Original article by Gold.co.uk can be found here
Gold might have had a slow few months but it will bounce back, according to the World Gold Council. The organisation has published its latest review of 2018, looking ahead to the remainder of the year. In it they acknowledge the good Q1 and the bad Q2, highlighting the impact the US Dollar has had on global gold prices between the two quarters and how gold had initially gained 4% in value and since lost 4%.
The US Dollar is on its best run since the last part of 2016. Investors are confident in the Dollar because they are confident in the US economy – especially when the Federal Reserve keep raising interest rates to rein in inflation; a sign of confidence that America can handle the rates because its growth will be constant.
Investment gold is also suffering from investor behaviour. The bull run for the stock markets from New Year until late May has means that investors have a higher threshold before they feel they’re in risk territory. As such, there’s less demand for physical gold, with many preferring to keep backing the high-flying tech stocks in the latest market bubble.
To quote the WGC report: “Gold’s long-term returns are positively linked to economic growth, but its short-term performance is more sensitive to risk and uncertainty”.
The report points out three key areas which will determine gold’s return to the higher prices we saw earlier in 2018, and how these short and long-term factors could play out.
Positive but uneven global economic growth
This year the average global growth is approximately 4%, though many countries (including the likes of the UK and France) are below this while others (China, India etc) are above. The nations with strong growth tend to be the ones driving gold demand as they look to diversify their wealth and savings for protection purposes.
The World Gold Council predicts a rise in demand from these growing nations, especially India, highlighting the harvest and wedding seasons as key windows for gold demand. In comparison, the report suggests continued low demand from Europe due to the uncertainty of Brexit and the impact it is having with regards investor caution across the continent.
Trade wars and their impact on currency
As mentioned previously, the US Dollar is on its best run since the final quarter of 2016. The resurgence of the Dollar has been driven by easy monetary policies elsewhere in the world, as well as the perception that America is in the best position to make gains from the ongoing trade war with China/EU/Canada/Mexico.
Another interest rate rise is likely soon, so the US Dollar should technically carry its strength into Q3, but the fear is that the trade war will eventually slow down the US economy. Less growth will limit demand for gold and drop prices, but equally the weakened Dollar historically softens that drop for Gold and keeps prices quite static.
The Dollar also has another problem: the trade deficit. President Trump wanted to close the deficit (the US imports far more than it exports) and the weak US Dollar helped this. Now the Dollar is strong, meaning imports are cheaper and they are taking demand away from domestic purchasing. Investors don’t like a big trade deficit, nor do they like one that’s widening, because it highlights an economy’s dependency on others. If the deficit continues to grow then investors will lose interest in the US, leading to a devaluation of the Dollar and a steady rise in the gold price.
Interestingly, the WGC report states that gold rises twice as much under a weak Dollar than it falls under a strong one, based on average monthly returns from January 1971 to June 2018. Two steps forwards and one step backwards isn’t exactly a bad situation for gold prices to be in.
Rising inflation and the inverted yield curve
Inflation is bad for currency. It devalues it, so investors use gold as an inflation hedge, i.e. it is protection against the imminent decreased purchasing power of a currency.
The demand for gold as an inflation hedge typically occurs when inflation hits 3% or above. Until this level investors are normally happy to let governments raise interest rates and keep inflation in check but raising rates can become expensive for government debt repayments – which is why the likes of the Bank of England and the Federal Reserve spend a lot of time deliberating about how often and how much to raise rates.
At the moment the EU and China are at 2% average inflation, but the USA is at 2.9% and India is around 5%. The Dollar is keeping prices and demand down, but the inflation levels show that there are markets ready to get on board with gold bullion. The WGC report states that protectionist economic policies (looking after oneself first) look set to drive inflation further. As inflation rises, so do tariffs, and its consumers who will foot the bill.
The other concern for investors and the public alike is the inverted yield curve. This is where the 10-year treasury gilds or bonds are better value for money than the short-term 2-year bonds. Such a switch around is uncommon and indicates uncertainty. In fact, this trend of inversion has actually been a regular precursor of recession, as we discussed in a recent article available here.
In fairness to the US Fed Res, they are boosting the 2-year bonds to try and fix the yield curve but manipulating the trend doesn’t mean that economic slowdown or even recession aren’t going to happen. The silver lining is that investment gold traditionally does well in economic downturns and given the current low price we could see a surge in demand for bargain bullion before the price per ounce jumps back up to peak 2018 levels.
