Staying true to the September effect (historically weak stock market returns in the month of September), global asset prices corrected in September driven by risk aversion and a strengthening US dollar. As the pandemic and geo-political tensions cast a shadow on global economic recovery, investors got nervous and we saw a sell-off in assets, including gold. Gold prices ended the month 4% lower at levels of $1885/ounce. This seems to be similar to what happened in March when gold temporarily moved in line with equities, as investors tried to sell what is liquid and profitable.
Gold is down ~9% from its August highs. Skeptics may be talking about an end of the bull market. But we believe this is a temporary corrective phase. That’s because the factors of ultra-low interest rates, soaring deficits & debts, rising inflation and debasement of dollar that caused the bull market in gold, are very much intact. In fact, they are expected to stay that way for the next few years. Gold is a form of money with potential to store value over long time periods. It has a general tendency to appreciate in times of negative interest rates or when there is a loss of confidence in the economy and monetary system. These traits will continue to make gold a preferred portfolio asset.
As such, gold investors with medium to long-term horizons can be ensured that gold will continue to play a risk-reducing, return-enhancing role for their portfolio.
In the short term however, as uncertainty persists in the global markets, gold too could witness some volatility. But here’s why it is important to view this volatility as an opportunity, not as a risk.
As stimulus weakens, stock markets start to reflect reality
Investors may be glad to say goodbye to choppy September markets, but October may be no better.
Optimism about a quick economic recovery and expectations of more fiscal stimulus, seem to have reduced. There is a good possibility that markets incorrectly interpreted a bounce from the bottom as a V-shaped recovery. Latest economic data suggests that the greatest benefits of the rebound may be behind us. As per September PMI data, business activity in the UK fell to 55.7, from a 72-month high of 59.1 in August. Gauges of activity in the US and Europe too showed signs of easing. Retail sales in the Euro area and US are on the decline following big gains in May and June when lockdowns were eased. Job-loss numbers are better than they were at the beginning of the pandemic, but still far above levels seen in any economic crisis since the Great Depression. Throwing some light on the extent of economic damage caused by the pandemic, the World Bank’s chief economist Carmen Reinhart has said that a full recovery will take as much as five years.
Hopes of another round of stimulus by the US government are fading now as attention seems to have moved to the elections and away from the economy. Without additional spending from the government, there are growing worries the economic recovery will slow down. Many of the stimulus programs have expired, hurting consumer spending.
Infections seem to be rising again in Europe and continue to be strong in the US and India. As long as cases keep growing, restrictions will not be completely reversed. Such uncertainty hurts spending and hits confidence. This will mean slower economic recovery.
Financial markets are unlikely to stabilize until a vaccine is developed. Most vaccines, in the final stages of clinical trials, are expected to be publicly available only by mid-2021.
With all the above forces influencing equities, gold will prove to be an attractive portfolio diversifier. Investors will continue to seek the stability of the asset in the uncertainty.
Recent dollar strength seems temporary
Till a few weeks ago, there wasn’t much talk about a dollar turn around, given that the US central bank is expected to continue its accommodative policy for years to come. But the dollar tends to strengthen during periods of risk aversion and stock market volatility, like the one we are currently witnessing. The dollar has also been gaining as coronavirus cases begin to resurface in the Eurozone. This is raising concerns about what a second wave of infections might mean for the European economy and the Euro, sending investors into the dollar.
It seems that the dollar’s recent advance is only a short-term event in what could be a longer-term downtrend. This is because of the large US fiscal deficit and its debasing effect on the dollar, and negative real yields. Gold will benefit as and when the dollar gets back to its weakening path.
US election turmoil spills onto markets
After suggesting that the election be postponed, as postal voting is prone to fraud, President Donald Trump has now indicated that he might not peacefully transfer power if he loses. If that happens, it could weaken confidence in the quality of political systems in the US. It could also raise questions about the stability of the US government and the dollar.
The political uncertainty after the election will be a bigger risk for equity markets than who actually wins the vote. Investors should be ready for market unrest not just till Election Day, but for weeks after that. This will be a catalyst for gold prices to move up.
Irrespective of who wins, strength in gold prices will continue as the stance of low real rates, further quantitative easing and government stimulus would not change given the state of the global economy is not changing in the foreseeable future.
US-China tensions continue to unsettle investors
US-China relations are moving in a ‘very dangerous direction,’ Antonio Guterres has warned. Clearly the United Nations Secretary General is concerned about what lies ahead, warning of another "Cold War”. Relations between the super economies have soured this year, with the pandemic worsening trade and technology disputes.
With just a month to go until the US election, more attacks on China are expected from President Trump. Effort will be made to divert attention from the United States dealing with the world’s highest number of deaths and infections from the coronavirus, and towards China having “exported” the virus to the rest of the world.
There are concerns that these attacks could turn into a military conflict with bad consequences for the world. This uncertainty continues to impact investor sentiment, making investors seek political risk-free assets like gold.
With a raging pandemic, slow economic recovery, and political worries, investors hoping things might smooth out in the coming days might be in for disappointment.
With the recent fall in prices, gold’s risk-reward offer now looks even better. It is indeed a smart time to actually be buying the metal, not avoiding it. We suggest that investors use this correction to build their allocation to this monetary asset that has given near 25% returns in 2020. Because the macroeconomic realities facing the world today are going to ensure that gold will remain a preferred strategic asset now and for years to come.
Source: Bloomberg, World Gold Council
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