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Published on 11/06/2019 8:57:25 AM | Source: Quantum Mutual Fund

Gold Monthly View - Quantum Mutual Fund

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Below is the Views On Gold Monthly View By Chirag Mehta, Sr. Fund Manager, Alternative Investments, Quantum Mutual Fund

 

Gold Monthly View By Chirag Mehta, Sr. Fund Manager, Alternative Investments, Quantum Mutual Fund

Gold is rediscovering its “sweet spot” as escalating concerns about the U.S.-China trade standoff, losses in equities and concerns about slowing growth combine to lift the yellow metal from doldrums. The amped up trade tensions helped gold breakout which was earlier stuck between U.S. dollar vigor and looming market uncertainties. With trade ructions escalating to Mexico, it makes it distinctly clear that U.S. can use its supremacy to weaponize trade on a whim. As impact of trade wars impedes economic activity, it could force the Fed to cut rates and pump in liquidity to support the ailing economy. This would undermine the last support for the dollar and act as a catalyst for gold. Gold saw its first monthly gain in May, breaking a streak of three straight months of losses. Gold prices ended the month at $1,305.5 an ounce, an increase of +1.7%.

The U.S.-China trade war continues to worsen. Trade negotiations seemed to have lost ground and moved farther away from a resolution. As a result, fresh rounds of retaliatory tariffs have everyone concerned on its impact on growth in an already slowing world. New tariffs on Mexico now extend a different dimension of immigration issue as opposed to be an unfair trade issue, exemplifying how U.S. can exploit its supremacy. It looks more likely that the trade wars will be long, messy and expensive for the world.

The U.S. economy is showing some weakness despite predictions of growth. American factory data has been disappointing, sales of new U.S. homes cooled in April from an 11-year high and pending home sales in April unexpectedly dropped, adding to signs the housing market is struggling to regain momentum. There is further risk of deterioration and trade war could only exacerbate the situation. Bloomberg economists Dan Hansen and Tom Orlik said, “If tariffs expand to cover all U.S.-China trade, and markets slump in response, global GDP will take a $600 billion hit in 2021, the year of peak impact.” This is just a direct impact; the second round order would be significant as the decline in equity market would undermine the wealth effect and thereby a headwind to consumption and investment, compounding the fallout.

 

Outlook

Gold is proving to be a major beneficiary of the U.S.-China trade war. Escalating trade tensions between the U.S. and China damped the outlook for growth. China’s retaliatory tariffs have fueled bearish sentiment on the global economy. There are growing signals that an economic slowdown is imminent, with the outlook for China’s manufacturing sector deteriorating more than expected. Should the pressures of the trade war hurt U.S. economic growth, it may prompt the Federal Reserve to reduce interest rates thereby undercutting the dollar. Vice Chairman Richard Clarida said “The Federal Reserve is prepared to ease if it sees mounting risks to the expansion”. Trade war could be a significant catalyst for Gold if it leads to Fed easing in the immediate future, as well as higher inflation expectations.

According to a monthly poll of consumers, expected inflation three years ahead dropped to 2.7 percent in April, which is the lowest reading since August 2017. A similar University of Michigan survey measure of expected inflation in five to 10 years also fell in April to a half-century low. However, the aggressive tariffs if maintained for long can change the inflation dynamics significantly. The U.S. is increasingly slipping into an inflationary environment with tariffs driving up prices. 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.

The U.S. yield curve has inverted and industrial production has weakened further, China’s economy is slowing dramatically and in Europe even the likes of Germany are stagnating. Our world has clearly moved from global synchronization to a global slowdown. If the Fed takes a u-turn in policy as a response to slowing growth or falling asset prices by beginning to cut rates or adopt further unconventional measures like QE, it will be perceived by the markets that the central banks are caught in a trap and will not be able to normalize monetary policy. This will be a big boost for gold prices.  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 the probability of the Fed to move quickly towards lowering rates to the zero bound and other unconventional tools used on first signs of recession in the United States. Such ill-conceived policy making can be another positive trigger for gold.

Central banks have tried to get out of this low-interest-rate trap but they aren’t able to. The market is addicted to cheap liquidity and doesn’t look like that is going to change anytime soon. The world continues to remain in state of great disequilibrium, both with respect to the global economy and geopolitics as well. Given the macroeconomic picture, gold will be a useful portfolio diversification tool and thereby helping you to reduce overall portfolio risk.

 

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