,000 25,000 US$bn *Volumes as of end-2016, values calculated using 2016 average LBMA Gold Stocks Bonds price of US$1,251/oz. Financial gold is defined as the sum of official sector holdings, bars and coins, and ETPs** (71,261 tonnes, US$2,866bn, 38%). *As of 30 December 2016 where available, otherwise most recent data published. **ETPs include gold-backed exchange traded funds (ETFs) and similar products. **Includes bars, coins, gold-backed exchange-traded products and official sector holdings. Source: Bloomberg; GFMS, Thomson Reuters; ICE Benchmark Administration; Source: BIS; Bloomberg; GFMS, Thomson Reuters; ICE Benchmark Administration; Respective ETP Providers; World Gold Council World Gold Council Gold Investor | February 2017 24

Copyright and other rights © 2017 World Gold Council. All rights reserved. World Gold Council and the Circle limitation, any advice to the effect that any gold related transaction is appropriate for device are trademarks of the World Gold Council or its affiliates. any investment objective or financial situation of a prospective investor. A decision All references to LBMA Gold Price have been provided for informational purposes to invest in gold, any gold related products or any other products, securities or only. ICE Benchmark Administration Limited accepts no liability or responsibility investments should not be made in reliance on any of the statements in this for the accuracy of the prices or the underlying product to which the prices may document. 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The World Gold Council does not inclusion of such information should not be regarded as a representation by the accept responsibility for any losses or damages arising directly or indirectly, from World Gold Council that the forward-looking statements will be achieved. the use of this document. The World Gold Council cautions you not to place undue reliance on its forward-The material contained in this document is provided solely for general information looking statements. Except in the normal course of our publication cycle, we do not and educational purposes and is not and should not be construed as, an offer to buy intend to update or revise any forward-looking statements, whether as a result of or sell, or as a solicitation of an offer to buy or sell, gold, any gold related products new information, future events or otherwise, and we assume no responsibility for or any other products, securities or investments. Nothing in this document should updating any forward-looking statements. be taken as making any recommendations or providing any investment or other Expressions of opinion are those of the authors and are subject to change advice with respect to the purchase, sale or other disposition of gold, any gold without notice. related products or any other products, securities or investments, including without Photography credits Front cover: Bloomberg/Getty Images Page 4: Centre left, Bikeworldtravel/Shutterstock.com Page 4: Top right, ArtisticPhoto/Shutterstock.com Page 4: Bottom right, Heraeus Deutschland GmbH & Co. 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Gold Investor | February 2017 26

Published by: World Gold Council 10 Old Bailey, London EC4M 7NG United Kingdom C046201702

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