Gold set to shine again?
INVESTORS have long held the view that gold is a perennial safe haven investment that performs well in volatile times. It might therefore surprise some to know that the price of gold at the close of 2022 was 7.15 per cent lower year on year – perhaps contrary to what one might expect, given the uncertainties that characterised the year.
However, gold has experienced a rally this year following the banking crisis, with prices rising by 12.4 per cent in March alone. Though the crisis seemed to be under control in April, gold prices continued to climb, growing by 3.54 per cent in the first 20 days of April. Will this trajectory continue? Perhaps so, given the possibility of a weakening US dollar and ongoing geopolitical risks – situations where investors usually turn to gold.
Weakening US dollar
When evaluating whether to invest in gold, it is important to have an eye on the greenback.
A stronger US dollar tends to drive gold prices lower. This could be seen when the Russia-Ukraine conflict escalated, inflation pressures increased and the US Federal Reserve introduced a rate hike of 425 basis points. The US dollar rose as a result and gold prices fell since the series of rate hikes in 2022 began; by the end of 2022, the spot gold price had dipped by 22.99 per cent while the US dollar increased by 4.52 per cent.
The recent banking crisis saw the value of gold surge due to increased fears about financial stability. Looking forward, the markets are expecting a rate cut in the second half of 2023. Referencing the US Fed Fund Futures reading, there is a 71.6 per cent probability that a rate cut will happen by the Federal Open Market Committee meeting on Jun 14, 2023. If interest rates were to come off, this will translate to a weakened US dollar which may trigger a gold rally.
Another issue also poses a threat to the US dollar – a Brazil, Russia, India, China and South Africa (Brics) reserve currency.
Brics nations announced plans to embark on the project last year. It will be based on a basket of currencies that include the renminbi, ruble, rupee, rand and real. Brics countries now account for 40 per cent of the global population and one-third of the world economy in purchasing power parity terms. The emergence of a Brics reserve currency could potentially weaken the US dollar.
In fact, China and Brazil recently struck a deal to conduct trade and financial transactions in renminbi and real directly, instead of using the US dollar as an intermediary. This means a dip in the demand for the US dollar, especially since China is Brazil’s biggest trading partner, engaging in bilateral trade amounting to US$150.5 billion last year.
Stock market uncertainties and potential rise of gold
Within the US, the government has hit its US$31.4 trillion borrowing limit. Yet an ongoing stand-off between the Republican-controlled House of Representatives and Democrats has prevented the lifting of this ceiling.
If no action is taken, this may lead to a debt default – a situation that could shake up the stock market. The track record of note is this: When both parties could not reach an agreement back in 2011, the S&P 500 was sent tumbling by 17 per cent.
In addition, geopolitical risks still abound. For one, the Russia-Ukraine war shows no signs of abating. Then there is the issue of mounting US-China tensions. China’s surge in defence spending to 1.56 trillion yuan (S$301 billion) was the fastest pace of increase in four years, and has stoked fears of the US and China falling into a Thucydides Trap.
It is in such times of uncertainty that gold shines brightest.
In 2020 at the peak of the Covid-19 outbreak, amid fears of an economic downturn, gold prices rose by nearly 30 per cent as investors looked to use it as a hedge against a weakening US dollar.
We have since stepped out of the shadows of Covid-19. But there are other turbulences to grapple with – and it is possible that investors’ eyes will be on the shiny metal once again.
The writer is a trading strategist at OCBC Securities.
