Gold markets suffered their worst blow in the last three years as prices fell over 8% to $1,173 an ounce, reducing the year-to-date (YTD) increase to just 10.7%. The fallout from the election of Donald Trump, the rising dollar and increased expectations of a US rate rise led to a selloff in gold.
The way the markets have reacted has been completely counter-intuitive following the election results.
Despite the short term adversities, we believe that Trump’s presidency and the resulting policies will be positive for gold in the long run.
Trump’s plan to revive the ailing economy centres around lower taxes, trade re-negotiations, massive infrastructure spending, military spending and deregulation. The markets have taken the view that a Trump presidency will be inflationary. Bonds are selling off, yields are surging higher and the market has stepped up its expectations of Fed tightening.
Outlook for the precious metal
Gold has corrected after the US election due to surging long-term real interest rates. Until we go past the rate hike in December, gold prices are likely to remain under pressure. Post the Fed rate hike, as markets try to ascertain the extent of rate hikes and realise that Fed would stay behind the curve to keep real rates negative for much longer, it should start putting bid under gold prices. Markets were playing the ‘lower for longer’ theme. If yields continue to increase it won’t just be bond prices that will collapse but every asset that has been priced off or the so-called ‘risk free rate of return’ offered by sovereign debt.
The problem is that with such a leveraged economy, elevated asset prices, rising bond yields and the anticipation of further increase in rates may well cause risk premia to rise, i.e., volatility in the market to increase, possibly causing overvalued equity markets to correct. The associated volatility may cause financial conditions to deteriorate as the Fed likes to put it, providing them enough excuse to abandon rate hikes. The anticipation of higher real rates may fizzle out yet again, providing support for the price of gold.
Trump will lead to two things: inflation and geopolitical chaos. Both the outcomes are positive for gold. There will definitely be a premium placed on gold due to this. The Trump policies seem to be extremely inflationary in nature, but are unlikely to deliver long-term sustainable growth. There is a high probability of the US moving towards a stagflation scenario which would be extremely beneficial to gold prices.
The recent fall in gold prices provides an opportunity to build your desired portfolio allocation to the precious metal. Given the macroeconomic picture, gold will be an useful portfolio diversification tool and will thereby help you to reduce overall portfolio risk.
The writer is senior fund manager, Quantum Mutual Fund