Monday Digest

Posted 24 February 2025

Global politics turn business
Capital markets ended last week on a slightly downbeat note. That was more about the US economy than its astounding shift in foreign policy – but here everyone is focussed on Donald Trump’s recasting of Russia as an ally and Europe as an antagonist. The most immediate impact was a rise in European defence stocks, which will benefit from the inevitable rise in European military spending. Spending will almost certainly be funded by government borrowing, which is why European yields increased more than the US. This should help short-term European growth, but it could also be inflationary. Interestingly, Britain is perhaps the best placed of any European country to benefit from the continent’s defensive shift.

Beyond those moves, markets seem unsure what to make of Trump’s tectonic shift – with most indices unmoved from a week ago. Under the surface, we see signs of falling risk appetite. What happens to markets next will depend more on US market sentiment than politics. Business sentiment disappointed in the world’s largest economy (and in Europe) and now points towards mild contraction. That might reflect previous overconfidence during Trump’s honeymoon period, rather than how bad things are now, but it’s a notable change from the start of the year nonetheless.

We shouldn’t overreact to the US’ political pivot, but we shouldn’t underestimate its market impacts either. The international financial system is built upon the very US-led world order that the president is chipping away at – by focussing on short-term transactional gains rather than long-term stability. A mild outcome would be worsening risk appetite; a terrible outcome would be global financial fragmentation.

Asset allocation decisions need to be based on a holistic analysis of how these factors will play out. Despite the noise, none of the major global risk signals are flashing red. Markets have dealt with Trump’s disruption well, but we should keep an eye on confidence indicators and Europe’s response will also be crucial. With a new government in Germany being formed by CDU leader Friedrich Merz already saying his “absolute priority” would be to “strengthen Europe as quickly as possible so that we can achieve real independence from the US step by step” more change is coming.

Risks are rewards for gold
Gold prices are still surging. Bullion is approaching $3,000 per ounce and has become divorced from historical valuation metrics. Historically, real (inflation-adjusted) gold prices have closely tracked real US bond yields, as it’s often considered a currency alternative, but that correlation broke a few years ago. Emerging market central banks started buying the precious metal after Russia was frozen out of the West’s financial system. Net central bank purchases have reignited in the last few months after seemingly plateauing in the autumn. Given the global geopolitical risks around, you would bet on this continuing.

People buy gold when there are global political or financial risks – and Donald Trump’s second term as US president is full of them. On top of that, gold is benefitting from a technical momentum trade. Technical squeezes can be particularly pronounced for an asset like bullion, which has a small physical supply and a comparatively huge market for its derivatives. For example, the cost of short-term gold borrowing has shot up due to a shortage of physical gold, seemingly due to increased demand from New York and subsequently drained supply in London (the world’s largest market for gold trading).

The long-term trends are hard to untangle from the short-term technical factors. Short squeezes always loosen, and perhaps Donald Trump’s détente with Russia could lessen central banks’ desire to buy bullion. They are unlikely to buy back into the dollar, though, as faith in the world’s reserve currency is based on long-term institutional stability rather than policy whim. It’s hard to see gold demand falling while the political temperature stays high.

This uncertainty and volatility is why we don’t consider gold a suitable long-term investment. It is the purest store of value there is – but that fact itself affects how we value it. As the old saying goes, “Gold is the currency of fear”.

Commodities point to growth
Commodity prices are a good indicator of global trade – which has been threatened this year by Donald Trump’s tariff threats. The Goldman Sachs Commodity Index (GSCI) is up more than 5% since the start of the year, with copper a particular standout (about 14.7% up year-to-date). The metal is strongly related to green tech, which China is still developing in full force despite US environmental rollbacks. Trump’s tariffs threaten global trade, but commodity prices suggest the underlying fundamentals are holding strong.

The exception has been oil, which has largely traded sideways in 2025. Even if global growth is improving, Trump’s “drill baby drill” policies will keep crude supplies high.

Commodities were weak last year due to the global manufacturing downturn. That was down to China’s weak economy and overproduction, which only started turning in September, after Beijing’s stimulus announcements. Overproduction might sound like a positive for commodities – and in periods it was – but it also means inventories fill up, leading to the peaks and troughs we saw through 2024. Notably, GSCI’s recent spikes (in September and at the start of this year) have coincided with the times when investors feel most confident about Chinese growth.

Improving demand will benefit global trade, even if trade wars pose a risk. The recent commodities rally suggests investors recognise this. The flipside of this, however, is potentially more inflation. Chinese overproduction hurt global growth last year, but it also gave western central banks a helping hand by reducing input costs. A reversal of that trend could be problematic, especially if it coincides with tariffs. That could be worse for the US (with its stubbornly tight labour market) than Europe (with its weak domestic economy). Higher commodity prices are ultimately a good sign for global growth, but there is a nagging feeling that the last leg of the post-pandemic spike in global inflation is the hardest to beat.