Now could be a good time to back gold, according to analysts at Smith & Williamson, as they believe the yellow metal could regain its safe haven status in the coming weeks.
Recent years have proved to be challenging ones for gold. FE Analytics shows that that S&P GSCI Gold Spot index has made just 14.25 per cent over the past years, in sterling terms, compared with a 25.01 per cent rise in the US dollar.
Ani Markova, lead manager of the Smith & Williamson Global Gold and Resources fund, conceded that gold has lost out to the rallying dollar in recent months but argued that a number of factors could lead to a weaker greenback and put bullion back on top over the weeks ahead.
Performance of gold vs dollar over 5yrs
Source: FE Analytics
“Down more than 10 per cent since peaking in April, gold continues to face a number of challenges and has not benefited – as would normally be expected – from the escalation in global trade tensions of the past few months and economic sanctions imposed by the US on Turkey, Iran, North Korea and Russia,” she said.
“In part, this stems from a growing confidence in the US economy, which has bred a certain degree of complacency towards these apparent geopolitical risks. The recent weakness in gold primarily boils down to expectations of higher interest rates in the US and strength in the US dollar.”
The Federal Reserve has continued with its plan to gradually increase interest rates, enacting a 25 basis point hike – which was the third of 2018 – at its monetary policy meeting in September. The central bank is expected to raise rates once more in 2018, three times in 2019 and once in 2020.
This tighter monetary policy path has weighed on the price of gold, given the well-established negative correlation between real interest rates and the metal.
Meanwhile, the dollar continues to perform well thanks to the Fed’s tighter stance and a flight to safety trade connected with the Trump administration’s programme to push its ‘America First’ agenda with the country’s major trading partners.
“This has contributed to the growing negative sentiment in gold with perhaps the most crowded trade this summer being long the US dollar and short commodities and US treasury bonds,” Markova said.
“Speculators have now gone to extreme short positions in gold, with total short positions reaching all-time highs and net positioning turning negative for the first time since December 2001.”
Gold net non-commercial futures positions and non-commercial short futures
Source: Bloomberg (CEI1GNCN Index and CEI1GNCS Index), as at 13 Sep 2018
While this ‘crowded trade’ could have further to run given the current macro environment, the fund manager argued that there are three reasons why the dollar could weaken and gold could rally in the short-term.
First up is the historical tendency for US dollar bull markets tend to last no longer than six-to-seven years. If the current bull run were to continue from here, it would soon enter an “unprecedented” eighth year.
Secondly, there has been a historically broad relationship between twin US deficits – a simultaneous budget and trade shortfall – and the value of the dollar, the manager noted.
“The US twin deficit currently sits at 6 per cent of US GDP and is expected to widen to over 9 per cent of US GDP in 2019, according to IMF forecasts,” she said.
“Given that it usually takes a weaker currency to make exports more attractive and improve trade deficit conditions, this deterioration of the US twin deficit could lead to a devaluation of the US dollar.”
Markova’s final reason to expect a rallying gold price is that the economic divergence between the US and other countries that has been in play since late 2017 has started to erode.
She explained: “This is highlighted by the spread of the Citi Economic Surprise index of the US versus the G10, which has recently closed and moved to the downside, indicating that economic releases in the US have surprised more to the downside relative to major economies.
“This underperformance can be expected to place additional pressure on the US dollar if the spread continues to widen to the downside.”
Spread between the US and G10 economic surprise indices have turned
Source: Bloomberg, Citi Economic Surprise Index, as at 13 Sep 2018
The manager also highlighted some other factors that could lead to gold outperforming the dollar.
US president Donald Trump recently said that the dollar was “too strong” and offered up criticism of the Fed’s pace of monetary tightening. While unlikely, these comments could lead to the US bringing in a more interventionist currency policy.
In addition, the US mid-term elections are another potential catalyst for gold prices to rally higher – especially if it leads to increased market volatility – while seasonal events such as the Indian wedding season have often led to a higher gold price.
“Ultimately, gold remains an important tool for currency hedging, portfolio diversification and wealth preservation in the current environment,” Markova concluded.
“In the near term, we believe prices could rise based on the potential for short covering but a more sustained recovery will still depend largely on the US dollar weakening, a slowdown in both US and global growth and a subsequent increase in market volatility in the weeks ahead.
“With the S&P 500 index now in its final innings of the longest bull market in history, it is not a matter of ‘if’ but ‘when’ the market will roll over – this is when we expect gold to start to shine again and outperform the US dollar.”