September 09, 2019
Quantum Alternative Investments Team
After a brief pause, Gold’s rally was further fueled from an array of mutually reinforcing factors, with slowing growth, central bank dovishness, and the high-stakes stand-off of the trade war sapping appetite for risk. Leading global economic indicators have begun to nosedive indicating significant economic deceleration amidst a backdrop of uncertainty. As the growing list of negatives in the markets adds up, it strengthens the case for holding gold as is evident in the strong investment flows in gold last month. Further flare up in trade wars and initial signs of it manifesting into a currency war continues to act as catalyst for gold. The month ended with significant gains of more than $100, an increase of +7.5% for the month.
An escalation in the U.S.-China trade fracas has given gold the much needed impetus. President Trump has made it clear that he was not abandoning his rough-and- tumble tactics to force a trade agreement with China. Recent moves from China to aggressively retaliate, is going against everything Trump has said about the trade war being "easy to win". It is hard to fathom that there will be a quick resolution as both sides seem to be digging in deeper. Actions from both sides seem to be widening the gap between the two superpowers.
The repercussions of the trade dispute have had a profound impact on the global economy which has shown signs of contracting. Investors are weighing weak data from two of the world’s biggest economies as Chinese retail sales and industrial output missed estimates and Germany’s economy contracted in the second quarter. U.S durable goods missed headline expectations falling 0.4% and U.S. PMI data declined to 49.9 signaling contraction. The inverted yield curve i.e. gap between two- and ten-year yields dropped below zero in the U.S. and U.K., triggering recession warnings.
As signs of a global slowdown emerge, central banks have boosted accommodation. The Fed cut interest rates last month for the first time in more than a decade, while the authorities in China have delivered targeted support. Fed officials viewed their first interest-rate cut in more than a decade as insurance against too-low inflation and the risk of a deeper slump in business investment. However, the Fed’s ‘insurance’ cut is a clear signal that the U.S. central bank panics in a desperate effort to steepen the yield curve. But this may be not enough to avert the recession.Outlook
There will be continued and deepening financial fallout until the trade war comes to an equitable and fair resolution. It also seems likely that to solve the issues at the core of this trade war it will take some time. China's retaliation to U.S. tariffs, which immediately invoked a response from Donald, will cost the global economy trillions of dollars. The coming election year just adds more uncertainty and integrates further unknowns, since Trump will now be motivated to do things that add to his popularity. This will largely shape up how financial markets behave and the baseline suggests that this clash for supremacy will keep gold well bid. The main risk to our call is a major flip-flop by Trump de-escalation by U.S. or China, paving the way for a trade deal ahead of the U.S. presidential elections next year. This may cause some short term dent in gold prices.
The global contraction has increased uncertainty in financial markets and has also shaped the monetary policy of many central banks worldwide causing them pivot to a more dovish stance in which they have lowered interest rates. In the case of the Federal Reserve the pivot was even more extreme, moving from a policy of quantitative normalization to quantitative easing. Fed Chairman Powell indicated the Fed would do what was necessary to keep the economy rolling and will act as appropriate to sustain the expansion. Traders of fed funds futures jacked up their expectations for the amount of easing they expect from the U.S. central bank this year after Powell’s remarks.
Central banks have been adding to reserves as growth slows, trade and geopolitical tensions rise, and a need to diversify away from the dollar. Official purchases now account for about 10% of worldwide consumption. Given Trumps tendency to weaponise trade and instill sanctions at will, it is indeed logical for central banks to diversify reserves away from the dollar. At the other end, negative yields are becoming common for many of the world's most mature economies. In a world awash with roughly $17 trillion of negative-yielding government debt and much more on a real interest rate basis, gold is looking as a better bet for investors seeking a store of value. We believe that diversification of reserves and investment in gold is bound to increase going forward in a world plagued with high uncertainty and policy irrationality.
Investors would do well to remember that gold is a time-tested store of wealth and a valuable diversification tool against the numerous downside risks that currently persist in the global arena. We suggest an allocation of between 10-15% of one’s portfolio. We suggest that investors use any corrections as an opportunity to add more gold to their portfolio or ideally keep allocating to gold in a systematic manner.
Source: Bloomberg, World Gold Council
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