Given the global economic headwinds, gold will be a useful portfolio diversification tool for investors.
The growing trade spat between the US and China has pushed the dollar up to an 11-month high and gold to a 6-month low. Two critical factors that have exerted the greatest selling pressure in gold has been the strong US dollar and the Federal Reserve’s current monetary policy of quantitative normalisation resulting in gold trading to the lowest price of 2018.
US-China trade war
It’s been a choppy first half as investors shunned gold and favoured the dollar and US treasuries instead as they weighed the uncertainties surrounding the impact of a US-China trade war on global growth. Trump’s unpredictability surrounding decisions have made investors bet on the dollar for now as opposed to the yellow metal. Gold prices declined by 3.5% in June lowering the year-to-date performance to 3.8%. Markets are currently balancing between stronger dollar prospects and a potential blowup in trade protectionist measures between US-China. The current trade dispute and the proposed implementation of tariffs on both sides indicate that trade policies between both countries probably contain more friction before these two superpowers resolve their issues. Markets, while backing the dollar for the time-being, harbour an inherent belief in Trump to pull it off.
Trump has demonstrated already that he changes his mind very quickly. If trade spat turns worse, one can expect him to take a U-turn. However, any escalation combined with a slide in the dollar could lift gold prices. If we see higher trade tension, it could at some point be positive for gold. It may adversely impact global growth and increase uncertainty, which are normally positive drivers for bullion.
Outlook for the metal
The current dispute between the US and China has been moving towards an all-out trade war. It will be the net effect on the US dollar if and when tariffs begin to be enforced that will indicate the future direction of gold. The question of essence that will shape the outcome is whether this trade agenda is one of Trump’s negotiating tricks or is it an all-out trade war against China trying to undermine its economic agenda and thereby its supremacy which is building fast?
Fed’s balance sheet normalisation would push rates higher and impact its own resolve for rate hike trajectory it envisions as high rates brings in focus the prevailing high debt levels. Absence of global support, turmoil due to trade wars or geopolitical concerns, Fed’s attempt to get ahead of its QE unwind is providing investors with a buying opportunity in gold before adversely impacting market and economy. Downside is limited as the negative fundamentals for the market are mostly already factored into prices.
The world continues to remain in a state of great disequilibrium, both with respect to the global economy and geopolitics. Given the macroeconomic picture, gold will be a useful portfolio diversification tool and thereby help reduce your overall portfolio risk.
The writer is senior fund manager, Alternative Investments, Quantum Mutual Fund