Below is the Views On Gold by Chirag Mehta, Sr Fund Manager, Alternative Investments, Quantum Mutual Fund
Following the remarkable rally over the last few months, it’s time for gold to take a breather. Optimism surrounding easing trade tensions, strength in the dollar and seemingly less accommodative US central bank added to pressurize gold. Deteriorating economic data, ECB cutting rates to further negative and announcing a return of QE supported gold but not enough to drive it into positive territory. The leading economic indicators globally are showcasing economic deterioration. European central bank has thrown in the towel whereas US is still in denial mode despite mounting evidence of economic malaise. Despite what they say, their rate cut actions speak much more than their “all is well” rhetoric. The month ended with gold prices falling below the $1500 an ounce levels, marking a decline of -3.2% for the month. Gold still retains gains of +14.8% for the year.
The Federal Reserve delivered a widely expected interest rate cut; they showed little appetite for further moves. ISM index (manufacturing) data in the US contracted from 49.1 in August versus 47.8 in September. This lifted the odds of a FED rate cut in October from 45% to 70% despite Fed’s dismissal of further rate cuts this year. The outlook for inflation stayed as before, which means that the FOMC does not see disinflationary risks but believes that inflation will reach the target in 2021. If this is the case, there is no rationale for further interest rate cuts and that is how they justify their stance. As a result, the dollar looks much more attractive given all the economic weaknesses and geopolitical issues; the best place for income in the developed world is still the U.S.
Despite Powell’s claims that the recent cuts are just an adjustment, the pace of economic deterioration suggests the possibility of a more aggressive posture going forward. Last month, the New York Fed had to intervene with an emergency injection of more than $125 billion to end a liquidity squeeze in the money market. It may be just an aberration, but such instances in the past have at times have magnified into much bigger problems for the financial markets.
Manufacturing activity in the Eurozone contracted more sharply in September, posting its worst reading in nearly seven years. Faced with slow inflation and bleak growth, the ECB eased again, delivering a fresh stimulus package. The ECB cut its deposit rate by 10 basis points from -0.40 to -0.50; yes you read it right. The subzero madness has deepened in the Eurozone. Importantly, the central bank announced that the ultralow interest rates would remain until inflation reaches the target. Also, The ECB will restart its quantitative easing in November. The bank will be purchasing €20 billion of assets monthly: the program is open-ended, tying Lagarde’s hands who will soon replace Draghi. He not only promised to do ‘whatever it takes’, but also ‘as long as it takes’.
Factory activity in Germany shrank at the fastest pace in a decade in September. Similar data for France and the euro area fell short of estimates, while in the U.S. a gauge of employment in U.S. service industries pointed to job losses for the first time in almost a decade. The future uncertainty and economic weakness will result in further reduction in interest rate. As nominal yields fall with every Fed cut, real rates will move and stay in negative territory; raising the appeal of holding gold given economic uncertainty.
In recent years, central banks have deployed nearly everything in their arsenal, including zero and negative interest rates and quantitative easing. Given the macroeconomic backdrop, brace for further aggression on rate cuts and quantitative easing measures. As these unconventional measures run its course, the last stage could very well be extreme currency debasement. For that to happen, rates would need to be taken deeper and deeper into negative territory as economies compete for the weakest currency.
There is calm on the trade war front as U.S and China comeback on the negotiating table. Given its just about one year for U.S elections, Trump will want to showcase he is in control and declare some victory. Despite the near term work arounds, trade wars are far from over. 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. In the near term, any respite on the trade war front will reduce the pressure on central banks to act fast and this could cause some pull back in gold. However, over the long term, the clash for supremacy enacted through trade war will continue to add fuel to gold.
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.
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