The launch of the AAOIFI Shariah Standard on Gold developed in collaboration with the World Gold Council has been a catalyst for the development of new Shariah compliant gold products. It has brought the benefits of contemporary gold products such as gold investment accounts and physically backed exchange-traded funds (ETFs) to the Islamic finance industry, ensuring that gold can play a role in protecting the wealth of consumers and institutions in Islamic markets.
Earlier in 2021, Deloitte and the International Shari’ah Research Academy for Islamic Finance launched a report titled ‘The Global Gold Investment Markets: Traits for Shariah-based investment solutions’. The report analyzes recent developments in the gold market and sets out the reasons for investing in gold.
It also highlights the impact of the AAOIFI standard — in the survey conducted by Deloitte, approximately 85% of respondents agreed that the introduction of the AAOIFI standard on gold will give investors more confidence to allocate to gold and approximately 87% agreed that the standard will provide more opportunities to develop Shariah compliant gold products.
It is clear that gold is playing a larger role in Islamic finance and one of the main market drivers is the need for a Shariah compliant safe haven. This was evident globally during the height of the COVID-19 pandemic in 2020 where institutional interest in particular significantly picked up.
Review of 2021
Compared with 2020, the dynamics of gold demand in 2021 have been different. 2020 was a record year for gold. Driven by pandemic-induced significant economic uncertainty, we saw record inflows into gold-backed ETFs. This pushed the price to its highest on record in August of 2020.
Institutional interest in gold offset weaknesses in consumer demand. Lockdowns, generally low economic sentiment and higher prices dented consumer demand. 2021 though was different.
As many countries started to emerge from the worst of COVID-19 and the economic outlook started to pick up, consumer demand globally started to recover. Institutional demand though has fallen, leading to a softening of the gold price.
If you look at bar and coin demand in particular, globally it increased in the third quarter (Q3) by 18% year-on-year (y-o-y). Strong Q3 growth was underpinned by a range of factors, including ongoing emergence from COVID-19 restrictions in many countries, continued fears over rising inflation and the price dip in August which encouraged many investors to buy (particularly in Asia).
Turning to the larger Islamic markets, the picture was more mixed. Bar and coin demand in Turkey was sharply lower y-o-y. Demand for small gold bars and coins was 10 tons — 80% below the record high of Q3 2020, although it staged a strong quarterly recovery from Q2’s very depressed level. The gold price remains at historically very elevated levels, at a time when Turkey is plagued by persistent high inflation.
In a repeat of Q2, Iran — the largest market in the Middle East — was the only country to register y-o-y losses. Bar and coin investment in Iran fell 30% y-o-y to eight tons as high inflation and housing costs continued to weigh on demand.
Lower gold prices and summer wedding demand offered some support and helped to explain the very strong quarterly uplift from the weak Q2. Markets across the rest of the Middle East saw solid y-o-y improvement, likely supported by the price correction mid-quarter.
Malaysia saw a y-o-y decrease in bar and coin demand of 52% in Q3. This is likely due to a combination of COVID-19 restrictions and economic uncertainty denting consumer confidence. Although economic forecasts have been revised upwards, this will take time to change consumer sentiment.
Preview of 2022
The strategic role of gold — as a potential protector of wealth, as a portfolio diversifier and a highly liquid asset — will persist in 2022. As economies continue to emerge from the worst of COVID-19 and economic activity picks up, consumer demand could continue to recover. Gold though is a dual asset.
Institutional interest in gold, which is a major component of gold demand, has different drivers. These include economic uncertainty, the interest rate outlook and inflation. It is looking increasingly likely that inflation will be dominating the minds of policymakers and asset allocators in the medium to short term.
In an inflationary environment, we would expect to see renewed institutional interest in gold. This could be even more pronounced in Islamic markets, where the range of Shariah compliant assets is smaller than in conventional finance. Many conventional diversifiers for example are not Shariah compliant.
Conclusion
Gold will likely continue to play a significant role in Islamic finance. But it is not just the financial climate that is having an impact. Technology is also likely to have a major impact on the gold market going forward.
We are at the cusp of the latest industrial revolution driven by the deployment of digital technology. The gold industry is not immune — digitization will increase access to gold, can improve market infrastructure efficiencies and can enhance the integrity of the supply chain.
Sustainability is a key consideration for both Islamic and conventional finance. The smart deployment of digital technologies can enhance market transparency, giving investors, market participants and regulators more granular information on the provenance, production and trading histories of gold bars and coins. This will be essential to ensure that gold and the gold industry remain trusted, ethical and sustainable.
Andrew Naylor is the regional CEO of APAC (ex-China) at the World Gold Council. He can be contacted at [email protected]