Amid worsening trade tensions between the US and China, US equity markets continue to remain volatile and risky, which has made investors movie into ‘safe haven’ assets of US treasuries and gold. In this environment, we also believe that an allocation to gold is key. While gold has rallied over the past year, we believe there is room for more. In our view, the 'safe haven' status of gold is not the only driver behind the price appreciation of gold, but there are other factors which can help it grow beyond previous highs.
The state and direction of real rates Real rates have been a contributing factor to the strong performance of the gold price in recent months, with the price of gold and real rates having a relatively strong negative correlation over time. Gold is not a yielding asset, which means that when yields are high there is a significant opportunity cost involved in holding gold. But in a low interest rate environment (like we are in today) the opportunity cost declines significantly. The US Fed plans another rate cut of 25bps and this rate cutting cycle will only add to gold's importance for investors.
The strength or weakness of the US dollar Gold tends to do less well when the US dollar is strong and appreciating but real rate expectations have changed significantly over the course of 2019. We started the year with markets pricing in 75 bps of hikes but have now shifted to about 100 bps of cuts. This should have triggered the US dollar to fall which in return should have helped gold price. However, this did not happen in 2019 and we believe this component will help gold achieve higher highs once it comes into play. The US dollar has remained strong on the back of tightening economic policy and stronger economic growth, but with the economy now moving at stall speed and Feds dovish stance, the US dollar is expected to weaken in 2020, creating a tailwind for gold.
Overall risk sentiment Lastly, another common driver of gold is sell off of risky assets such high yield credit and equities; but these have performed well in recent months, pricing in dovish monetary policy rather than weak fundamentals. Once these risky assets start to sell off, we believe that gold’s status as a traditional ‘safe haven’ will continue to support the price or even drive it higher.
Investing in gold?
We ask our investors to be careful with the kind of exposure, when allocating to gold. The more aggressive exposure to gold can taken by investing in the equity securities of gold mining firms, which are exposed to the gold price and 'equity market risk'. However, the more defensive approach is to invest in physical gold, where you are not not exposed to equity market risk.
Head of Investment Research