Negative Real Interest Rates
I want to start with the interest rate factor as the fed is expecting to hike rates "relatively soon." There is no doubt that economic activity remains resilient, but I believe that the outlook for gold will remain bullish as long as real interest rates remain negative.
As the chart below shows, real interest rate has been in negative territory since 2008 and is likely to remain in negative territory in the coming years as well.
I see negative real interest rates as an ongoing QE for the economy. Investors will argue that gold has been depressed even as real interest rates have been negative, but the other factors that I will discuss will support the thesis along with this sustained factor.
The Donald Trump Factor
Going by the economic views of Donald Trump, the focus is likely to be on "Make in America" once again. The key point to note here is that the dollar has strengthened in the recent past and this is negative for exports.
Just to put things into perspective, the dollar index was approximately at 80 in July 2014 and surged to 100 by March 2015. The dollar strength has sustained thereafter with the index currently at 100.8.
In my view, once Donald Trump assumes power, there will be focus on ensuring that the dollar trends lower. It would not be surprising to see a stimulus that is targeted towards encouraging manufacturing driven growth.
Overall, the current dollar level is not ideal for exports growth and that is likely to change in the coming years.
The Donald Trump Factor...Again
The Duke's Faqua School of Business (Global business outlook survey) covers 485 US firms and provides some key insights on the growth of the corporate sector in the foreseeable future.
According to the survey for 3Q16, 52% of US CFOs said that they are holding off spending with 40% holding off hiring due to political uncertainty. Further, of the ones holding off spending, 26% are doing it specifically for US elections. The following point is worth noting from the survey -
Of the 26% mentioned in the previous bullet, 77% say they will continue to delay investment if Hillary Clinton is elected, as they wait until more uncertainty is resolved. 51% say they will continue to hold off on investment after the election if Trump is elected.
The point I am trying to make here is that there is more uncertainty related to Donald Trump and as capital spending is on hold for many firms, I expect economic weakness in the coming quarters and economic weakness will sustain until there is more clarity on the policies to be adopted by Donald Trump.
In turn, it would not be surprising to see interest rate hike in December 2016 followed by an interest rate cut 6-12 months down the line. In addition, it economic slump is significant, further monetary easing is likely.
Overall, this will be an ideal scenario for Donald Trump as it will allow him to use the economic weakness factor to ensure that the dollar trends lower.
Central Banks Are Bullish
Call it currency diversification or any other factor; central banks are certainly bullish on the only honest currency in the world.
According to data from the World Gold Council (3Q16), central banks were net buyers of gold not just for 3Q16, but for the last seven quarters on a trot. In my view, this trend is likely to sustain in the coming quarters as China and Russia aggressively purchase gold.
Besides gold being a store of value, China is looking for diversifying dollar holdings and China's gold as a percentage of total reserves is still below 5%. This will ensure sustained demand for gold and is an indicator that gold will trend higher in the long-term.
Investment Ideas
In my view, the best investment option is physical gold and investors can consider exposure to the precious metal to the extent of 15% to 20% of their portfolio. Gold ETF (NYSEARCA:GLD) is also an alternative investment option, but I personally prefer exposure to physical gold.
In addition, gold mining stocks have slumped in the recent past after big upside through the year and I see gold miners as attractive for the medium to long-term. In particular, I am bullish on Newmont Mining (NYSE:NEM) and Barrick Gold (NYSE:ABX).
Both these gold mining stocks have ample liquidity and strong financial muscles. Further, these names have an attractive all-in-sustaining-cost that will ensure free cash flow even if gold is around $1,200 to $1,250 an ounce.
However, I do believe that gold will bounce back strongly in the coming quarters and this is likely to translate into expanding EBITDA margin and stock upside for these beaten down gold miners.
Conclusion
In conclusion, gold has been battered in the recent past, but I don't see any reason to panic for medium to long-term investors. Real interest rates will remain negative in the coming years and economic uncertainty is also likely to sustain.
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