Posted On Wednesday, Jun 03, 2020
May turned out to be yet another eventful month for gold markets. Investors digested the conflicting news of economies opening up businesses on one hand, and rising US - China tensions on the other. Tensions surrounding a second wave of infections in China, South Korea and Iran continued to weigh on optimism. Poor economic readings and Powell’s discouraging comments on the state of the US economy were to some extent shrugged off by risk assets. Despite rising equity markets, the weak underlying economy kept investors uneasy. This in turn supported gold above $1700 for most of the month. Gold continues to perform as it should in times of never-seen-before economic uncertainty, with prices up 14% YTD in dollar terms and 20% YTD in rupee terms.
INVESTORS DIDN'T ‘SELL IN MAY’
Despite a grim economic outlook, thanks to the enormous stimulus measures and aggressive rate cuts, investors hunting for higher returns flocked to equities. This drove up global indices. This was unusual from historic patterns at this time of the year. This “don’t fight the central banks” liquidity driven rally in equity markets isn’t backed by fundamentals and thus requires investor caution. For instance, S&P 500 quarterly earnings per share have fallen by 13% y-o-y. This is in fact the worst collapse since 2009. In spite of that the S&P 500 is up ~4% for the month.
In these times of heightened risk and uncertainty, positions in equities can potentially be hedged by allocating to gold. Gold has historically had low correlation to equities.
DON'T BET ON A V-SHAPED RECOVERY
As we head into June, equities are rising on hopes that a restart in global economic activity could fuel a V-shaped recovery. A V-shaped recovery implies that once the economy hits its lowest point and lockdowns are lifted, workers will get their jobs back. Consumers will shop, socialize, travel and invest the way they did pre-Covid-19.
The rebound from the recession will appear V- shaped, given the sharp deterioration in economic activity but won’t be a sustainable one. There are millions of people who lost jobs and are coping because of the handouts from the government and the Fed. The policy makers have once again papered over the problems caused by the lockdowns, but can’t generate real wealth by this printing of money. Once the freebies end when things open up, not many of these will get their jobs back soon. The rebound thus will be much short lived and won’t be sustainable as there is decline in real wealth, increase in debt and less income to support.
Also, if people are scared of the disease and uncertain about their financial security, it is unlikely that they will get back to spending like they did prior to the pandemic. Businesses too will be nervous about restarting normal operations and rehiring. Thus, a quick rebound in economic activity seems unlikely in the near future. This will cap gains in equities and keep the increased investment demand for gold intact.
TOO MUCH OF ANYTHING IS BAD
Massive monetary policy easing and government relief packages have helped escape economic collapse. But the monetary inflation moonshot will have its consequences in the form of a weaker dollar. A weaker dollar and high liquidity could result in higher commodity prices as well and thus could be inflationary. Gold, known for preserving purchasing power, will be preferred asset in such times.
INVESTORS QUESTION POWELL’S REJECTION OF NEGATIVE RATES
The Federal Reserve boss has insisted that he isn’t considering negative interest rates. But investors aren’t convinced. Reasons being that rates that have plummeted close to zero and central bank’s “do whatever it takes” approach to save the economy.
Yields at the short end of the Treasury curve have already turned negative in nominal terms. Also, the 10-year US Treasury bill now yields 0.64%. This is more than 100 basis points below where it began 2020. This is below most expected rates of inflation, meaning in real terms it has turned negative too. This means a long-term investor in US Treasuries is almost guaranteed to lose a small amount of purchasing power over the life of the bond. This makes holding gold a more viable option. Gold can preserve purchasing power in the upcoming negative real rate environment. This trend will be supportive for the yellow metal.
US-CHINA TENSIONS ARE SET TO DRIVE GOLD HIGHER
Rather than encouraging greater cooperation, Covid-19 has further soured US-China relations. Both sides are pinning the blame on the other for the origin of the pandemic and severity of the crisis. But as the pandemic continues to weaken their economies, both countries could have less appetite for further trade wars. As such the tensions between the two could manifest on other fronts such as currency, military, technology, international cooperation, and even ideology.
Issues between the two are deep and will persist even once the pandemic and the 2020 election are over. At the core of these issues is China’s ambition to become a dominant global power and America's resistance to that. As such, tensions between the major economies seem unlikely to de-escalate soon.
This will have consequences for global order and wide-reaching economic ramifications. The resulting uncertainty in equity, credit and currency markets will trigger a risk-off sentiment. This will push up investment demand for alternatives like gold.
RUPEE’S DEPRECIATION IS ADDING TO GOLD RETURNS
The FY20 fiscal deficit has breached its 3.8% target by 80 basis points. The Indian government is set to borrow more to fund its Rs 20 lakh crore stimulus package. This has deteriorated India's credit profile. The Indian rupee continues to depreciate against the US dollar as foreign investors flee Indian markets. The government hasn’t done much to support Covid induced economic deceleration which further dims growth prospects. Foreign outflows, rising government deficit and falling interest rates contribute to falling Rupee.
International gold price is converted to Indian gold price using the prevailing Rupee-Dollar rate. Thus, a depreciating rupee is pushing up gold prices in India.
MANY INGREDIENTS TO LEAD GOLD HIGHER
In conclusion, the macroeconomic backdrop has become favorable for gold. Our analysis shows that higher risk and uncertainty combined with lower opportunity cost and competitive debasement of currencies will boost investment demand for gold.
In the coming quarters, gold’s behavior will depend on the speed of global economic recovery. The extent of monetary and fiscal stimulus will also be important. But over the long term, Gold will play a risk diversifying role. We believe investors can use the ongoing correction to build long-term positions in Gold.
Source: Bloomberg, World Gold Council
|Name of the Scheme
|This product is suitable for investors who are seeking*
|Quantum Gold Savings Fund
An Open Ended Fund of Fund Scheme Investing in Quantum Gold Fund
|• Long term returns
• Investments in units of Quantum Gold Fund – Exchange Traded Fund whose underlying investments are in physical gold
Investors understand that their principal will be at Moderately High Risk
The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments.
Mutual fund investments are subject to market risks read all scheme related documents carefully.
Please visit – www.quantumamcom/disclaimer to read scheme specific risk factors. Investors in the Scheme(s) are not being offered a guaranteed or assured rate of return and there can be no assurance that the schemes objective will be achieved and the NAV of the scheme(s) may go up and down depending upon the factors and forces affecting securities market. Investment in mutual fund units involves investment risk such as trading volumes, settlement risk, liquidity risk, default risk including possible loss of capital. Past performance of the sponsor / AMC / Mutual Fund does not indicate the future performance of the Scheme(s). Statutory Details: Quantum Mutual Fund (the Fund) has been constituted as a Trust under the Indian Trusts Act, 1882. Sponsor: Quantum Advisors Private Limited. (liability of Sponsor limited to Rs. 1,00,000/-) Trustee: Quantum Trustee Company Private Limited. Investment Manager: Quantum Asset Management Company Private Limited. The Sponsor, Trustee and Investment Manager are incorporated under the Companies Act, 1956.
Get In Touch
Take small steps in financial planning to achieve big dreams! Start your investment journey today!