Rising trade tensions could breathe new life into the yellow metal

With trade-related tensions between the US and China heating up, and political tensions within the euro zone also rising, both equity and currency markets are likely to be impacted. Experts say that by diversifying into gold in times of such turmoil investors can not just stabilise their portfolios but can also earn good returns from the yellow metal. The recently published 'In Gold We Trust' report 2018 by Incrementum, too, suggests that the yellow metal is likely to do well in the near future. Year-to-date, it is up 4.78 per cent in the Indian market and down 2.35 per cent in the international market.  

Trade war heating up: In his latest salvo, US President Donald Trump has asked the US Trade Representative to identify another $200 billion worth of Chinese goods for imposing additional tariff of 10 per cent. True to script, China has promised to retaliate. The ongoing tariff war could lead to prices of goods, and hence inflation, rising in the US. An inflationary environment is positive for gold. 

If the trade war escalates, it could lead to higher inflows into the US dollar in the short term. "In the longer term, it will lead to reduced dollar dominance as trade becomes more bilateral in nature and countries have lesser need to maintain dollar reserves. Reduced dollar dominance could lead to its depreciation, which will be positive for gold," says Chirag Mehta, senior fund manager–alternative investments, Quantum Asset Management Company. Gold is priced in dollar terms. When the dollar depreciates, the price of gold rises in the international market.

Escalation of trade wars with China and even the European Union will also impact the global financial markets. Gold tends to do well in a climate of heightened fear and uncertainty in the markets. 

Rising euro-scepticism in Italy: Currently there are growing fears that with a Euro-sceptic coalition coming to power in Italy, the country may quit the European Union, thereby posing a challenge to the very survival of the currency union. Whenever there is high political uncertainty in Europe, or there is a question mark on the euro zone's survival, European investors tend to seek refuge in gold. Another safe-haven instrument that they like is German bonds. But experts say that investments in German bonds are already nearing saturation point. 

If global economic recovery falters: The 'In gold we trust' report points out that the global economic recovery is on shaky ground. A large part of the global economic boom is being driven by cheap liquidity. Growth may not sustain once this flood of cheap liquidity dries up. Liquidity has driven the top global markets up, creating what is known as 'wealth effect' among investors. If it goes away, there could be an impact on equity markets, which could in turn lead to diminishing wealth effect. Consumers may feel compelled to curtail consumption. Thus, if the cheap liquidity tends, there are doubts about whether the global economic boom will sustain. Such a development will again be positive for gold. 

Depreciating rupee pushing up Indian gold prices: From the Indian investor's perspective, the rupee-dollar exchange rate also comes into play. Gold has done better year-to-date in the Indian market than in the international market because of the depreciating rupee. "The rupee has depreciated by about 7 per cent in the past three months. That has provided a fillip to rupee gold prices. The rupee could depreciate further owing to its current downward momentum," says Navneet Damani, assistant vice president-research, Motilal Oswal Commodities. If there are more rate hikes in the US, and the dollar strengthens further, then the rupee could depreciate more. This will help gold perform better in the Indian market. (However, a strengthening dollar will not be so good for gold's price in the international market, and India takes its prices from the international market. The two trends will counteract against each other and the stronger one will prevail). 

Why gold hasn't budged so far: Gold has not risen in the recent past owing to the rising dollar. The latter has been strengthening because the US Fed has stuck to its rate hike stance and it is also unwinding its balance sheet. On the other hand, the European Central Bank has said that it will unwind accommodation this year, but will hike rates only next year. This has propelled the dollar up against the euro and a host of other currencies (whose central banks have not yet begun tightening). A rising dollar is negative for gold.

Moreover, real interest rates in the US have turned slightly positive. Again, gold doesn't do well when real interest rates turn positive. Adds Damani: "There is no major flow of money coming into gold exchange traded funds (ETFs) and physical buying has also not been very strong so far. Gold is not attracting much inflows because it has not given much returns over the past three-four years, while equities and bonds have done better."

Will this change? If the Fed fails to stick to its stated intent to hike rates, and in the extreme case, is forced to go back to quantitative easing to support the economy, that will be positive for gold. This could happen if either the trade-related uncertainty gets aggravated further or if the economic recovery falters.

What should you do? Investors should have a 10-15 per cent allocation to gold. "Hard data suggests that that having a 10-15 per cent allocation helps investors mitigate the risk in their portfolios," says Mehta. While investors should have an allocation to gold at all times, now is a especially opportune time, given the growing turbulence in the world economy and markets. Longer-term holdings in gold should be held in the form of sovereign gold bonds (SGBs) while shorter-term holdings should be parked in gold ETFs which are more liquid.  

 


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