Is gold still a safe haven? Some started to ask this question as prices declined despite mounting global trade tensions and a non-negligible risk of a trade war. From our point of view, the answer is “yes”. While there is a lot of noise around trade tensions, their impact on the global economy and financial markets has been limited so far. For gold to benefit, their impact would need to be much bigger, causing a broader risk aversion in financial markets and triggering a flight to safety. Nevertheless, we would have expected some support for gold from the uncertainty related to the trade tensions.
What has mattered most for gold so far this year was the assessment of the US interest rate cycle. The expected number of future rate hikes has progressively increased as the US economy demonstrated stellar growth and the Federal Reserve reiterated its determination to normalize interest rates. As a result, the US dollar rebounded; investment demand softened and gold started to slide. Despite being aware of the potential rate cycle headwinds which were expected to weigh on gold, we were still surprised by the size and speed of the recent sell-off. Prices are currently under pressure at around $1,200 per ounce.
The reason why the US dollar mattered so much for gold was the lack of demand. Gold has traded in a “currency mode” rather than in a “commodity mode” for most of this year. Considering the uncertainties related to trade tensions, the softness in investment demand is surprising at first sight, as is the fact that some structural buyers became sellers. Holdings of physically backed ETFs dropped sharply from their early summer peak. Most of the selling came from the US, which we believe is due to three reasons:
Firstly, US real interest rates (nominal rates adjusted by inflation) play an important role in overall holdings. Indeed, holding gold has an opportunity cost as it does not carry any coupons or dividends. Hence, in the event of a rise in real interest rates, holding gold is less attractive. As shown in the graph, US real interest rates reached a decade high in September this year.