DoubtsonreopeningandGold'srise

Yesterday we had written that how markets are trading in a stable range with the scale tipped in favour of more stability. But as it turns out, some bad news was just around the corner to make the markets circumspect again.

Firstly, the never ending news about the virus and growing concern about the second wave. New cases have been on the rise in a number of US cities which has prompted businesses to rethink their reopening strategy. In Texas, the increase in numbers has prompted the Governor to again plea for people to stay indoors while Apple decided to reclose its stores in the city. The hopes that the economy will be back in shape quickly now has to be recalibrated with the sober reality that reopening won’t be a one way street.

Secondly, news impacting hope trade was from the stables of the IMF which forecast that global growth is going to take a negative 4.9% hit in the year 2020. This is close to 2% worse than the forecast which was done in April. The Indian economy will also see a 4.5% contraction in year 2020. Another dampener was that the US is considering tariffs on USD 3.1 billion of exports from the EU and Britain. The Euro, which was trading comfortably above 1.13 levels yesterday, declined after the news came out. The combined impact was that the stocks were down (Dow Jones down by 700 points), US yields slightly up, the dollar index and Yen slightly stronger and EM currencies trading right against the dollar.

But in all the melee and the ensuing explanations, one market touched close to a seven year high. Gold is now trading close to 1762 $/oz, a level last seen in 2013. We have written previously about the impact of money printing across the world on commodities like gold which can be seen as a hedge against inflation induced by printing of fiat currencies. It should be noted that throughout history money printing was always pegged or required to be pegged with some gold to back it up.

The most recent historical attempt at the gold standard for the world economy was in the Bretton Woods system where it was decided to peg the US dollar against gold and peg other currencies against the US dollar to keep world trade in a stable equilibrium. The mantle of keeping enough gold against the dollar issued was on the US. The gold price against the dollar was decided as 36 $/oz.

Now as per basic economics, the money supply should keep pace with the nominal growth of the economy. In the post WW II era the world witnessed sharp growth rates and hence readers can see a dilemma emerging here. If the peg has to be maintained then the gold production should also grow at the same pace. If it doesn’t then the money supply would be constricted presenting a disinflationary impact. All of this resulted in the US deciding to completely do away with the peg in 1971 and all currencies coming to a free float model. Due to the paucity of space, we will discuss the implication of the same in a follow up note.

On the domestic front, the INR is trading at 75.68, benchmark nifty trades in slight positive and 10 year G sec at 5.91. Today the weekly jobless claims data will be out in the US giving markets further direction on the pace of economic reopening.