Gold Golden Long-Term Opportunity / Commodities / Gold & Silver 2019

As global jitters are escalating with economicuncertainty and market volatility, gold looks more attractive. But there’s abig difference between its short- and longer-term prospects.

Those analysts who believe that fear has made a comeback arguethat gold is benefiting as equities slide and investors are increasinglyconcerned about the economic prospects of the U.S., China, Europe and Japan.Yet, even at $1,290, gold still remains more than 30% behind its all-time highof $1,898 in September 2011 amid the U.S. debt-limit crisis.

Although U.S. dollar has not strengthened as much as anticipated,the Fed’s rising rates have contributed to the fall in gold prices. In thisview, a reversal may be unlikely because the investor assumption is that theFed will continue to normalize, though perhaps slower than anticipated.

In the postwar era, such tightening meant a strengthening U.S.economy and a stronger dollar. But at the time, American economy was not hauntedby budget and trade deficits or a debt burden. Today, it suffers from both twindeficits and a massive $22 trillion sovereign debt burden.

In this view, the Fed’s normalization may not herald increasingstability, but contribute to instability and mixed signals in the U.S. economy.In that case, rising international uncertainty and volatility is likely tosupport an upward gold trajectory in the longer term.

Uneasy markets - and gold

Following the burst of the asset bubble in the U.S.(2008), Europe’sdebt crisis (2010) and the U.S. debt-limit crisis (2011), markets plunged andgold soared until it peaked at almost $1,900 in September 2011. In the courseof the past eight years, these fundamentals have not improved.

As central bankers in major advanced economies resorted toultra-low interest rates and rounds of quantitative easing, markets tankedalong with the oil prices, whereas gold soared. That period prevailed as longas central banks pushed cheap money and bought their multibillion dollar assets,while major advanced economies supported their ailing economies with largefiscal stimulus packages. It was great for gold but bad for equities.

The great reversal began with the Fed’s tightening in 2015, whichboosted markets and strengthened the dollar, but penalized gold and oil, whichboth tanked. This phase accelerated significantly even before the Trump era withthe expectation of the new administration’s deregulation, privatization andliberalization. Markets soared, gold lingered.

However, as Trump’s agenda became constrained by the Muellerinvestigation and investors grew concerned about tariff threats that becameeffective last summer, the mood became more volatile and the sentiment moreuncertain. Today, Dow Jones remains more than 13% below its October peak (Figure).

Figure          ThePost-Crisis Decade: Gold and Equities, 2008-Present



Market forces behind upward trajectory

After its all-time high, gold has been seen largely as a weakasset until 2016, when it began to bounce, along with the Fed rate hikes. Whileit has advanced to $1,290, lingering uncertainty has resulted in fluctuations,which have effectively penalized further gains, yet prevented new plunges.

Market consensus tends to offer habitual reasons for gold’s upwardtrajectory. First, market volatility and economic uncertainty are back. EvenTrump’s erratic tweets favor gold as a hedge against volatility, which boostsgold prices. And equity market volatility, as measured by the VIX, has tripledin just two months, after a long period of perceived calm.

Second, when a solid asset loses almost a third of its value, asgold did between 2011 and 2016, it becomes more cost-efficient. Gold’s averagereturn is now more attractive.

Third, there’s the dollar story. Historically, a rapidly-strengtheningdollar, typically boosted by rate hikes, has undermined gold’s gains. However,as the dollar has stabilized since early summer, downward constraints do notwork as much against gold.

Finally, gold tends to be constrained by rising real rates (interestrates minus inflation). Since rising rates raise the opportunity costs of anasset that does not generate income, gold was expected to languish as the Fedwould hike rates. But if real 10-year yields have peaked, as some argue, realrates may no longer pose a critical constraint to gold’s advances.

Secular strength in long-term

In the long-term, the picture may look different, however. It isthe thriving U.S. economy and markets that keeps gold down. But have Americanfundamentals improved since 2011 debt-limit crisis? After all, today U.S.sovereign debt is twice as large as in 2011. And, according to CAPE(cyclically-adjusted PE ratio), equity valuations are almost twice as high asthe historical norm – even amid the government shutdown.

Moreover, U.S. economy is no longer the key driver of globalgrowth prospects; China and other large emerging economies are.

In long term, secular stagnation is set to broaden across themajor advanced economies, which cannot be disguised by hyper-aggressive monetarypolicies, such as ultra-low rates, quantitative easing, or overpriced markets.

That’s one reason why several large emerging economies, whichtoday fuel most of global growth prospects, and major oil exporters, areintrigued by the idea of re-coupling gold with a multilateral currency basketto avoid excessive exposure to U.S. denominated energy and commodity markets.

As China-supported One Belt One Road (OBOR) initiatives advance, U.S.dollar is being effectively sidelined by the yuan and other emerging-countrycurrencies. Moreover, over time the OBOR is also likely to have a substantialimpact on the gold market as it takes place in regions rich in mining resourcesand accounts for a vital share of global gold supply and demand.

Furthermore, there have been interesting shifts in gold reserves. Whileadvanced economies, such as the U.S. and Germany, still own most global goldreserves, the U.S. has increased its gold holdings in the past decade only marginally,while Germany has been forced to cut its reserves. In contrast, China has tripled its reserves, while Russia has nearly quintupled its gold (afterdumping billions of U.S. Treasuries), despite rounds of sanctions.

As some 90 percent of the physical demand for gold comes fromoutside the U.S., mainly from large emerging economies that are also fuelingglobal growth prospects, gold is on the right side of the future.

(Based on an investor briefing on gold prospectsamid new international uncertainty)

Dr Steinbock is thefounder of the Difference Group and has served as the research director at theIndia, China, and America Institute (USA) and a visiting fellow at the ShanghaiInstitutes for International Studies (China) and the EU Center (Singapore). Formore information, see http://www.differencegroup.net/

© 2019 Copyright DanSteinbock- All Rights Reserved

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