BREXIT AND THE BOOST FOR GOLD- Shri. V.P. Nandakumar

After experimenting with artificially low interest rates, the trend towards negative interest rates on sovereign bonds is proving to be another support for gold. The conventional argument against investing in gold is that the metal generates no income while investment in bonds and shares fetches interest and dividends which offset the risk of fall in capital values. In contrast, when you invest in gold, you are effectively betting only on favourable price movements.

However, with the trend towards negative interest rates in the advanced economies, holding on to cash and gold is now a sensible option. According to a recent reports in the international press, about US$13.4 trillion of sovereign bonds, primarily European and Japanese, are trading with negative yields. For many central banks these days, it’s become a race to the bottom and beyond. Moreover, a number of highly rated corporate bonds are also beginning to get into the negative yield business. The case for gold has become stronger.

Of course, if there is a dark cloud somewhere, it is that the most recent upsurge in gold price has been driven strongly by exchange traded funds (ETFs) getting back in to the market.  The risk is that demand will fade once there is an economic recovery prompting investment to head elsewhere. And that is the potential threat to gold price going forward.

Other likely consequences

Post Brexit, there can be significant,  but difficult to predict, negative spill-over to the euro area in the days to come via a number of channels, including trade and the financial markets. However, losses may not be as large as earlier feared even if Article 50  (which governs exit from EU) is triggered immediately because the UK’s trading arrangements with the rest of the EU is likely to remain unchanged for at least two years (possibly longer).

Brexit has given hope to Euro-sceptic political parties across Euro-zone to pursue their own exit options. While markets have so far managed so far to ride out the impact, the real danger is that it may strengthen anti-EU voices in European countries, some of which may follow suit. With elections coming up next year in the Netherlands, France and then Germany (these economies together represent more than half the euro-zone output), the worries are real. An upsurge in anti EU sentiments leading to further pullouts from the EU would pull the EU economy into recession which will spill over to the global economy via trade and finance.  A slowdown in global economy would impact US growth rate. Any uncertainty and weakness in the global economy would likely further delay the process of normalisation of interest rates by the US Federal Reserve. And that will, once again, strengthen the appetite for gold among investors.

V.P. NANDAKUMAR ( MD & CEO of Manappuram Finance Ltd.

and Chairman of CII, Kerala State Council)

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