Gold: Geopolitical risks to support gold prices

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on January 1, 2018 - January 07, 2018.
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Gold had a fairly eventful 2017. Gold prices appeared to be on an upward trend, having climbed steadily from about US$1,125/oz at the start of the year to around US$1,275/oz on Dec 22.

But looking back over the past five years, it is still about 30% below the highest price of US$1,751.90/oz achieved in October 2012. This spectacular rise to the peak was helped by investors rushing out of risky financial instruments, as panic from the 2008 global financial crisis spread. Gold was the “go-to” asset class as investors tried to preserve their wealth in any way possible.

Ten years on from the crisis, things are somewhat different. Unprecedented intervention by central banks through quantitative easing, low interest rates and expansionary fiscal policies have helped stabilise the major economies and put them on a better growth footing.

At this juncture, the shine on gold as a safe haven may have dimmed. Nonetheless, the yellow metal continues to attract investors seeking to profit from a potential price appreciation.

 

What’s in store for gold?

If gold closes 2017 at or above US$1,300/oz, we believe it can likely hit US$1,430/oz next year (an upside potential of 10%).

Equities, especially US stocks, have done extremely well, with both the Dow Jones Industrial Average and S&P 500 index continuing to post new highs. The S&P 500 is up about 15% this year (as at November 2017) and some expect it to continue adding gains in the next couple of months.

As equities continue to do well, gold has lost some of its lustre. Gold, which is traditionally considered a good hedge against uncertainties, has not done well in bull markets. If bulls turn into bears in 2018, there is a likelihood of funds moving out of more risky stocks and back into gold, which will support higher prices.

The markets have reacted positively to the appointment of US Federal Reserve chairman Jerome Powell, who replaced Janet Yellen. Powell, who is a Republican and President Donald Trump’s pick, will likely continue the policy of gradual interest-rate hikes and work with the White House on its calls to ease financial regulations.

With US inflation within the target 2% range, the new Fed chairman still faces a delicate balance. If rates rise too fast, he faces the risks of stalling the third-longest US economic expansion and hurting a stock market rally. Tighten too slowly and a hot economy may boost the cost of living, inflate asset bubbles and fuel investor doubts about the US central bank’s inflation-fighting ability.

Gold, as we know, is a good hedge for inflation and prices will likely benefit if the latter scenario prevails next year. As a hedge against any currency weakness and geopolitical risks, gold is the investor’s preferred asset class.

The US dollar is expected to strengthen on the back of the continued strong economic expansion under Trump’s administration. The Senate has passed a proposed budget that will advance the president’s proposed tax cuts, which will likely spur the economy’s growth further.

All this bodes well for the US dollar, but not so for gold, given its historical negative correlation. In 2008, the International Monetary Fund estimated that 40% to 50% of the movements in gold prices since 2002 were US dollar-related. It is found that a 1% change in the US dollar led to more than a 1% change in gold prices.

In terms of geopolitical risks, gold has already benefited greatly, including from the French general election, Brexit negotiations and increasing tensions between the US and North Korea. The rhetoric between Trump and North Korean leader Kim Jong-un saw gold prices soar in July and August 2017 as the threat of war escalated. We expect gold prices will continue to be supported by heightened geopolitical risks in 2018.

Investors seeking to diversify their portfolios after realising gains from their equity (and other risky) investments that have performed well should look at adding some physical gold. The long-term attractiveness of the precious metal as a reliable preserver of wealth and hedge against possible uncertainties has not changed. Instead, the importance of gold, given its safe-haven characteristics, is now more pronounced than ever.

In 2018, as we celebrate 10 years of post-global financial crisis, it is opportune to be reminded that markets, especially equities, work in cycles — what goes up, must eventually come down. And having some gold may just be the right hedge.


Chris Gan is senior vice-president at the Singapore Precious Metals Exchange