Gold is losing its sparkle, yet the economy cheers

With rising fears about the US-China trade war and an imminent global recession, investors sought safety in assets like precious metals and sovereign bonds to hedge the risk against unfavorable market conditions. Gold prices move inversely with inflation, and bonds are perceived to be a safer bet as the risk of default is lower than equities. In recent months, demand for gold has risen as global outlook looks increasingly pessimistic. That trend, perhaps comfortingly, started to falter last week.

In global markets, spot gold prices fell 0.1 percent to $1,465.97 per ounce, and were poised for their biggest weekly fall of 3 percent since May 2017.  Sovereign bonds plunged around the world. A global bond sell-off last week caused ten-year bond yields in France and Belgium to move above zero for the first time in months. In the US, the benchmark 10-year Treasury yield climbed 12 basis points to 1.94 percent, its highest level in three months.

goldGold prices have fallen by 1.7 percent in a single week as investors eye market conditions more favourably, leading to a fall in demand for the precious commodity. 

Just in September, however, we saw a very different picture. Investors fled the equity markets in droves, withdrawing net £676 million from UK equity funds in what was the worst quarter in history according to the Investment Association, a trade union representing UK Investment Managers.

Just two months later, the picture looks more rosy. JP Morgan Securities decreased its gold hedge because of “signs of a cyclical recovery, easing geopolitical tensions, synchronized monetary easing,” the bank’s asset-allocation team said last Thursday. Citigroup Inc. strategists have abandoned a long position in gold.

As the proverb goes, all that glitters is not gold, so what does the downturn in precious metals mean?

graphGold was at $1,467.27 an ounce as of 10:55 a.m. in Tokyo on Friday last week, having fallen 1.5 percent on Thursday. Silver lost 0.7 percent, extending its 3 percent slide in the prior session.

Signs of a detente in the US-China trade war has contributed to the recent price drop. China and the US have agreed to roll back tariffs on each others’ goods if the first phase of a trade deal is reached between the countries. This trade deal would reduce import costs and therefore boost companies’ earnings and economic growth, and it appears to have encouraged investors to buy riskier investments to reap the rewards of a more positive macroeconomic environment.

However, don’t rejoice just yet as the situation is still precarious. President Donald Trump said the U.S. will increase tariffs on China in case the first step of a broader agreement isn’t reached. “If we don’t make a deal, we’re going to substantially raise those tariffs,” he said on Tuesday in a speech to the Economic Club of New York. 

Despite this, investors are looking on the bright side and hoping for progress on a trade deal. This has dulled the appetite for safer assets like gold and silver, which investors tend to buy in times of economic uncertainty. If reports of a substantial progress in the talks between the world’s two largest economies are true, risk appetite will likely climb, weighing in on safe-haven assets for the future to come.

The drop in popularity of such assets signal better times could be ahead of us. This is because investors’ flight from bonds pushed their prices down and yields up. Price and yield submit to an inverse relationship. This is a far cry from a few months ago, when investors were bracing for a recession brought about the dreaded yield curve inversion that’s preceded almost every economic downturn in the US over the last 60 years.

The theory goes that when it costs more to borrow money in the short term than it does in the long term, the yield curve inverts or slopes downwards. At best, an inversion suggests that investors expect the economy to slow. At worst it signals a recession is coming our way.

worm dance

Almost every inverted yield curve in the last 50 years have preceded a recession. But there are good reasons that this time it might be different. 

The yield curve inversion itself does not directly cause the slowdown. Arguably, a more important story is to look at the effect of monetary policy on both short and long term rates

Short-term bond yields go up when the Federal Reserve raises its interest rate to keep inflationary pressures in check. A drop in long-term yields often occurs when markets expect slower growth ahead. 

 Over the course of 2019, the Fed abandoned plans to keep raising rates (which had been going up since 2015), then cut its policy rate three times, reducing the effective rate from 2.4 percent or so to 1.55 percent. In this way, the central bank may have helped prevent a yield curve inversion by stimulating growth, thus helping the US avoid the dreaded recession. Aiding this optimistic view, consumer consumption is strong across the US complemented by a robust labour market, helping spur economic growth and activity. 

The shift away from gold signals a hungrier economy with a larger appetite for growth. With a healthy upwards sloping yield curve, it signals we can relax our fears – for the time being at least – of an upcoming economic downturn. That could be a cause of cheer leading into the festive season. 

 Written by Alexandra Butterworth

Sources

https://www.bloomberg.com/news/articles/2019-11-07/precious-metals-crushed-as-end-of-the-world-trade-implodes

https://www.livemint.com/market/commodities/gold-silver-today-prices-slump-set-for-biggest-weekly-fall-in-over-two-years-11573182033429.html

https://www.livemint.com/market/commodities/gold-prices-today-fall-to-lowest-in-three-months-silver-rates-slide-11573298021261.html

https://www.finimize.com/wp/news/gold-aint-glittering/

https://www.fxempire.com/forecasts/article/silver-prices-under-pressure-612300

https://www.economist.com/united-states/2019/11/14/americas-yield-curve-is-no-longer-inverted

https://www.nytimes.com/2019/09/04/upshot/recession-not-inevitable-economic-optimism.html

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