In our Hype Cycle report on 10 April 2019 we stated that gold was overhyped and heading for a weak quarter. Part of the argument was the seasonally weak demand for gold from China and other countries. And indeed, since the report was published, gold prices have declined by up to 2.7% in a volatile downward trend.
However, since the beginning of May as trade fears started to dominate financial markets again, the picture has slowly shifted. Unlike last year, when hostile trade rhetoric led to a strong appreciation of the US Dollar and hurt Asian markets more than US markets, this time, the lift to US assets seems much more muted. In 2017, the Bloomberg Dollar Index rose 3.1% after Donald Trump introduced import tariffs on solar panels and other goods. In 2018, the introduction of steel tariffs led to an appreciation of the US Dollar by 6.5% in two months. And in 2019? Since the beginning of April, the Bloomberg Dollar Index rose a mere 0.8%. Looking at the chart, you would be hard pressed to find the time when the US-China trade talks broke down or when Donald Trump announced tariffs on Mexican imports.
On the other hand, classical safe haven assets like Treasuries have come back into fashion. In 2018, 10-year Treasury yields did not react to the steel tariffs at all as the US economy was still benefitting from the sugar rush of the US tax cuts earlier in the year. This year, this fiscal stimulus has faded and while economic growth is holding up nicely in the US so far, the risks of an economic slowdown are increasing. Correspondingly, 10-year US Treasury yields have declined sharply from 2.59% in mid-April to 2.16% today. About half of that 43bps decline in yields has been due to declining inflation expectations, while the other half has been due to declining real yields.
In other words, we are witnessing the classic shift in expectations that comes with rising recession fears. Inflation expectations, as well as real rates, are declining. What is different this time, though it makes sense if one assumes that the US economy is likely to slow down faster than the economy in Europe or Asia, as we have argued in our recent Market Outlook , is that the US Dollar is not strengthening that much. One major beneficiary of these developments should be gold. Not only does gold head into a period of seasonally strong demand at this time of year, but the relatively stable US Dollar, together with declining bond yields, should provide support to the precious metal. If Donald Trump follows through with his trade war with Mexico, he is effectively opening a second front, besides the conflict with China, which is likely to hurt the US economy at least as much, if not more, than the tariffs on Chinese imports. This should give additional support to gold in coming months. History teaches us that fighting a war on two fronts at the same time is never a good idea. In this case, the loser could be global stock markets while the winner could be gold.