The rise of gold financialization and its safe haven role

Abstract

Gold has always been considered the most safe haven asset in market turmoil. However, this role has appeared to disappear in recent years. Besides, the significant fluctuations in the level and volatility of gold prices have become increasingly evident over the past two decades, compared with a prolonged market stability period. These changes bring to question what has driven these developments. Understanding the transformation in the gold market can help assess gold's role in investment strategies and its revolving function in the global financial environment. This thesis aims first to assess gold market behaviour over the past 37 years and examine the role of gold during equity and bond market stress. Notably, investigating whether gold lost its appeal as a safe haven asset due to its own market instability. Second, it examines whether gold financialisation, through the introduction of gold ETF in the early 2000s, contributes to the observed volatility in the gold market. Next, it investigates the ramifications of gold ETF's onset on traditional gold roles and whether gold ETF supplanted gold's traditional roles. Then, it investigates if the co-integration between gold ETFs' holdings and gold spot prices exists. Last, it determines whether a causal relationship exists between gold ETFs' holdings and gold markets, i.e. whether gold ETFs' holdings cause gold prices. The study first demonstrates that the gold market exhibits two distinct periods, each with differing market movements: a stable era followed by a highly volatile era, in which gold plays an insignificant role during the latter unstable period. Moreover, it exhibits a positive correlation in most high volatility periods of the S&P 500, again, especially during the unstable period. This implies that gold is losing (lost) its safe haven role during market stress. The outcome suggests that as the gold market encounters higher volatility periods, a more positive correlation is expected with the stock market in times of extreme stock market conditions. Second, the study establishes that the gold market exhibits a structural change around the onset of gold ETFs, in which gold spot volatility in the post-gold ETFs period is characterised by an unstable (highly volatile) era. Notably, the findings suggest that the changes in gold market volatility can be attributed to an increase in the rate of information flow to the gold spot market. The outcomes imply that the gold spot market is more efficient in the post-gold ETFs period. Yet, it is highly volatile. Third, The study finds that gold financialisation has altered the traditional roles of gold after the introduction of gold ETFs. In the post-ETF state, gold's traditional hedging capability is shifted and weakened, and the safe haven role is lost. Moreover, the gold ETF shows better roles, playing a strong risk diversification role during normal times and a safe haven role at certain market thresholds. The outcomes suggest that gold ETF is a successful successor for gold, offering new options for mitigating market risks and implementing different investment strategies. Furthermore, the study finds that gold ETF holdings are co-integrated with gold prices, implying a long-run relationship exists. Besides, the findings show that gold ETFs' holdings significantly cause gold prices in the long run and, hence, may play an important role in gold price determination. This suggests that changes in gold ETFs' holdings (inflows and outflows), with limited gold production and high demand, may increasingly influence gold price dynamics and potentially substitute the traditional supply and demand forces in the gold market. These findings have important implications for investors, financial regulators and policymakers. Investors should be aware that the gold traditional roles seem to have waned, and adding gold to a portfolio may raise volatility without providing the expected protection. Gold is more likely to exhibit high volatility and co-movement with other financial markets. Investors should act with cautious hedging strategies to avoid taking on gold volatility risk and deterioration in hedging and safe haven roles, consequently destroying their portfolios. Besides, increasing gold market responsiveness after introducing gold ETFs requires additional attention and reassessment of gold's role in portfolio diversification. Investors may consider including gold ETFs in their investment and trading strategies as they offer more effective hedging and diversification strategies and risk management. Financial regulators need to pay attention to the potentially destabilising effects of financial innovations like ETFs on spot market volatility., i.e., recognising the link between information and volatility. Gold ETFs facilitate the acceleration of the assimilation of new information into gold prices, making the market more responsive and efficient but also more volatile. This indicates that further monitoring and regulation of financial innovations like ETF is needed to minimise detrimental effects. Regulators and policymakers need to monitor gold ETF activities to ensure transparency and promote accuracy and timely disclosure of vital information to market participants, leading to better market stability, portfolio and risk management decisions, and gold price forecasts. Understanding the impact of gold ETF leads to better anticipation and effective adaptation by regulators and policymakers to future changes, not only for the gold market but also for other future innovations and markets.