Gold’s rise since mid-December has coincided with the US dollar’s free-fall that began just after the Fed raised interest rates for the fifth time since December of 2015.
Keeping up with seasonal trends, this January too was positive for gold. The fact that two big gold buyers, India and China, got involved during the period brings in the positive bias. India loads up in preparation of the wedding season and China readies for the Lunar New Year.
From an economic perspective, gold’s rise since mid-December has coincided with the US dollar’s free-fall that began just after the Fed raised interest rates for the fifth time since December of 2015. However, stronger than expected job data accompanied by hawkish Fed rhetoric took some sheen off gold. All in all, gold managed a close at $1,345.15 an ounce clocking gains of 3.2% for the month.
The Fed, basically guaranteeing another rate-hike at the upcoming March meeting, was unable to bring any meaningful gains in the dollar. This is most probably because markets are currently pricing in the same three rate hikes this year that the Fed has forecast and expectations from a tighter monetary policy from the European Central Bank (ECB) adds the pressure on the dollar.
While it may be that the ECB reduces its monthly asset purchases in the months ahead, the fact that ECB president Mario Draghi recently made it clear that he does not expect ECB interest rates to rise this year suggests that the dollar should not weaken too much further against the Euro.
Although the US government shutdown was in a way averted by another stopgap measure, it helped gold prices as the drama unfolded. It’s far from over yet. How the current administration, as well as the House and Senate, deal with funding the government will absolutely affect the financial markets.
US Fed rate hike
The Fed’s balance sheet reduction rises to $50 billion per month by October. The Fed’s dot-plot predicts three more rate hikes this year and the ECB has halved its quantitative easing (QE) programme and is predicted to completely finish printing money by the end of this year. Exploding debt and the reversal of central bank support for bonds should cause rates to spike. The impact of less money will be felt over time by the markets until the euphoria on tax cut optimism, liquidity and higher asset prices comes to an end this year. The recent correction in risk assets seems to be an early indication of just that.
Investors will do well to remember that, so far, the Fed has been behind the curve and only delivered when markets brought it on a silver platter. Since the normalisation of monetary policy hasn’t yet progressed sufficiently, renewed stimulus measures would probably shake market confidence in the efficacy and sustainability of the unconventional monetary experiments applied to date.
The world continues to remain in a state of great disequilibrium, with respect to the global economy and geopolitics. The fallout of geopolitics globally seems to now cap the downsides in gold. Given the macroeconomic picture, gold will be a useful portfolio diversification tool, thereby helping you to reduce overall portfolio risk.
The writer is senior fund manager, Alternative Investments, Quantum AMC