May 30, 2020
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Opinion | All That Glitters Is Not Gold. Why Fiscal Stimulus Have Limitations

Safe assets like gold, Japanese Yen and US treasuries have rallied sharply during this time of distress but unlike treasuries, gold hasn’t been able to hold its gains, writes financial analyst Praveen Singh

Opinion | All That Glitters Is Not Gold. Why Fiscal Stimulus Have Limitations
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Opinion | All That Glitters Is Not Gold. Why Fiscal Stimulus Have Limitations

Besides its tragic health consequences, COVID-19’s impact on the global economy will be far-reaching. Monetary and fiscal stimulus have their own limitations in fixing a worldwide medical problem. Despite the major central bankers adopting loose monetary policies, the IMF and World Bank offering monetary help to affected countries and talk of coordination between major economies, we are seeing that risk assets are simply unable to find the bottom.

Safe haven assets like gold, Japanese Yen and the US treasuries have rallied sharply during this time of distress. However, unlike treasuries, gold hasn’t been able to hold its gains. Currently, it is trading at a price of $1,490/Oz, lower than what it was before the surfacing of coronavirus. It surged past $1,700/Oz mark on March 9, before correcting sharply lower. The US treasuries have done the best. Gold, in a way, is suffering on two counts: Firstly, in this panic sell-off, some investors are dumping anything and everything. Secondly, some investors are selling gold to remain liquid and cover losses elsewhere. Also, many investors keep gold in their portfolio only up to a certain proportion, so their portfolio’s shrinking value due to falling markets is forcing them to sell some of their gold holdings too. Yet, considering the sharp decline in global yields, hefty cuts in interest rates and unprecedented stimulus from governments, we are positive on gold prices and look for steady gains of 10-15 per cent in the near to medium term.

Copper, the bellwether metal susceptible to the global economic downswing, has fallen sharply and could go further down amid prolonged sell-off. Its Shanghai inventories are rising sharply as China faces a sharp slowdown. Although the US economy is still doing well, it won’t be long before data start showing a sharp deterioration. The LME cash-to-3-month spread (difference between 3-month forward price and spot price) of the metal is weak and doesn’t betray any signs of a tight supply. Currently trading at around $4,800, the red metal can fall another 10-15 per cent.

Some investors are dumping everything in panic. Others sell gold to cover losses elsewhere.

Although lower crude oil prices act as a stimulus for the global economy, lower production cost and demand concerns due to the contagion portray a bearish picture for aluminium, an energy intensive product. The metal has fallen nearly 15 per cent in past two months. The OECD, IMF and World Bank have slashed their estimates for global growth rates sharply. LME cash-to-3-month spread of the metal remains in a wide contango of $23. The outlook is deteriorating as US automakers close their plants and troubles mount for airplane manufacturers. Suppliers of processed aluminium are reportedly selling their product at a zero premium to the raw metal as they want cash. Shanghai inventories continue to rise sharply. The virus peak impact remains a big unknown. Considering all the factors, we are bearish on aluminium, which needs large production cuts to steady itself.

Nickel has fallen over 15 per cent in the past two months. It could be months before Chinese stainless steel production starts recovering from the disastrous impact of the contagion. The demand for the metal may contract in the near-term. Although nickel inventories across Chinese ports have fallen sharply in the past two weeks, demand remains weak. The LME cash-to-3 month spread reflects no supply concerns as the spread remains in a wide contango of $78. Concerns related to Indonesian supply could offer some support to the metal, but prospects of recovery in prices in the current circumstances remain dim. Nickel can fall to as low as $10,000 in the next few months. But, once the contagion starts diminishing, we are likely to see a sharp recovery in the prices. In that scenario, the metal can bounce back quickly as demand from electric vehicles remains a supportive point.

At times, there are sharp rallies in the risk assets and industrial commodities on oversold conditions and bargain hunting buoyed by supporting steps of the governments and central banks. However, these rallies are proving to be abortive. It is to be noted that the outlook described in this article is logically and reasonably assuming that the COVID-19 contagion, in all probability, will continue to hurt financial market sentiments for at least a few more months before the virus peak occurs.

(Views are personal.)

Praveen Singh,  AVP, Fundamental Research (Commodities), Sharekhan by BNP Paribas

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