Gold investors enjoyed huge gains last week after global uncertainty and political turmoil pushed the safe-haven commodity to a nearly 7-year high. In the days since, prices have been sliding from a peak of US$1574.37 an ounce but are yet to fall back below US$1500. This is despite a significant cooling-off of the US-Iranian tension that led to the price hike in the first place, with neither side looking likely to escalate the conflict further in the immediate future.
Gold-tied assets are highly sought-after during the times of uncertainty, as a way to store value that is not intrinsically linked to any particular government or financial system. Though the immediate threat to international peace that the recent conflict posed seems to have abated as quickly as it emerged, a gold bear market is yet to take hold. So, why are investors hanging around?
Gold is a complicated asset with many different factors affecting its value. While there are continuing risks to international confidence that could push more money into gold, there is also the chance that things could move the other way.
Why investors are still attracted to gold
Even though the threat of an Iranian/US war has abated for now, uncertainty remains a threat to international markets for a number of reasons. Britain is set to finally exit the EU this year with an exit deal that is yet to be finalised. For now, international trade remains an unknown for UK businesses and those that export to them. The possible turmoil this exit can create for markets was proven in December, when Boris Johnson passed provisions to allow for a no-deal Brexit; the situation where no new trade agreement with the EU is reached before the old one expires. The move led to a 1% drop in the pound and flow-on disruption to international markets. It is conditions like these in which gold prices thrive.
In the US, the upcoming presidential election has the potential to rock equity markets, a topic that we covered in our look at macro factors that could affect the stock market in 2020. A wide-open Democratic race and volatile opinion polls for incumbent Donald Trump is making things hard to predict. Also, the highly varied policies of candidates are deepening this uncertainty, as businesses and investors remain in the dark about the state of play for 2021.
In spite of these risks, the stock market has remained undaunted, with both the Dow and the ASX hitting new heights this week. This disconnection of optimism in the one market and pessimism in the other is unusual. Normally the stock market and gold would move in opposite directions, as healthy gains in share prices generally undermines the necessity for a safe-haven asset. The gold price remaining so high might suggest that some investors are preparing for the stock market to correct downwards.
Economic fundamentals have not shown significant signs of improvement here or in the US, with last month’s lacklustre jobs report disappointing pundits on Friday, and Australian economic growth statistics continuing to flatline. There are now fears that the bull market is being propped up by speculative investments that could evaporate at any moment. If the market took a significant plunge, gold is likely to soar upwards. Alternatively, if the bull market continues, gold prices are likely to drop in response, being a less attractive investment.
Another reason behind the high prices of gold is the potential weakening of the US dollar expected in 2020. Gold is often used as a store of value during a currency devaluation. Currently, growth outlooks are looking stronger abroad, as the impact of Trump’s tariffs continues to be felt by producers throughout the US. Comparative economic strength in other G20 countries is likely to prompt a weakening US dollar. Slower US growth may also prompt a cut in interest rates by the Fed, which would lower the US dollar as well. The Fed is certainly unlikely to raise interest rates any time soon, after correcting an overenthusiastic rate hike just last year. This search for yield may push investors into other financial systems, lowering demand for the dollar.
Factors that could hurt gold prices
Even though the socio-political factors we’ve already considered could rock global markets, there is also the significant possibility that we will return to a more stable benchmark over 2020.
Though uncertainty regarding Brexit remains high, if a deal is secured and the UK’s exit from the European Union is facilitated relatively smoothly, it should return a level of confidence to a region that has been in flux since 2016. In this instance, gold will no longer be used to hedge against the risk of a no-deal Brexit.
Another factor that has brought gold down from its heady peak of last week is the smoothing of US/China trade relations. Although American businesses are still feeling the pangs of tariff taxation, which is believed to have damaged economic growth and jobs in the country, that could be about to turn around. The countries are expected to sign an early-stage trade deal this week, which will bring a truce to two-years of escalating tariffs that have cost both countries billions. A return to form for the two largest economies in the world is likely to improve confidence globally, a metric that is generally at odds with bullion prices.
Gold is also tied to inflationary expectations. When people expect the value of a currency to be eroded by inflationary pressures, people often turn to gold to store value.
However, considering the tight labour market it’s still a very low figure. Inflation all over the world is at historically low levels. In Australia, the CPI has sat below the RBA’s target range of 2-3% for the better part of five years. This trend of low inflation may turn around in the future, but it’s going to limit the price of gold while it persists.
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