By Dan Steinbock
Until recently, conventional wisdom dictated that the continued recovery of the US economy would support rate hikes, thereby strengthening the US dollar. This would pave the way for a further decline in the value of gold. However, this theory is flawed and does not hold true. In reality, US economic recovery will not retrieve the pre-2008 world, but rather establish stagnation across all major advanced economies. As a result, the Fed’s rate hikes will be lower and will experience longer intervals than anticipated.
While the Fed has begun following a tightening trajectory, the central banks in Europe and Japan have maintained quantitative easing and low-interest rates. Historically, periods of low, if not negative, returns coincide with higher than average returns on gold. However, this is not the case this time.
After months of gain in 2016, the value of gold plummeted to $1,140 in December. Nevertheless, the past quarter has witnessed a new wave of gains, with gold rallying to a five-month high of $1,290.
With rising tensions in Syria, North Korea, and other places, there are new factors driving the value of gold. While the victory of Marine Le Pen is undetermined, the bitter political struggle has left Europe vulnerable to short-term uncertainty. This unpredictability is accentuated by the turmoil within the Italian parliamentary and the upcoming German election. In the USA, relations between Washington and Moscow are now worse than ever, despite Trump’s promise of fixing US-Russia ties. The rise in global jitters has investors scanning traditional havens that are safe from geopolitical risks.
Rising worth of gold
Treasuries have lost their significance with the central banks turning the bond market into a bubble. Gold, an entity both under-represented in most portfolios, and under-valued in current prices, has proved to be a safer bet.
The role of gold is gradually changing in world trade. In March, the Russian central bank opens its first overseas office in Beijing, as a step to foster Sino-Russian monetary cooperation. This move takes place at a time when Moscow is preparing to issue its first federal loan bonds in Chinese renminbi denominations. Russia, the world’s fourth-largest producer of gold after China, Japan, and the USA, may become a major supplier of gold to China.
These developments have raised speculations about the efforts to shift from the US dollar to a gold-backed standard of trade.
Debating the standard of gold
Today, gold is still priced in dollars and thus assessed in relation to the US currency. On the other hand, some 90% of the physical demand for gold comes from outside the US. So, for all practical purposes, most investors already price gold in their local currency – particularly Chinese renminbi and Indian rupee – not in the US dollar.
For non-dollar buyers of gold in the emerging economies, the local price holds utmost importance. In 2016, as the dollar strengthened, gold’s returns in euro, sterling, the Indian rupee, and the Chinese renminbi were higher than gold’s returns in the US dollar. Over the past decade, the return of gold in other currencies has been 2.3% higher every year than its return in dollars.
This concludes that valuing gold from an exclusive dollar perspective is detrimental to the benefits that global investors, particularly from emerging economies, can derive by adding gold to their portfolios.
Featured Image Source: The Financial Express
Dan Steinbock is the founder of Difference Group and has served as the research director of international business at the India, China and America Institute (US), and as a visiting fellow at the Shanghai Institute for International Studies (China) and the EU Centre (Singapore). For more, see http://www.differencegroup.net/
This article was first published in the Shanghai Daily on April 20, 2017.