ECONOMY Is Gold still a resilient hedge to stem Geopolitical fallout?

ECONOMY Is Gold still a resilient hedge to stem Geopolitical fallout?
Posted by: Iain Fraser - Consultant Editor-at-large
Malaga City (Remote)

I have been monitoring "spot" gold [Pegged: 17 March 2020 at €1331.00 per oz & closing off last Friday - 22nd May 2020 at €1590.71 per oz] -v- "black gold" with the focus on gold price rises, as an observation project to monitor the Geopolitical and Macroeconomic effect of both the Coronavirus and the Saudi-Russia oil price war, which of course hasn't done Russia any favours.

While, of course oil fell completely out of bed as a result of these joint-factors, traders generally believe the worst is over, but no one is rising above the parapet (that I can find) to predict when global demand for oil will recover to pre-pandemic levels, or as one trader told me "if it ever does".

Even ultra blue-chip Shells´, head honcho, Ben van Beurden has called the scenario a "crisis of uncertainty" at the same time slashing it´s investor dividends for the first time since the second World war.

Historically, as crude oil prices fall, inflation falls. Gold is usually known as a good hedge against rising inflation and gold usually only increases when inflation rises. Gold and crude oil are further related in that a rise in the price of oil dampens economic growth due to its excessive industrial use.

High oil prices increase the costs of making and transporting goods, driving consumer prices higher. Holding gold is one way of protecting against inflation. So higher oil prices, often the result of Geopolitical instability, will frequently lead to a similar rise in gold. 

Similarly, gold and interest rates traditionally have a negative correlation. Although its not always the case, in general the gold price goes up when interest rates go down, and obviously vice-versa. This is because rising interest rates make stocks, government bonds and other investments more attractive to investors.

Global interest rates are at an all time low. For example the global outbreak of coronavirus has forced the UK Government to take drastic steps to stem the economic downturn by slashing the base rate for the second time in a single month from 0.25% to 0.1% warning that the pandemic will result in a "sharp and large" economic shock. This may seem a pitiful return, but regard the Euro-area where today's rate is 0%. Across the pond in the US, the FED (The Federal Reserve Board) has the current base rate at a comparatively attractive 0.25%.

However, these historical generalisms have been totally turned on their head by the Coronavirus pandemic and gold is moving higher as strategic hedging protocols kick-in ahead of equities going the same way as oil, collectively all these factors are breathing new life into gold markets as prices look primed to move significantly higher.

European stock markets fell yesterday [Monday, 4th May 2020] amid continued tensions between the US and China over the COVID-19 pandemic, failing to recognise an ease in lockdown restrictions in both Spain and Italy. Markets on mainland Europe were closed the previous Friday for Labour Day, so there was large scale selling as investors’ played catch up. The CAC 40 was down 4.2% in Paris by mid-afternoon and the DAX was 3.6% lower in Frankfurt. The Euronext 100 was down 4%.

The FTSE 100 had opened down 0.7% in London but was flat by mid-afternoon. The UK market was open last Friday but traders sold off over 2% during that trading session as US President Donald Trump turned up the rhetoric on China.

The increase in Geopolitical risk is the primary catalyst due to renewed US-Sino tension after the White House put China "firmly" in the frame for at best concealing the scale of the outbreak and at worst for being responsible for the alleged leak from a laboratory in Wuhan, the seat of the outbreak. (I had credible intel from a trusted US Intelligence officer affirming this as far back as 15th March 2020.)

On Friday, after a White House press conference, President Trump announced that he had a high degree of confidence that the Covid-19 pandemic originated in a laboratory in Wuhan, while simultaneously threatening additional far reaching tariffs towards China. The renewed focus on China has prompted a flurry of press articles about possible economic retaliation by the US, but the smart money is pointing to tariffs.

Gold is highly sensitive to Geopolitical events, especially as it relates to trade risks, which bolstered gold throughout much of 2019 with bullion prices soaring by 18%.

The short term future for all these indices lays firmly with Trump and the successful development and large-scale production of a vaccine a view shared by the UN and cited as a "unique global public good of the 21st Century". [My latest on vaccine development here] The EU has pledged support for a plan to raise €7.5bn to find a coronavirus vaccine in a jointly signed open letter.

The Brussels-led initiative was set out by current European Commission President Ursula von der Leyen last Friday.[1st May 2020] Italian Prime Minister Giuseppe Conte, French President Emmanuel Macron and German Chancellor Angela Merkel are also among those who have signed up to the initiative.

Post-Brexit, UK Prime Minister Boris Johnson, who himself spent three nights in intensive care with Covid-19, has pledged of €441m for vaccine research, testing and treatment at the same time urging countries to "pull together" to meet "the most urgent shared endeavour of our lifetimes". [More on the vaccine development]

As for Donald Trump, lets be fair, love him or detest him, nobody can second guess him. I just hope that the ensuing countermeasures he deploys against China halt at tariff increases. This is going to be a worrying time for all Geopolitical and Macro-economic indicators - Lets all just hope there will be an economy and jobs to go back to once the pandemic has been arrested.