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Published on 6/07/2019 11:11:54 AM | Source: Quantum Mutual Fund

Budget Impact on Gold - Quantum Mutual Fund

Posted in Budget Expert Views| #Quantum Mutual Fund #Chirag Mehta #Budget Expert View

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Below is the Views Budget Impact on Gold - By Mr. Chirag Mehta, Sr. Fund Manager-AlternativeInvestments, Quantum Mutual Fund

A trifecta of geopolitical/ trade tensions, slowing global economy and overarching central bank dovishness especially from US Federal reserve, translated to an array of gains for gold last month. Market dynamics have quickly changed that led to the repricing of gold. The transition to a low-growth disinflationary environment exacerbated by trade war uncertainty and with it the next rate cut cycle has caught markets by surprise as far as the timing is concerned. As impact of trade wars impedes economic activity, Fed seems in a hurry to support the ailing economy eroding a long standing support for the dollar. Increased uncertainty is attracting strong flows to gold forcing unwinding by short sellers, fueling rise in prices. Gold prices ended the month at $1,409.45 an ounce, an increase of +7.97%.

Global economic contraction is getting worse by the current trade war pre dominantly between the United States and China with Europe now getting dragged as well. For the time being, there’s sort of ‘ceasefire,’ in which the two sides have agreed to halt further escalation of tariffs while high-level negotiations take place. The marketplace is not quite so upbeat on the prospects of a final agreement any time soon. Despite a pause, there could still be additional tariffs later this year.

Among recent data pointing to weakness, factory activity across Asia and Europe shrank in June, while the U.S. seemed on a cusp of contraction, according to purchasing managers’ indexes. Weaker-than-expected U.S. jobs data underscored mounting economic concerns. Manufacturing is weak and world trade is decelerating ahead of most expectations because of more slow-moving global effects as opposed to just a reflection of trade wars.

Amid the Trump uncertainty and evidently slowing growth, Fed seemed confirming market expectations for a cut at the July meeting. The FOMC statement has turned more dovish, so have the Fed’s forecasts particularly inflation and so has the dots chart. Things are still data contingent but the Fed has removed the phrase “patient as it determines” and overall it presented a significantly softer tone. The Fed recognizes that wage pressures are abnormally absent given the state of unemployment. Even other central banks around the world are also adopting a more dovish tone, with European Central Bank President Mario Draghi saying earlier this week that additional stimulus may be needed if the economic outlook doesn’t improve.

Outlook

Despite the recent truce on the US China trade dispute, Trump trade wars are far from over. The threat is that Trump sees political advantage in turning hawkish again. The key risk to our view is if a U.S.-China trade deal is reached. This would significantly reduce the risks to the global economy and lower rates by central banks. However, this certainly does not reflect a base case scenario. The dubious issue of enforceable compliance against maintaining China’s sovereignty in their view is something that still remains difficult to address. 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.

The cost of tariffs has fallen entirely on U.S. businesses which will sooner or later be passed on to consumers. The US could soon end up staring at a stagflation environment where growth will continue declining and inflation moving higher. Fed will be biased towards supporting growth and therefore cut rates which will mean that real interest rates will be on a decline. This scenario will be extremely bullish for gold.

Powell’s signal was pretty clear that the Federal Reserve is moving closer to lowering interest rates. A likely rate cut amid slowing economic growth will limit the upside in the U.S. dollar and also lower the
opportunity cost for holding gold. The global capital market’s mood is shaky due to the fear of the unknowns, signs of fresh strains on the global economy may prompt stimulus from central banks. In a way, it seems moving back to yesteryears of loose monetary policies, which led to the last bull run in gold. Also, it is important to note the academic discussions at the Fed are in agreement of further unorthodox monetary policy which implies use of more unconventional tools like monetary easing (money printing) and even negative interest rates. This significantly increases not only the probability of the Fed to move quickly towards lowering rates to the zero bound but other unconventional tools used on first signs of recession in the United States. Such ill-conceived policy making bodes well for gold.

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 investment. Gold will remain a highly relevant portfolio diversifier amid increasing uncertainties around global growth.

 

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