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Gold - No revival of the rally

Carsten Menke/Industry Insight/Dubai
Filed on May 24, 2021
Gold market investors were generally eager to leave the crisis behind and parted with some of their positions after it became clear that there would be no revival of the summer record-run. — File photo

Gold is much more sought after as a safe haven if the economic backdrop darkens. In contrast, safe-haven seekers tend to sell part of their positions if the backdrop brightens up


After briefly dropping below $1,700 per ounce in early April, gold prices were able to recover lost ground more recently. The latest leg of this recovery seems to have been triggered by the US Federal Reserve. At its meeting at the end of April, Jerome Powell, the Federal Reserve‘s chairman, reiterated the central bank‘s commitment to low interest rates and an expansionary monetary pol-icy to support the US economy on its path back to pre corona crisis-levels. Judging by the most re-cent US labour market report for the month of April, which disappointed in terms of job creation and the unemployment rate, such support seems necessary, at least at first sight. A closer look unveils that special factors have been at play, such as generous unemployment benefits, which are keeping people at home. We have the impression that due to the rapid speed of the economic recovery, companies simply struggled to fill open positions on short notice. Accounting for these factors, we are thus of the opinion that the US economy is in a strong state and the outlook very favourable.

How do the US economy and the country’s monetary policy impact the gold market? The US growth outlook in particular and the global growth outlook in general are key in determining the demand for gold as a safe-haven. Gold is much more sought after as a safe haven if the economic backdrop darkens. In contrast, safe-haven seekers tend to sell part of their positions if the backdrop brightens up. This happened last November, after the first positive news around Covid-19 vaccines emerged. Since then, holdings of physically backed gold products, our preferred gauge of safe-haven demand, have declined by more than 10 per cent (380 tonnes). This is a typical reaction if economic and financial market risks recede, in this case related to an even longer-lasting pandemic. It also suggests that gold market investors were generally eager to leave the crisis behind and parted with some of their positions after it became clear that there would be no revival of the summer record-run.

At the same time, the gold market is also influenced by moves in the US dollar and US bond yields. The lower they go, the higher gold typically trades. Between those three factors, the economy, the dollar and the yields, we believe the economy is most important. The impact of the dollar is often overestimated and the yields are, simply speaking, not more than a symptom of how the economy is doing. Hence, in order to revive last year’s rally, the Federal Reserve’s commitment to low in-terest rates and an expansionary monetary policy is not sufficient. It would need to engage in much more aggressive monetary easing which would require a massive deterioration of the economic outlook, which we do not believe is on the horizon.

Instead, we expect a further fading of safe-haven demand over the course of this year as global growth continues to recover. This should more than offset the expected weakness of the US dollar, which in itself is a sign of improving global growth and increasing risk appetite in financial markets. This speaks against assets which benefit from risk aversion, such as gold. How about inflation? There is no need to be afraid. While the inflation issue is gaining prominence at the moment for various reasons, none of these should lastingly lift gold prices. We are still facing good inflation, resulting from the recovery of growth, and not bad inflation, signaling a loss of trust in the world’s major cur-rencies, most notably the US dollar. Only the latter would be bullish for gold, which is why we think that prices will move lower rather than higher over the course of this year.

Carsten Menke is head of Next Generation Research at Swiss Wealth Manager, Julius Baer. Views expressed are his own and do not reflect the newspaper's policy.





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