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The precious metal has failed to follow historical patterns and rally on the latest troublesome event
Thursday 16 Aug 2018 Author: Daniel Coatsworth

Stock markets are flashing red in various parts of the world, Turkey’s economic crisis and lira collapse continues to dominate the headlines and several other emerging market currencies are going through a patchy period.

In theory these conditions should be positive for gold given it is seen as a safe haven asset. So why is the precious metal trading at a 19-month low?

While an appreciating US dollar is partly to blame, there are other possible reasons that may explain why gold is not shooting up in value, as it has done in previous times of peril.

Turkey’s central bank was the biggest buyer of gold after Russia last year, picking up 85.9 tonnes of the precious metal. It may therefore dip into this stockpile and sell some gold during its current crisis – something that could be seen as negative for the metal price, according to Nitesh Shah, director of research at ETF provider WisdomTree.

He says Turkey has an unusual system whereby commercial banks can use gold to meet reserve requirements with the central bank. ‘In 2017 gold inflows into the Turkish Central Bank from commercial banks (held on reserve) amounted to 187.7 tonnes. Combining these two sources of flows to the central bank, gold inflows were into Turkey were the highest of any central bank.’

Turkish Lira has weakened by more than 30% versus the US dollar since late July. Over the same period, gold has fallen by a mere 1.1%.

CONFUSED BY GOLD’S FAILURE TO REACT

Clearly many investors will be left confused by gold’s failure to strengthen when a currency has depreciated by a significant amount in such a short period of time.

Gold also has a reputation of moving up when stock markets are moving down. For example, gold moved up 0.9% during the two month stock market sell-off in February and March this year where the FTSE All-Share declined by 7.4%. Previous sell-offs in August 2015 and January 2016 saw gold rise 3.7% on both occasions versus a 9.3-9.5% decline in the UK stock market.

What’s interesting this time is that the FTSE All-Share – a benchmark for the UK stock market – has barely moved since the lira started its latest descent in July. One could argue that Turkey’s economic problems and spat with the US aren’t deemed serious enough to destabilise the UK market which is dominated by banks and resource companies at the upper end of the market cap spectrum.

But what if investors are simply being cautious now and waiting for events to unfold before they start to seriously reduce exposure to higher risk assets such as emerging markets?

Shah at WisdomTree points out that gold doesn’t always react quickly in times of stress. ‘During the Argentine crisis, the Minister of the Economy froze bank accounts on 1 December 2001 (a clear sign the writing was on the wall) and on 23 December 2001 the government defaulted on its sovereign debt,’ he says.

‘In the month of December 2001, gold only rose 1%. But in the first half of 2002, gold rose 15% as the ramifications of the Argentine crisis (and dot-com bubble issues) introduced a clear geopolitical premium into gold.’

We see merit in having some exposure to gold in a portfolio but do not believe the current situation warrants dumping equities in favour of increasing positions in the precious metal if you already have decent exposure. (DC)

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