The risk factors affecting gold prices

The US-China trade war and Brexit hold the cards for what happens next with the precious metal

One kilogramm fine gold bar are pictured in the Pro Aurum KG in Munich, Germany, on Wednesday, July 10, 2019. Photographer: Michaela Handrek-Rehle/Bloomberg
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Uncertainty over trade disputes and the established world order of economic pacts like the European Union have had an impressive impact on gold prices. Gold prices rose dramatically in the wake of the Brexit vote in 2016 and were carried higher by the US-China trade war which started in July 2018.

The underlying sentiment for the rapid uptake of gold instruments like futures and exchange-traded funds is mainly safe haven buying to hedge against rising risks in the financial markets. While it’s true that the trade talks progress made between the US and China in October may have lulled prices for the precious metal, the uncertainty still nags at investor sentiment.

What are the risk-on and risk-off factors for gold?

Risk-on factors

A risk-on mood in the markets is defined as a stronger risk appetite during periods when risk is perceived as low. As a non-yielding asset, gold is usually downplayed during low-risk periods.

While it goes too far to say that risk is low at the time of writing, investors may be more favourable to risk assets like stocks if US-China trade talks continue to show progress. This might inhibit safe haven buying in October and November, when a second phase deal is planned for discussion. Having said that, even if gold prices stay in a lull, any signs of trouble in the trade talks are likely to send investors rushing back to safety.

We cannot underestimate the influence that positive trade talks have on investors. The most important risk-on factor is progress in US-China trade talks. Nothing else compares to it. The perception that a trade deal is close is the single thing which could stem the losses in the trading ecosystem, return the world economy to growth, calm investor nerves and restore confidence.

Risk-off factors

Currently, there are considerably more risk-off factors than risk-on, which explains why gold prices remain elevated compared to the beginning of the year. Investors are concerned over global growth which has declined slightly under the pressure of trade disputes. The UK and EU have been particularly affected by economic fallout over Brexit, with Germany close to a recession and the UK’s economy contracting in the second quarter.

Economic data in other regions also show weaknesses, with shrinking growth in China and America’s industrial sectors leading the way downward. The IMF recently said that global growth is expected to be lower in 90 per cent of the world’s economies in 2019, confirming concerns that the US-China trade dispute and Brexit negatively affected regional and international growth. If economic data continues to show weakness, gold may be further supported by safe haven buying in spite of any signs of a positive Brexit deal.

In a related risk-off development, the quickened pace of central bank easing also confirms investor fears of a global slowdown. While investors are somewhat reassured by the prospect of a lower interest rate environment and easier borrowing, the mixed message coming from central banks is that investors should be concerned at the same time because the economy is slowing.

It is no wonder that growth in salaries and spending is inhibited in the gigantic economies of the US and China. With central banks in risk-off or dovish mode, investors are following their lead. Nonetheless, stock markets are benefiting from easier borrowing in spite of ongoing volatility.

But … Brexit

Prime Minister Boris Johnson has failed to get his new Brexit deal approved by the British Parliament on October 19, and he was obliged to request an extension. It is highly likely the EU would grant an extension to Article 50, making a no-Brexit deal a less probable scenario. However, the longer the Brexit drama drags on, the more uncertainty and frustration as result.

My outlook for the rest of the year is that the odds are in favour of further gold gains if the economic winds turn against positive outcomes for the US-China trade war and Brexit. These two issues will determine whether gold sees new highs for 2019 or falls out of favour with investors.

Hussein Sayed is the chief market strategist at FXTM