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Below is the views on Gold by Mr. Chirag Mehta, Sr. Fund Manager-Alternative Investments
Gold Monthly View –April 2019
Recent spate of consensus beating economic data in the U.S. along with dollar breaking out to 52 week highs pressured gold prices. Better than expected Chinese export and credit growth were also seen as evidence of recovery against chants of a grim global outlook. Optimism surrounding the U.S – China trade deal not only removed the uncertainty factor but furthered expectations of growth revival as many pundits cite trade wars as the primary reason for slowdown. Despite growth trends and forecasts pointing to a slow down and the resulting central bank dovishness, risk assets continued moving higher and gold continues to trade sluggish. All in all, gold prices ended the month at $1,283.5 an ounce, a decline of -0.7%. This third consecutive monthly loss brings gold at par to trade where it started the year.
As the US enters late cycle, increasingly data points towards slowing growth but at times tend to depict contradictory readings causing volatility in currency, equity and gold markets. However, it’s too much to read one month’s data to conclude it as a change in trend. For e.g.: U.S. retail sales jumped by 3.6% in March as compared to 2.2% the previous month. However, it pales in comparison to the 6.6% seen in July of last year. Although, Jobs data sprang back to the positive, wage data displayed a downtick. Orders placed with U.S. factories for business equipment fell in February for the third time in four months. U.S GDP expanded at a 3.2% annualized rate for the first quarter, higher than all forecasts in a Bloomberg survey calling for a 2.3% increase. At the same time, the increase reflected a boost from inventories and trade; volatile components that may soon weigh on growth. The U.S. economy’s first quarter is looking a lot rosier than a few weeks ago, but the factors supporting that growth may be more momentary rather than a sign of sustained momentum.
Powell Fed made it clear that they believe that the weakness of core inflation is transient and therefore not something that warrants a policy response. There by reiterating that the US monetary policy will be on hold for a protracted period. If the fall in core inflation is transient and growth is good and if the financial markets behave, there is no reason for the Fed to cut rates. Equally a rate increase is a distant prospect. This Fed dovishness with an accommodative bias is a significant U-turn which should be positive for gold but is currently supportive of the froth in stock markets, restricting flows to gold in the short term.
Federal Reserve officials are of the view that there are high hurdles to raising rates, while inflation continues to undershoot their target and risks abound. Fed is of the view that inflation is possibly being dragged down by “transitory” forces like portfolio management services, apparel prices, and airfares. It is hard to see the Fed lowering rates without signs of a more severe deterioration in economic indicators or a precipitous drop in inflation expectations. However, looking closely, the latest inflation decline appears to be more broad-based. Important component of the inflation jigsaw, services inflation is looking depressed by the slowdown in unit labor cost growth. Inflation has undershot Fed target for a significantly long time now. Sooner rather than later, if it further continues to remain low, Fed officials will eventually be forced to admit it is more persistent and rate cuts would likely be their first choice of action. Rightly so, sharp and ongoing decline in core inflation is what has driven markets to attach such a large probability to rates being cut this year which currently stands at 53% by the end of 2019.
The U.S economic momentum earlier fueled by stimulus, tax cuts and cheap liquidity is clearly facing headwinds. The U.S. economy isn't doing great but that has not stopped the dollar from gaining value. The market's appetite for U.S. dollars is driven by a few factors, mainly its relative performance of the economy, equity markets, bond yields but most importantly, growth abroad. While U.S. interest rates are falling, the real yield differential moved in favor of the dollar because the economic outlook for the rest of the world is even worse. Buoyant U.S equity markets has been attracting significant flows, thereby further supporting the dollar. With rate hikes of the table, the slowdown in earnings growth may soon start reflecting in equity markets, alleviating another support for the dollar.
If the Fed takes a u-turn in policy as a response to slowing growth, lower inflation or falling asset prices by beginning to cut rates or adopt further unconventional measures like QE, it will be perceived by the markets that the central banks are caught in a trap and will not be able to normalize monetary policy. This will be a big boost for gold prices. It is important to note the academic discussions at the Fed are in agreement of further unorthodox monetary policy which implies use of more unconventional tools like monetary easing (money printing) and even negative interest rates. This significantly increases the probability of the Fed to move quickly towards lowering rates to the zero bound and other unconventional tools used on first signs of recession in the United States. Such ill-conceived policy making can be a positive trigger for gold.
In line with the comments from leaders of the two nations, the US –China trade deal seems a given and to a large extent is already priced in by the markets. However, that doesn’t mark an end to Trump trade wars. While one seems settling, other is brewing. EU said it’s preparing retaliatory tariffs against the U.S. over subsidies to Boeing Co., significantly escalating transatlantic trade tensions. The threat of new European retaliatory tariffs comes hours after Washington vowed to hit the EU with duties over its support for Airbus. While Trump threatens tariffs on various EU products including the probability of it extended to car and car part imports which could be a big blow for Europe. An intensification of the EU-U.S. trade war could soon be impacting global markets.
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 doesn’t look like that is 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 helping you to reduce overall portfolio risk.
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