Gold Shines on Global Trade War Jitters, Less Hawkish Fed

Gold prices are currently reigning at 5-week highs as a “less hawkish” Fed stance and looming threat of a trade war between the United States and China weighed on the dollar and equities. Lured by the safe haven appeal of gold, investors scurried to the yellow metal, lending support to gold prices.

Spot gold was at $1,355.16 per ounce on Mar 26, achieving its highest since mid-Feb. This further builds on the 2.6% gain noted last week — its biggest weekly gain since September 2017. Given the momentum, gold seems not far from breaching its 2018 high of $1,366 an ounce achieved on Jan 25. Let’s have a look at what fueled the rally and where prices are headed.

Fed Chair Jerome Powell commenced his stewardship of the U.S. Federal Reserve by increasing the federal funds rate by 0.25 percentage point to 1.50-1.75% citing a brighter economic outlook. This is the sixth rate hike time since the cycle of raising rates began in December 2015.

For 2018, the Fed maintained the number of expected rate hikes at three, sticking to a gradual path of increases. However, the Fed stated that it favors a faster pace of rate hikes for 2019 — of at least three instead of two. Further, the speculation of four hikes this year led to a plunge in dollar and subsequently provided a lift to gold prices.

The Fed also raised the GDP projection for 2018 to 2.7% from the prior 2.5%. For 2019, the forecast is at 2.4%, up from the prior 2.1%. However, growth is likely to slow down thereafter in 2020 to 2%. The Fed projected the longer-run growth measure at 1.8%. Inflation expectation remains the same at 1.9% for 2018 and 2% for 2019 but was raised to 2.1% from 2.0% for 2020.

A rate hike could erode gold’s appeal as an investment option. Higher interest rates push up bond yields and tend to strengthen the dollar, so a slower pace of increases to interest rates is good for gold prices.

Gold has long helped preserve and grow capital in times of rising inflation. If the Fed proceeds on a tighter monetary path in case of higher inflation, inflation could encourage investment in gold as an inflation hedge.

Protecting U.S. manufacturing from imports was among Trump’s key campaign promises. On these lines, the Trump administration has slapped a 25% tariff on steel imports and a 10% tariff on aluminum imports following the U.S. Department of Commerce’s investigations under Section 232 of the Trade Expansion Act of 1962. The reports concluded that the quantities of steel and aluminum imports “threaten to impair the national security,” as defined by Section 232.

The imposition of tariff is a major move to protect the long-struggling U.S. steel and aluminum industries and safeguard American jobs. Canada and Mexico — two major sources of steel imports to the United States — were exempted from the tariff orders. The Trump administration later added that it would temporarily exempt more countries from steel and aluminum tariffs, which includes the European Union, Argentina, Australia, Brazil, Canada, Mexico and South Korea, many of which have been in talks with the United States to win an exemption. However, the administration may impose import quotas on these countries to protect the domestic industries.

China had earlier warned that it is ready to take an "appropriate and necessary response" in case of a trade war with the United States. Last week, Trump signed a memorandum that could impose tariffs on up to $60 billion of Chinese imports. Reportedly, China plans to levy retaliatory tariffs on up to $3 billion of U.S. imports.

Other countries are also closely monitoring the situation between these two countries, and might also think about retaliating. Consequently, fears of an impending trade war have gripped the equity market, weakened the dollar but worked in favor of gold.

Another development that rattled global markets was Trump’s appointment of John Bolton, who is considered a foreign policy “hawk”, as National Security Advisor. Bolton had previously advocated using military force against both North Korea and Iran. Bolton’s appointment sends a major signal that the United States will take a more aggressive stand towards adversaries. This enhances the risk of the United States getting into another devastating war.

The increasing geopolitical tensions add to the investors uncertainty while gold is sought as a store of value in these times. This provides a boost to gold prices.

The developments over the past month led to shares of NovaGold Resources Inc. NG, Harmony Gold Mining Company Limited HMY, Kinross Gold Corporation KGC and Goldcorp Inc. GG rise 15%, 16%, 11% and 10%, respectively. While NovaGold currently sports a Zacks Rank #2 (Buy), Harmony Gold, Kinross Gold and Goldcorp each carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The gold mining industry has advanced 6.3% compared with the S&P 500’s dip of 2.1% in a month’s time. Going by the EV/EBITDA multiple (a preferred valuation metric for mining companies that have high capital expenditures), the gold mining industry has a trailing 12-month EV/EBITDA multiple of 8.13, much lower than the S&P 500’s EV/EBITDA multiple of 11.3. The industry’s lower-than-market positioning calls for some more upside in the quarters ahead.

All these recent developments and resultant uncertainty will continue to fuel gold prices as investors will shun risk assets such as equities and instead turn to gold. There are also plenty of reasons to be optimistic about gold’s performance in 2018. A number of new mines entered production in fourth-quarter 2017, which might support mine production till 2018. On the demand side, major markets, India and its neighbor China will continue to be growth drivers.

Last year, the Indian market had suffered a setback due to the impact of imposition of Good and Service Tax (“GST”) and anti-money laundering legislation (“AML”) around jewelry retail transactions. We expect it to bounce back as the market adapts to GST. Pent-up demand as well as festive buying is anticipated to boost demand for jewelry in the country. Moreover, government measures like mandatory hallmarking in 2018 is likely to be a positive for the industry. Further, the United States continues to be a strong market driven by economic growth, improving employment levels and growth in consumer confidence.

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