Gold: A hedge with benefits - UBS · PDF file tons of gold in 2018, the most in 47 years,...
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15 May 2019, 1:41PM UTC Chief Investment Office GWM Investment Research
Gold: A hedge with benefits Precious metals Authors:Giovanni Staunovo, Analyst, UBS Switzerland AG; Wayne Gordon, Analyst, UBS AG; Dominic Schnider, CFA, CAIA, Analyst, UBS AG
• The gold price rises when real US rates are low, equity markets are volatile and/or the US dollar is weak – all of which we anticipate for 2H19.
• With the Fed unlikely to hike this year or next and inflation improving, real US rates should stay low this year. Equity markets should be volatile due to late-cycle dynamics and US-China tensions. And we foresee broad US dollar weakness as investors re- focus on fiscal issues.
• We forecast the gold price at USD 1,400/oz in 12 months. The metal is also a valuable insurance asset, as adding it can help to reduce the overall volatility of a portfolio.
Source: Getty Images
Our view The gold price has been a roller-coaster this year. After rising from USD 1,280/oz at the start of the year to nearly USD 1,350/oz in February thanks to the Federal Reserve's dovish shift, gold prices fell to a four-month low of USD 1,270/ oz in April. The yellow metal suffered last month as the US stock market recorded record highs, equity market volatility (VIX) declined and the USD gained strength. But thanks to the renewed US-China trade spat, which has dragged down equity markets and heightened volatility, prices have shot up to test the USD 1,300/oz level in recent days.
Amid rising US-China trade tensions and geopolitical tensions in the Middle East, it makes sense to look at safe havens ahead of key dates in the US political calendar. We see gold as a valuable portfolio hedge for investors with an affinity for real assets and an ability to cope with gold's volatility of around 10–15%. Recent market volatility and gold's reaction to it have again confirmed its place as a safe-haven asset; it served investors well as a diversifier and helps reduce portfolio swings. These qualities should remain highly relevant for investors as the business cycle matures further.
Gold should also benefit as a non-yield-bearing asset from a prudent Fed (our base case is for no hikes this year or next) and if our view of a weaker US dollar pans out due to the country's twin deficits. Hence, we expect gold to trade at USD 1,350/oz in three to six months and at USD 1,400/oz in 12 months.
Further support for gold comes from demand from long- term-oriented investors like central banks, which appreciate gold's lack of credit risks, its liquid market and its role as a hedge against tail risks and inflation. After buying 651.5 tons of gold in 2018, the most in 47 years, central banks added another 145.5 tons of gold to their reserves in 1Q19. While central bank demand alone is not enough to drive a price break-out, it should help lift prices together with the support of a weaker US dollar, peaking US real rates, ongoing political risks and equity market volatility.
The main downside risk to owning gold is the Fed becoming hawkish again and hiking interest rates this year, which would likely support the US dollar and weigh on gold prices. A recovery in US equity markets would also limit gold's rise.
This report has been prepared by UBS Switzerland AG and UBS AG. Please see important disclaimers and disclosures at the end of the document.
Gold: A hedge with benefits Gold has three drivers that greatly influence its price direction: real US interest rates, the value of the US dollar, and fear. While not a direct driver, the positioning of financial investors is also important. Gold is a non- yield-bearing asset and is perceived as commodity and currency. Hence, investors are most interested in its negative correlation to real rates and the USD and its positive correlation to fear.
Before investing in gold, our views on the direction of these main drivers should be considered.
• Real US interest rates: With the Fed likely on hold this year and next, and US inflation (CPI) improving from the lows of 1.6% in 1Q19 and expected by UBS to fluctuate between 1.8% and 2.2% until the end of 2020, we believe US real rates peaked last quarter. Real US rates are an important driver for gold due to its non-yield- bearing status – the lower the rate the better for gold.
• US dollar: We expect the US dollar to weaken on a broad basis as the country's twin deficits erode the currency's fundamentals – we forecast EURUSD at 1.20 in 12 months. Gold is negatively correlated to the greenback. But under certain risk cases where the demand for traditional safe-haven assets rises, as it did during the 2008 global financial crisis, gold's correlation to the USD can swing into positive territory.
Chart 1: Negatively correlated to the USD Our expectation of a weaker USD over 12 months should help gold
Source: Bloomberg, UBS, as of 15 May 2019
• Fear: Fear in markets is routinely measured by the volatility index (VIX). Historically, the VIX tends to be higher during the late cycle. And with trade risks rising and the 2020 US presidential elections approaching, volatility could be even higher than usual. Gold prices usually do well in such environments.
Chart 2: Gold remains a safe-haven asset Gold outperforms equities when volatility (the VIX) soars
Source: Bloomberg, UBS, as of 15 May 2019
• Positioning of financial investors: While ETF holdings have increased this year, futures and options held by non-commercial accounts declined in recent weeks and net length still looks lean. If the above-mentioned drivers materialize as we expect, non-commercial accounts could significantly increase their net length and support gold prices.
Chart 3: Lean speculator positioning Non-commercial account positioning in gold futures in million ounces
Source: Bloomberg, UBS, as of 15 May 2019
Recommendation As long as the above drivers remain in place, we advise holding exposure to gold. We continue to advocate gold as an insurance asset, as we believe it can help shield investors from geopolitical flare-ups, macro data disappointments and sharp gyrations in earnings (leading to higher market volatility). Our analysis shows that, for long-term investors with an affinity for real assets and an ability to cope with gold's volatility of 10–15%, adding gold can help reduce portfolio volatility.
Source: Bloomberg, UBS, as of 15 May 2019; UBS View: Bullish = we target the upper bound of the range, Sideways = we expect a sideways move, Bearish = we target the lower bound of the range; Abbreviations: Impl. Vol. = Implied market volatility, Active F. = Active Futures, L. Range = Lower Range, U. Range = Upper Range, ER% = Expected spot return in %
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