All glitters: Gold can help you to reduce overall portfolio risk – here’s how

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New Delhi | Updated: February 8, 2019 7:44:37 AM

The world continues to remain in a state of great disequilibrium, both with respect to the global economy and geopolitics

gold, china, global growth, gold prices, dollar, indian economy, Federal Reserve, GDP, equity marketsGold prices closed the month at 21.21 per troy Oz, up by 3.21% this year and set for a fourth straight monthly gain, while the dollar is down for a third month.

Keeping up with seasonal trends, this January too was positive for gold. It’s usually the physical buying from China and India that drives gold prices. However, this time it was the investment demand that took the lead. Slowdown in global growth, volatility in equity markets, dovish central banks and geopolitical worries have led to increased uncertainty; thereby driving investors to look for diversification that really works.

The Fed pivoting away from its bias toward tighter policy is a complete U-turn from their robust economy rhetoric in October and has really been the trigger for gold to move higher. Gold prices closed the month at $1321.21 per troy Oz, up by 3.21% this year and set for a fourth straight monthly gain, while the dollar is down for a third month.

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Dollar weakness

Recent dollar weakness is a reflection of a shift in market sentiment based upon the Federal Reserve altering to a much more dovish tone over the last month. Market participants believe that the Fed will be much less aggressive in terms of the number of rate hikes initiated this year. Also, there has been talk for the first time about addressing their massive balance sheet liquidation which has been on autopilot since the Federal Reserve shifted their monetary policy to favour normalisation. The lingering US China trade war and the government shutdown were other factors that kept the dollar under check. World leaders at Davos, the IMF and central bank chiefs across the globe are all of a sudden echoing slower growth.

Rate hike by Fed

The Fed raised rates four times in 2018 and is now holding the benchmark interest rate in a range of 2.25 to 2.5%. It was obvious that at some point Powell would have to flinch given some evidence of slowdown as tighter policy starts impacting the economy. In this current rate hiking cycle, the Fed has raised rates nine times but also has already sold off about a half trillion dollars from its balance sheet.

A reduction of this size in the balance sheet, which is a huge liquidity squeeze from the financial system, is something never before done or even attempted. Add to this the fact that total non-financial debt in the US has surged from $33.3T (231% of GDP) at the start of the Great Recession in December of 2007, to $51.3T is creating a huge interest burden in a rising interest rate environment.

There’s increased optimism about some type of agreement on trade between the US and China, and can result in equity markets turning supportive of a rate hike. This removal of lingering trade uncertainty and further tightening could result in some pull back in gold prices. As the Fed continues to tighten in 2019, there is a risk that this could be much more than the economy can handle as the underlying cyclical recovery is largely fueled by stimulus, tax cuts and cheap liquidity. The inverted yield curve will potentially put further brakes on economic expansion and undermine confidence and investments.

The year 2018 was the first time central banks tried to remove some liquidity from the market after a decade of stimulus. Central banks have tried to get out of this low-interest-rate trap but they aren’t able to. The market is addicted to cheap liquidity and this isn’t going to change anytime soon. The world continues to remain in state of great disequilibrium, both with respect to the global economy and geopolitics as well. Given the macroeconomic picture, gold will be a useful portfolio diversification tool and thereby help you to reduce overall portfolio risk.

The writer is senior fund manager, Alternative Investments, Quantum Mutual Fund

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