We expect gold’s rally to resume after correction. Although there are signs that the coronavirus pandemic is stabilizing, the recovery path of global economy remains thorn and gradual. Central banks around the world will have to maintain expansionary monetary policy, pressing interest rates to zero, if not negative. Meanwhile, renewed tensions between the US and China are adding uncertainty to global growth, making gold’s safe haven status more attractive.
Gold is famous for its safe haven status. Contributing to this role are the yellow metal’s historical role as currency, its negative or zero correlation with traditional assets, and the ability to hedge against both inflation and deflation, maintaining the value holders’ wealth. There is no doubt that gold price has increased sharply over the past few months, as the coronavirus pandemic has hit the global economy, raising the uncertainty of the recovery path and causing central banks worldwide to inject massive liquidity to the markets.
Global Low Yield Environment
The exceptionally low yield environment bodes well for gold. In March, major central banks acted aggressively by cutting the policy rates to record low levels. They also resumed, or embarked, QE, pledging the buy assets in order to bring market rates to also most 0%. This supported gold, sending the yellow metal to a record high of US$1775/oz on April 14. After a month’s correction, gold’s momentum return. Despite reluctance to adopt negative rates, Fed chair Jerome Powell’s dovish comments before the Congress on May 18 lifted gold to US$1771/oz, just a few points shy of the record high, again. Powell indicated that the recovery may not begin until the end of 2021 and pledged to use a “full range of tools to support the economy”.
We expect recent rally to resume again after correction. The following chart shows the strong negative correlation between gold price and Treasury yield. Although the Fed has ruled out negative rate, the market continues to price in lower Fed funds rate from now. The 30-day Fed funds futures show that the implied policy rate will fall to 0% by February 2021, from this month’s 0.05%. After the QE infinity announcement in March, Fed’s balance sheet has been increased, by US$ 2.46 trillion, to US$ 6.92 trillion. Although the pace decelerated over the past months, there are signs that the Fed is picking up purchases last week. We expect Fed’s purchases will accelerate if economic data suggests that recovery thorny. This should pressure Treasury yield and support gold.
Geopolitical unrest are another driver for gold. Hong Kong has become the latest battle fleld of US-China tensions. US Secretary of State Mike Pompeo has reported to the Congress that the city is no longer enjoys a high degree of autonomy from China. This could result in revoking Hong Kong’s special trading status with the US and put at risk the city’s status as an international financial hub. Earlier this week, President Donald Trump suggested that some powerful measures will be announced later this week in response to China’s proposed imposition of national security law in Hong Kong. Trump’s economic adviser, Larry Kudlow, has also proposed to offer full expensing and to past the cost if American firms relocate supply chains and production plants from Hong Kong or China to to the US.