FTSE 100 And Its Co-relation With Gold Prices

  • Nov 04, 2019 GMT
  • Team Kalkine
FTSE 100 And Its Co-relation With Gold Prices

Gold Prices - Stock Markets and Gold prices have long enjoyed an inverse relationship. Gold, like most other precious metals, has been used in the past as an instrument of hedge against inflation, deflation or in circumstances of currency devaluation, though its efficacy as such has come to diminish on recent times. historically, Gold has proven itself to be  moderately reliable as a hedging instrument with increasingly less numbers of investors investing in this metal to hedge against their exposure to equity markets, more recently the price scaling of this commodity has been more on account of investment and consumption factors rather than risk hedging. Gold has a unique feature that it poses no default risk to its holder.

Gold historically has been benefitted during periods of a heightened risk from flight-to-quality inflows. By providing reducing portfolio losses and positive returns, gold has especially been an effective instrument during a systemic crisis when investors withdraw funds from stocks and other risky assets. The precious metal also helps investors to meet their obligations while more illiquid assets in their portfolio may be undervalued and may even have been mispriced. Most investors usually through the use of futures contracts & derivatives invest in gold as a way of diversifying risk. This precious metals’ market like all other markets is also subject to speculation and volatility. This precious metal, as compared to all other precious metals, has the most effective safe haven properties and risk hedging properties that can be used for investment.

The FTSE 100 stock Index - This index after the FTSE All Share index is the second highest value stock index of the London Stock Exchange. The index which was launched in the early parts of the eighties comprises of the top 100 stocks listed stocks on the London Stock Exchange based on the decreasing order value of their market capitalization, representing at least eighty percent value of the total market capitalization of the London Stock Exchange calculated at any point of time. The Index also boasts itself to be the United Kingdom’s globally recognized benchmark. The FTSE 100 companies have long donned pathbreaking new technological and business practices, they have fostered global business outlook and have brought about business and economic success for the United Kingdom and the rest of the countries in which they operate.

This FTSE 100 stock index, representative of the largest companies in the United Kingdom, also known as the large-cap stock index, in terms of revenues and market capitalization, is seen by many as the barometer of the British economy. It is studied across the board by investors, economists, debt market makers, stock market professionals and fund managers alike to carefully consider the implications of any untoward movements in the general economic parameters of the British economy on the headline index and vice versa. However, this concept of FTSE 100 being the barometer of the British economy has now changed  as the index is now increasingly being represented by a number of multinational and foreign companies whose performance is not linked or to a very little extent linked to the macro-economic fundamentals of the British economy.

Comparison of FTSE 100 and gold prices in the past decade

The FTSE 100 has underperformed for the most part in the past decade. On account of Brexit and weakened business sentiment in the United Kingdom the FTSE 100 companies have traded lower to their global counterparts, and the growth of the Index as a whole has been moderate. The same cannot be said about the gold prices which has risen very strongly with minor dips recorded during 2014-16. Gold during most of the period from 2008 to 2019 has proved itself as a value preserver, while both stocks and currency in London markets were losing their sheen it was the only one still able to hold on to its value.

The primary reason for this is that gold prices are determined by international demand and supply dynamics. While London is an important trading centre for bullion, still a significant part of the pricing of the metal is determined by the international traders.

One of the main reasons for the bad performances of the United Kingdom stock markets has been the weakness of the Pound Sterling. The entire United Kingdom has been gripped under the  clouds of economic uncertainty, and also the payout amount that must by shelled out by the British economy as part of its departure from the European Union, as envisaged to put the country in a mid-term balance of payment adverse position. While this factor had an impact on everything British, Gold was not a British commodity, the investors under this case found the commodity a safe haven.

The performance of the American economy and other large economies like China and Japan are responsible for the good performance of the precious metal. The growing prosperity of Asian Countries like China and India has meant that the demand for the precious metal for consumption has increased manifold.

Another major factor that had its impact on gold prices that was specific to the British economy has been the switch of the British currency with gold and other currencies due to the weakness of the British Pound Sterling. With the anticipated worsening balance of payment situation of the Pound, many a country which kept large reserves of the currency started to switch it with other currencies and gold, further weakening the currency and the British stock markets as a consequence. However, it is an observed phenomenon that British Pound Sterling and FTSE 100 index have enjoyed an inverse relationship, and the fortunes of the stocks on the index rose with a fall in the currency value, hence some weakness of the currency will be compensated by the cyclical effect of currency and trade volumes.

The relationship thus of the FTSE 100 index and the prices of gold can be quantified in terms of strength of the British Pound Sterling. While the weakness or otherwise of the currency is having some impact on the demand and supply dynamics of the Precious metal, on the other hand the same weakness or otherwise of the currency is making the value of the FTSE 100 companies lower in comparison to their international counterparts. The relationship thus FTSE 100 index and Gold prices is not a direct one, but a derived one.

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