Market Insights – July 27, 2020

Each week, a team of experts shares its market views with you.

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Essentials

Eurozone purchasing managers indexes rebounded sharply for the third month in a row in July and were well ahead of consensus estimates. The recovery is broad-based: both the manufacturing and the services sectors have moved back into expansionary territory, corroborating the improvement in high-frequency indicators.

Geopolitical tensions between the USA and China continue to escalate, with the consulates in Houston and Chengdu being shuttered. This dispute is likely to last until the US presidential election in November.

World-leading chip manufacturer Intel has fallen behind with the rollout of its 7-nanometer chips, which was initially scheduled for the end of 2021. This means it will have to produce some of its chips in the TSMC and Samsung foundries in Taiwan and South Korea respectively. This should further complicate the trend towards relocating in the tech sector.

Gold skyrockets

As we start the week, gold prices have reached a record high and are nearing the symbolic threshold of USD 2,000 per ounce (around 31 grams). They have gained close to 7% in a week and 30% since the start of the year. Rises like these are rare outside of a financial crisis. The last period in which gold prices rose so sharply was during the 2008 subprime crisis and the eurozone sovereign debt crisis starting in 2010, when fears about the financial system were at their peak. Since then, systemic risks have dropped off sharply, so they don’t explain gold’s recent rally. Concerns about the COVID-19 pandemic have certainly driven up demand among both private and institutional investors. But we have to look to central banks to find the main reason for this rise. The world’s major central banks have broken with the monetary policy dogma in place since the Second World War. Economic history is full of examples of currencies depreciating sharply when central banks inject too much money into the economy. And now all major central banks are using unconventional methods to expand their balance sheets and flood the banking system with liquidity. We can therefore expect all currencies to depreciate to some extent against real assets, including precious metals and especially gold. This is one of the reasons that prompted us to keep large amounts of gold in our portfolios, even if it is slightly overbought in the short term and could be subject to some profit-taking. The US dollar is one of the currencies hit hardest by the central banks’ actions. The Federal Reserve responded quickly and aggressively to the public-health crisis and the ensuing recession. The greenback had long been weighed down by the USA’s twin trade and fiscal deficits, but the yield spread was still attractive. Now, however, US yields are at rock bottom, which has put off investors. The decline recorded in recent weeks looks set to continue and shows that we were right to reduce our exposure to the dollar at the end of June.

Has Europe's time finally come?

It was no easy ride, but they made it: the 27 European Union member states sealed an economic recovery deal that for the first time involves joint borrowing. Unsurprisingly, there were some compromises, like a reduction in the amount of the grants to be awarded. But the key aspects of the Commission’s plan have not changed. It’s an historic plan: first, it will support the economy as it recovers from an unprecedented crisis, focusing on the energy transition while helping peripheral countries hit hardest by the pandemic; and second, it undoubtedly represents a first step towards greater fiscal integration. These are very strong signals and reduce the risk of the eurozone collapsing, which had been a major concern in recent years. Eurozone stock markets have been the top performers since the initial Franco-German plan was announced, a sign that investors’ view of the region has improved significantly.  We think this trend could last because, after underperforming for many years, eurozone equities are underrepresented in portfolios around the world. What’s more, the eurozone managed the pandemic well, economic indicators are bouncing back sharply and the European Central Bank and governments have brought in unprecedented stimulus measures, so the eurozone could even come out of this crisis more quickly and permanently than other regions.

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