The year 2018 started with positive sentiment with global investor wealth at a little more than $87 trillion at end January, 2018, and even gold prices were trading firm.
By- Prof. Arvind Sahay, and Sudheesh Nambiath
The year 2018 started with positive sentiment with global investor wealth at a little more than $87 trillion at end January, 2018, and even gold prices were trading firm. However, over the year equity investors globally have lost approximately $15 trillion from that peak. As the year has eroded this magnitude of paper wealth, investors have started to explore other assets. The Citi Macro Risk Index which measures the risk aversion is at 0.85 showing the level of risk aversion is above the average level of 0.5 (measured between zero to one). Last time it was these levels in 2015 and 2008, although it touched peak at 2011.
The year-to-date returns of global equity benchmarks on currency adjusted basis have turned to be deep in red across majority of the countries due to a combination of geo-political, economic and technological transformation reasons. Geopolitically there is increased uncertainty about the unpredictability of American policy, the uncertainty of what will happen with Brexit, and the Indian elections coming up in H1 of 2019, which is now going to be a lot closer than earlier thought.
Economically, there are very large problems in Argentina, Venezuela and Turkey, and managed funds are pulling funds out from emerging and developing countries on account of increase in interest rates by US Fed. There are concerns about debt becoming unsustainable in China. During this time, the Fed had increased rates for four consecutive session in 2018, making it the ninth rate rise since the Fed began to reverse from its near zero interest rate policy.
The Dow Jones Transportation index, considered a barometer of economic activity, has fallen by 14% during 2018; the Baltic Dry Index, on the other hand, is at 1000 in December 2018, about the same that it was in January 2018 – this is would mean that world merchandise trade is in good nick – despite the rhetoric of trade wars between China and the US.
The PE ratio of S&P 500 has drifted to long term average. However, there is a note of caution; Schiler’s Cyclically Adjusted PE ratio (inflation adjusted) has started showing descent recently indicating that it may be safe to view this as a mean reversion and could see diversion of funds back to equity from cash or safe haven assets.
So where does this put gold on the horizon of investors and bankers? Some Central Banks have been increasing their holding of gold – primarily Russia and China – but also the ECB and the Reserve Bank of India. Demand from China and India continues to be strong. Gold has given positive returns on a non-dollar denominated currency, evidently due to currency depreciation although in dollar terms it has declined approximately 2%.
While the world witnessed a rout in global equity markets, gold ETF investment hit a five-year high in May, but then declined steadily till early October. Similarly, Managed money positions in Comex noticed net short position build toward last week of September as price declined. Nevertheless, post that there has been addition to ETFs and physical gold prices have recovered from the bottom by nearly $100 as we write this at the end of 2018.
The risks going to next year we think are more controlled and we don’t fear the R word. As the stimulus to the US economy from the tax cuts peters out and the effects of raised tariffs start to kick in, in the US, growth in the US will slow. China is also slowing with fears of a negative fallouts of the very large debt positions. How US Fed reacts to the situation of an inverted yield curve as noticed since last five trading days, indicating Fed may be dovish going to 2019, another reason we think President Trump may not fire the Fed Chairman. That said, the difference between one year and 3 year treasury yield is something to watch for. This would mean dollar could be turning lower and drive gold prices higher.
Within India, with the general elections coming and that seems to be indicating no full majority for the ruling party, uncertainty will rise. Assuming customs duty remains same and the rupee remains in the range of Rs. 70 to 75 per US dollar, we think that gold price in India would be in range of Rs. 30,400 to Rs. 34,900/- for 2019. If customs duty were to drop to a range that makes smuggling uneconomic, we think, then that the prices of gold would likely be more subdued.
(This article is authored by Prof. Arvind Sahay, IIMA and Sudheesh Nambiath, India Gold Policy Centre at IIMA. Views expressed in the article are authors’ own)