The Federal Reserve has indicated it will embark on hiking interest rates and a tighter monetary policy. Nevertheless, gold exchange traded funds may still find a position in a diversified investment portfolio in the face of rising risks ahead.
“With rates rising, should the price of gold decline? I can see Eurozone based investors getting less enthusiastic about gold as the euro has been rising. That said, rising risk premia may be a positive for the price of gold. Because gold does not have cash flow, there’s also no greater discounting of future cash flows as risk premia rise. In contrast, stocks may well be under pressure as risk premia rise. This is an academic way of saying that gold may be a valuable diversifier should stocks suffer,” Axel Merk, President & CIO, Merk Investments, said in a research note.
Merk argued that the robust quantitative easing out of the Federal Reserve has served to compress risk premia, or diminished the spread between risky and so-called safe haven assets. For example, junk bonds trade at less of a premium over investment-grade debt, peripheral Eurozone bonds trade at a less premium over traditionally safer German bunds and equities are trading at higher valuations.
Consequently, more observers fear that winding down an ultra-accommodative policy could cause markets to revolt. While the Fed may have seen markets show a relatively calm reaction to recent small hikes, the eventual balance sheet reduction will likely fuel increased risk premia, Merk said.