August 08, 2019
Quantum Alternative Investments Team
Gold prices consolidated on its huge gains from the earlier month, hanging in the balance of slowing growth and central bank denial. Economic data, globally, is increasingly showing signs of stress. The anticipated economic deceleration with the waning of sugar rush from fiscal stimulus accompanied with tighter financial conditions is not only impacting the trade war hit goods sector but is also now spilling into so far resilient services sector. However, central banks seem shrugging the evidence as cyclical to seem in control of the situation; leading to a brief pause in gold's rally. Further flare up in trade wars and initial signs of it manifesting into a currency war rekindled the dynamic rally in gold. The month ended flattish with gains of 0.3% but recent developments ensured further gains in store.
Economies worldwide are under continued strain from slowing industrial demand. The most recent Global Manufacturing Purchasing Manager's Index (PMI) showed that, at 49.4, factories contracted for the second straight month in June. We haven't seen back-to-back sub-50.0 PMI readings since the second half of 2012. China's purchasing managers' index remained in contractionary territory as pressures on exporters persist. A similar gauge in Europe slipped, driven by shrinking factory output in Germany and France. U.S. is also showing visible signs of contraction. There's also a one-in-three chance we could see a full-blown recession sometime next year. That’s according to the New York Fed’s recession probability index, which flashed a 12-year high of 32.9 percent. Since 1960, every time the index has surpassed 30 percent, the economy has tanked within the next 12 months.
Central banks in a bid to show that they are in control of the situation are acknowledging signs of slow down but in outright denial of anything more than cyclicality at play. Draghi downplayed fears of recession in the Euro area and that the central bank hadn’t considered interest-rate cuts. After delivering the expected 0.25% rate cut, Powell said that the rate decision was "intended to insure against downside risks" and only further act if necessary. The central bank reluctance to signal a change in direction and absence of details and a timeline of upcoming rate cuts kept gold prices subdued.
Trump trade wars are far from over. The threat is that Trump sees political advantage in turning hawkish again. There is a higher probability of a continuation of trade disputes, particularly if President Trump is polling well in the period ahead of the elections. He seems intent to keep the dollar under check by pursuing trade war politics. China attempted to negate tariffs by engineering sharp currency depreciation. The Chinese central bank was forced to act on the pace of depreciation after being labeled as currency manipulator by the U.S. As trade wars continue to take toll on growth, countries will seek ingenious ways to negate it and could result in a currency devaluation race. Given the low yields and potential inverted yield curve, people are actually interested to invest in something that is truly independent and is not actually within the currency war circle where every government is trying to depreciate their currencies.
Understandably, central banks are not forthcoming in acknowledging global slow down. Fed's monetary policy u-turn, recent cut in policy rates and their willingness to do more if need be; does signal that the threat is more than cyclical down tick. The Bank of International Settlements has recently issued a scathing annual report suggesting the global Central Banks have been negligent in properly managing debt levels, QE functions, and fundamental economic policies in an attempt to continually chase growth and inflation. However, central banks don’t care and will be biased towards supporting growth and therefore cut rates which will mean that real interest rates will be on a decline. They will undertake further unconventional policies aka money printing to stay afloat. In the U.S, it is extremely doubtful the Fed will be able to resist the influence of the president that wants to get re-elected and hence expect such policy measures sooner than expected, more likely before the elections next year. This scenario will be extremely bullish for gold.
President Trump and congressional leaders struck a critical debt and budget agreement. This agreement contains intrinsic risks in that the budget deficit is approaching the $1 trillion level which carries tremendous costs. It requires the government to borrow a quarter of every dollar spent. At some point these expenditures and increased debt will have the opposite effect on the US dollar and could take it dramatically lower. The dollar, which is usually a headwind for gold, may depreciate or remain range bound as trade tensions, lower rates and slowing growth offset any relative economic benefits.
Indifference toward gold is starting to fade and the metal has been reasserting itself as an asset of choice amidst escalating trade and geopolitical tensions. In a world where many competing assets such as government bonds are offering negative rates and the yield curve is pointing to a recession, gold is looking like a good bet. Gold will remain a good portfolio diversifier amid increasing uncertainties around global growth.
Source: Bloomberg, World Gold Council
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