Wait it out, hold on to gold? What investors in S’pore can do as ‘stagflation’ risk mounts

SINGAPORE – Tensions in the Middle East are driving up oil prices, raising concerns about the risk of stagflation in the US economy and leaving investors wondering how it might impact their portfolios.

Rising oil prices make everyday activities like driving a car or eating a meal more expensive. Consumers then cut back on spending, which could further slow the US economy, already grappling with weakening job growth – all factors contributing to slowing economic growth, which could heighten stagflation risk.

US Federal Reserve chairman Jerome Powell acknowledged on March 18 that “higher energy prices will push up overall inflation”. However, he also said that “it is too soon to know the scope and duration of the potential effects on the economy”.

On the risk of stagflation, an economic phenomenon of rising prices and sluggish growth, Mr Powell said: “I would reserve the term ‘stagflation’ for a much more serious set of circumstances. That is not the situation we are in.”

While stagflation is not playing out for now, the big question is what will unfold if this economic scenario pans out.

If stagflation hits, the Fed will be in a dilemma. Raising interest rates could curb inflation but might hurt growth further. On the flip side, keeping rates low might fuel inflation further.

Mr Dan Farley, chief investment officer of the investment solutions group at State Street Investment Management, said the answer lies in how long the Middle East conflict lasts.

Independent investor Wong Kon How from Weipedia added that the market’s initial perception was that any supply chain disruption would be short-lived.

He said that if the tensions were to persist for weeks or months, there could be a more significant market meltdown.

Maintain status quo and wait for clarity?

For the moment, it is status quo for most investors as the conflict in the Middle East enters its fourth week.

Mr Farley said there are clearly many potential outcomes, but that it is more crucial to manage risk within the portfolio at this point.

Doing anything more would “just be a bit of a coin flip in terms of outcomes”, he added.

Mr Farley, who is based in the United States, was in Singapore earlier in March to meet clients. He said a couple of clients whom he spoke to are “holding tight” to their investments as they wait for more clarity. 

These clients are comfortable with the fact that the outcomes have not been significant so far, he added. At the same time, they recognise there is uncertainty, which could prompt them to change their views as the situation evolves.

What is going on with gold and the Japanese yen?

Traditional safe havens like gold and the Japanese yen have not quite lived up to expectations during this crisis, further underscoring why investors should sit tight and wait for clarity before they react.

Instead of going up, gold has dropped about 8 per cent from Feb 27, before the US-Israeli strike on Iran was launched on Feb 28.

Similarly, the yen has weakened about 1.4 per cent against the US dollar over that period. 

Safe havens have not performed as expected because markets are expecting that in the off-chance US interest rates go up, the US dollar will become more attractive. 

Mr Wong, the independent investor, noted that if the greenback strengthens, gold tends to weaken because it is seen as an alternative currency. Investors are more likely to hold dollars rather than gold in this instance.

Furthermore, gold is priced in US dollars, so a stronger dollar makes gold more expensive, which can reduce demand and put downward pressure on prices.

The weak yen is also a function of a strong US dollar. “When the US dollar strengthens, currency pairs against the USD should face some pressure,” he said.

Mr Wong is monitoring the US dollar and US interest rates closely, “This relationship seems healthy now – with the market anticipating higher interest rates alongside a strong USD trend.”

What happens if rates rise and the dollar weakens?

If the relationship reverses – a scenario where interest rates are high, but investors lose interest in holding the US dollar, causing the currency to drop – it could become a concern. 

Higher interest rates mean higher borrowing costs for companies and consumers, while a weak currency means imported items become more expensive.

Gold and precious metals should start to pick up again when the US dollar begins to decline, Mr Wong noted.

“I am not suggesting that this scenario will happen,” he said. “Stagflation is a situation I hope not to see, but one that I still need to prepare for.” 

Mr Wong is protecting his portfolio by keeping his gold allocation. 

State Street Investment Management also remains overweight on gold. Mr Farley said the precious metal has not been as strong a diversifier as many people hoped it would be in the current market environment.

He added that on a longer-term basis, there are plenty of other fundamental reasons that support gold.

What other asset classes should one invest in?

State Street is overweight on global equities and underweight on fixed income. Mr Farley said the underweight in bonds is not because it is negative on fixed income but because it sees better opportunities in equities. 

“When we look at the underlying fundamentals for companies, we find good quality companies with good earnings,” he added.

“Stock valuations are not great, but they are also not awful.”

Mr Wong is hoping to invest closer to home. “If it is so uncertain in the US, why try so hard? There are greener pastures at home and nearby,” he said.

The independent investor is taking advantage of US dollar strength to cash out of his US dollar holdings and he intends to invest in quality Chinese, Malaysian and Singapore equities.