The price of the yellow metal gained over 16% this year as widespread financial uncertainty led to a risk-off sentiment in asset markets driving investors to gold
Gold seems to be the biggest beneficiary as the world leans towards negative yields. The price of the metal gained over 16% this year as widespread global financial uncertainty led to a risk-off sentiment in asset markets driving investors to gold.
With the slowdown in Chinese growth, there ran a high degree of speculation surrounding the Chinese currency where many predicted a sizable one-off depreciation in the currency. There were also risks surrounding European credit markets. There also seemed a looming risk of deteriorating geopolitical situation in West Asia. Amid all these ambiguity surrounding the economic landscape and increasing policy consensus of negative yields as a sign of desperation to ignite growth, it was not surprising to see a rush to gold.
Though mixed views surrounding interest rates increases in the US prevail, it is clearly tilting towards a moderation of the tightening cycle. There are optimists who point at rising core inflation and strong job creation data for more rate hikes; may be two rate hikes for 2016. Others cite slowing global growth momentum, rising risk of the US credit-default cycle, and increasing likelihood of a large one-off yuan devaluation that would force the US Fed to relent from tightening.
There has been a clear deceleration of expectations surrounding rate increases in the US markets, which signal just one rate hike this year and the most optimists now expect about two rate hikes at the maximum. This is in stark contrast to Fed expectations for four rate hikes in 2016. Given the Fed communiqué it looks highly probable that the Fed would communicate a reduction in their expectations to may be two rate hikes.
Global central banks have fewer options and have become less potent and effective in their ability to reach their current goals of boosting economic activity and inflation. In a desperate attempt to lift off demand, they have pulled the rabbit from their respective hats in the form of negative rates. With about a quarter of the world economy facing negative rates in some form and growth faltering, negative rates are becoming commonplace. Suppressing interest rates doesn’t work either, because all that happens is demand is made to shift from current to deferred consumption, introducing distortions into the economy that might look like a positive result.
Also, negative interest rates convey to the public that central banks are worried about the economy and thereby make them more reluctant to spend more money. In addition to lowering returns on savings, they will make consumer sentiment worse. People may resort to hoarding cash rather than yielding negative and also to meet any contingencies arising out of the perceived economic uncertainty. This again will neither lift spending nor investments but has a potential to spark a rush to real assets like gold.
Gold has seen a good move up over the last two months. Any improvement in risk sentiment may also reduce flows to gold. Fundamentally, gold seems to be on a solid footing as central bankers have again hit the wall. Gold should benefit as central bankers attempt further measures through newer, unconventional and untested ways to revive growth.
Given the macroeconomic picture, gold will be a useful portfolio diversification tool and help you to reduce overall portfolio risk. We anticipate more buying to emerge on any meaningful pull backs supporting prices. To our investors, we always advocate a 10-20% allocation to gold since it is a great tool for portfolio diversification. It may be a good idea to have this allocation to gold. Investors are requested to consult with their financial advisors.
The writer is senior fund manager, Quantum AMC