Using Gold ETFs to Hedge U.S. Fiscal Cliff Risk

ETF Trends

One of the key concerns of investors today is the potential of a severe blow to risk assets if the US “fiscal cliff” is not dealt with responsibly by the US Congress by the end of the year. If they don’t, there is a high risk that the US economy will be driven into recession and will see its sovereign credit rating downgraded again.

This concern is likely one of the main reasons risk assets have not performed better despite the announcement by the Fed of an open-ended QE3 in September and improving US and China data in recent weeks.

As we show below, being long gold is potentially one of the best hedges against a worst case scenario in the US. During the last Congressional stand-off on the budget ceiling in the summer of 2011 (and resulting US sovereign downgrade), the gold price rallied nearly 30%.

With the US Presidential election this week there have been no signs that Republicans and Democrats are in a frame of mind to make the compromises necessary to resolve budgetary issues. If this situation continues after the election and investor concerns about a possible US downgrade escalates, gold will likely be a beneficiary.

But the factor that will likely have the strongest positive impact on the gold price is Spain (or even Italy) asking for a bailout, permitting the Euro to rally, the dollar weaken and general risk appetite to improve. In the meantime, investors that want to hedge against worst case US fiscal cliff scenarios will likely continue to build long gold positions.

Rising China demand improves outlook for “industrial” precious metals

Silver rose to a 2-week high of $32.5/oz last week on signs of improving demand from China. The state Chinese research institute, Antaike anticipates silver demand in China will rise by 10% in 2013 to a record high of 7,700 tons mainly due to growing investment demand.

Last week China’ manufacturing PMI rose to a 4-month high, breaching the 50 point expansionary level. Increasing signs the industrial cycle in China has bottomed out, together with improving US data, bodes well for the more industrial precious metals such as silver, platinum and palladium. But for a full-blown cyclical rally, the fiscal cliff and Spain bailout issues likely need to be resolved.

Key events to watch this week

While there is no consistent relationship between political affiliation of the US President and the performance of precious metals, the size of the electoral win will help determine the president’s ability to push for a budget compromise.

The new leadership of China that emerges from the 18th Chinese Party Congress will be closely examined for its support of current expansionary macro policies and its external political/military stance.

ETFS Physical Swiss Gold Shares (SGOL)

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