Uncertainty in global economy and politics makes gold useful

Last Updated: Tue, Feb 13, 2018 17:06 hrs
Gold (Image Courtesy: Bloomberg)

Keeping up with seasonal trends, this January too was positive for gold.

The fact that two big gold buyers, India and China, get involved during the period brings in the positive bias. India loads up in preparation of the ensuing wedding season and China readies for the Lunar New Year.

From an economic perspective, gold’s rise since mid-December has coincided with the US dollar's free-fall that began just after the US Fed raised interest rates for the fifth time since the rate-hike cycle began in December of 2015. However, stronger than expected jobs data accompanied by hawkish Fed rhetoric took some sheen off gold. All in all, gold managed a close at $1345.15 an ounce clocking gains of 3.2% for the month.

The US Fed basically guaranteeing another rate-hike at the upcoming March meeting was unable to bring any meaningful gains in the dollar. This is likely because markets are currently pricing in the same three rate hikes this year that the Fed has forecast and expectations from a tighter monetary policy from the European Central Bank (ECB) adds the pressure on the dollar. While it may be the case that the ECB reduces its monthly asset purchases in the months ahead, the fact that the ECB President, Mario Draghi, recently made it clear that he does not expect ECB interest rates to rise this year suggests that the dollar should not weaken too much further against the Euro.

Although the US government shutdown was in a way averted by another stopgap measure, it helped gold prices as the drama unfolded. It is far from over yet. How the current Trump administration, as well as the House and Senate, deal with funding the government will absolutely affect the financial markets. As much as we all hope for real progress to occur, if past performance is any indication, it seems more likely that they will come to some sort of impasse or once again play 'kick the can'. They are simply unable or unwilling to tackle the real issue: fiscal prudence. This could lead to more downside pressure in US equities as well as the dollar.

Outlook

The US Fed's balance sheet reduction rises to $50 billion per month by October. The Fed's dot-plot predicts three more rate hikes this year and the ECB has halved its QE (Quantitative Easing) programme and is predicted to completely finish printing money by the end of this year. Exploding debt and the reversal of central bank support for bonds should cause rates to spike. The impact of lesser money will be felt over time by the markets until the euphoria on tax cut optimism, liquidity and higher asset prices will likely come to an end this year. The recent correction in risk assets seems to be an early indication of just that.

For now, the Fed seems to be keen to use the euphoria in order to push the normalisation of monetary policy. We don't expect real rates to move up too much. After the December increase in rates, there would perhaps be another two hikes in 2018 at maximum.

By contrast, the so-called dot-plot of individual policymakers shows that they envision three more next year. There is a material difference between reductions in liquidity infusion vis-à-vis withdrawing liquidity. The US Fed's balance sheet normalisation would push rates higher and therefore impact the Fed's resolve for rate-hike trajectory that they envision today. The Fed's attempt to get ahead of its QE unwind may provide investors with a buying opportunity in gold before adversely impacting the market and economy.

Should the current expansion fail to become the longest in history and the U.S. GDP growth indeed turn downward over the year, we believe the consequences could be grave. The knee-jerk reaction by the US government and the Fed would definitely comprise renewed stimulus measures in order to stem the downfall, which implies a complete U-turn in monetary policy. Currently, financial markets are almost exclusively focused on the planned normalization of monetary policy. Almost no one seems to expect an impending recession or a return to loose monetary policy. Investors will do well to remember that, so far, the Fed has been behind the curve and only delivered when markets brought it on a silver platter. Since the normalisation of monetary policy hasn't yet progressed sufficiently, renewed stimulus measures would probably shake market confidence in the efficacy and sustainability of the unconventional monetary experiments applied to date.

The world continues to remain in state of great disequilibrium, both with respect to the global economy and geopolitics as well. The fallout of the geopolitics globally seems to now cap the downsides in gold. Given the macroeconomic picture, gold will be a useful portfolio diversification tool and thereby helping you to reduce overall portfolio risk.

Data Source: Bloomberg

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