As political uncertainty in the United States drags on, leading to dollar weakness, investors should consider buying the yellow metal.
As political uncertainty in the United States drags on, leading to dollar weakness, investors should consider buying the yellow metal. Adding to the dollar's weakness is strength in the euro and pound. The second rate-hike of the year, expected after the FOMC’s June meeting, has now been almost fully priced in, leaving few roadblocks to gold rallying in coming weeks. According to the CME’s Fedwatch tool (on June 9, 2017) there is a 96 percent chance of a hike.
Outside America, Europe is embroiled in political events. With Theresa May falling short of majority there is a hung parliament in the UK. The British Pound so far has reacted negatively to the development. Germany’s election is in September and it is largely expected that Angela Markel will return. After France’s election, the possibility of the euro falling to parity with the dollar has diminished. It has, on the contrary, strengthened. The only threat to strength in the euro is Greece. The ECB head, Mario Draghi, recently said that the European Central Bank would not consider buying Greece government bonds in its asset-purchases programme before a pending bailout review is concluded and creditors agree how to ease the country’s burden.
Draghi’s comments come after euro-area finance ministers failed last week to break an impasse on debt relief to Greece, delaying the completion of the country’s bailout review and the disbursement of fresh loans needed to repay obligations in July. The bottom line is; whether it be political uncertainty in the US or the UK or all of Europe, gold will always attract buyers.
The above chart (released by The World Gold Council, dated May 4, 2017) shows that Germany and the UK bought more gold ETFs than US-based investors and hedge-fund managers. The main cause was political uncertainty in the European region. The US was third on the chart. At the same time last year, it was the first. The positive view on gold is well supported by the risks associated with the global geopolitical situation and the consequent economic backdrop (the ongoing crisis in Syria, uncertainty about BRexit, slowing growth in China, friction between the West and Russia and, more recently, tension regarding North Korea’s nuclear program). Further, questions arise about the path of US growth and inflation.
Don’t Go Long in US dollar yet
The US dollar index has fallen to levels not seen since the US election. This might make it look like an opportune time to invest, but it could fall further. We expect the euro to strengthen in coming months, weighing heavily on the index. The remarkable turnaround of the US dollar was completed when the dollar index returned to its pre-election level. Whilst the fall from grace for the dollar may have come as a bit of a surprise to some traders, this was inevitable. Furthermore, there is the potential for the index to drop lower still. Because of this, we would caution traders from opening dollar long positions at this time, no matter how tempting that might be. Even the Fed meeting minutes, published on May 24, have hit the dollar again. Now, the focus of investors will shift to the Fed’s policy meeting (June 13-14).
Fed sounds cautious note, but doesn’t deter forecast of a rate increase
Federal Reserve Board officials said at a meeting early this month that they wanted to see evidence of stronger economic growth before continuing to raise the Fed’s benchmark interest rate, according to minutes of the meeting published on May 24. But the account presented in the minutes did not shake a widespread conviction that the Fed would raise the rate at its next meeting, scheduled for mid-June. Recent economic data were strong enough to reassure the Fed, and investors increased their bets on a June rate-hike. Fortunately, for gold bulls, this second rate-hike has already been nearly priced in; so, the gates are wide open for gold to rally in coming weeks.
Factors to monitor closely
First, the US dollar. After holding considerable ground above 100 in the index, the dollar has been through a bumpy 2017. But with weakness at home due to immense political uncertainty, coupled with positivity from other G7 pairs such as a stronger euro and pound, the dollar has been sold off for the better part of 2017.
Second, the British pound and the euro are up this year against the US dollar, by respectively 3.71 percent and 6.30 percent. Britain's voters have delivered a stunning blow to Prime Minister Theresa May, wiping out her parliamentary majority and prompting calls for her to resign. With most results declared, May's party won the most seats -- but not enough to govern without the support of minority parties. The Brexit negotiations are not going to be easy when they begin from June 19.
Third, if we don't get guidance from Yellen for the third rate-hike later this year, gold may close out Q2 on an upswing past USD 1,300. A more dovish outlook from Yellen would be the perfect fundamental fodder to keep this upward channel in gold going.The writer is AVP commodities research at AnandRathi.You can now invest in mutual funds with moneycontrol. Download moneycontrol transact app. A dedicated app to explore, research and buy mutual funds.