After a sharp selloff in May as trade tensions re-emerged, risk assets recovered in June and July on the back of central bank dovishness, with US equity markets touching all-time highs. But with prices where they are today, investors need to be very high conviction that the best is yet to come in order to add to risk. We have not seen sufficient evidence that this is the case, and instead fundamentals have continued to deteriorate.
Corporate confidence in the US continues to show signs of weakness, and June’s Duke Fuqua School of Business CFO survey data indicates capital spending growth forecasts for the next 12 months have declined from 8.2 per cent in March to 3.4 per cent. There has also been signs of weakness in manufacturing in Europe and the US, and an elusive Chinese recovery.
If the corporate sector reduces levels of discretionary spending as a result, and if the earnings season results in a downside surprise, there could be worrying signs on the horizon. All eyes are focused on the earnings season, and the results could be a meaningful signal on the direction for markets for the second half of the year.
Given this backdrop of uncertainty, an area of conviction at present is an allocation to gold. We view the gold price as driven by three main factors: overall risk sentiment, the level of real rates, and the strength of the US dollar. We believe at least two of the three factors have not yet come into play this year, with gold primarily driven by lower real rates after the Federal Reserve ‘pivot’ earlier this year.
Gold as a hedge against risk asset downturns is one of the most commonly associated drivers of the gold price. But this has not factored into gold’s trajectory in any major way in 2019. We have continued to see risk assets perform strongly, pricing in dovish central banks as opposed to struggling fundamentals. If this were to reverse and negatively impact risk assets, we believe the precious metal’s status as a safe haven would be supportive of the price. This leg of the thesis still has room to run.
The US dollar is another factor, and a strong US dollar is typically a drag on the gold price. Given the global central banks’ return to dovishness and real rate expectations declining, the US dollar should have depreciated and been positive for gold. This has not happened yet, but we do think that the US dollar is likely to decline as Fed dovishness and the US economy continues to show signs of weakness. This could potentially contribute to another leg up for gold.
The final leg of the thesis, the level of real rates, is a factor we believe has mostly run its course as a factor driving our outlook on the gold price. When yields are high, so is the opportunity cost of holding a non-yielding asset like gold. But in an environment where rates are declining, like we have seen so far in 2019, gold becomes more attractive. While this factor may still be in play given easy monetary policy shifts by central banks, we don’t see this driver of the gold price as meaningfully driving another leg up from here.
When allocating to gold in our portfolios, balancing exposure between gold miners and physical gold is something we weigh up carefully according to each portfolio’s objectives. We see two of the three main drivers of the gold price as having room to run, and with markets still unsure whether a downturn in growth or monetary easing will drive markets in the coming months, allocating to gold may be an attractive position for some investors.
Bill McQuaker is portfolio manager of Fidelity Multi Asset Open funds