Is it time to go back to gold

Markets have been more volatile than normal so far this year due to many factors, including geopolitical tensions with North Korea and the Middle East, Italian government upheaval, rampant speculation related to interest rates and the spectre of potential trade wars involving the United States, Canada, China, and European powers as a result of tariffs.

Recently the gold price has depended on the dollar’s cross-border flows. They in turn have been driven by market perceptions of increasing credit risks in emerging market currencies, and the Fed’s policy of normalising interest rates while other major central banks are still applying monetary stimulus. The result has been a stronger dollar on its trade-weighted basis and a weaker gold price.

Spot gold dropped 0.4 percent to $1,225.89 an ounce during Thursdays trading hours, after it rose 0.6 percent on Wednesday. Earlier in the session, the metal hit $1,235.16, its highest in more than a week but eased by the end of the week due to a strengthening dollar.

Gold prices are back under pressure, with the U.S. dollar gaining ground against its major counterparts, and the precious metal may continue to consolidate over the remainder of the week as market attention turns to the Federal Open Market Committee (FOMC) interest rate decision on August 1.

Even though the FOMC is widely expected to keep the benchmark interest rate on hold, Chairman Jerome Powell & Co. are likely to implement higher borrowing-costs over the coming months as officials warn ‘gradually returning interest rates to a more normal level as the economy strengthens is the best way the Fed can help sustain an environment in which American households and businesses can thrive.’

In turn, a batch of hawkish comments may sap the appeal of gold as the FOMC appears to be on track to further embark on its hiking-cycle, and growing expectations for four rate-hikes in 2018 may reinforce a bearish outlook for gold prices on the back of expectations for higher U.S. Treasury yields.

One more interesting thing witnessed during the past week was gold reserves. It seems that strong economies have increased their gold reserves which are a good sign for gold.

CHINA – Officially, China has kept its gold holdings unchanged at 59.24 million ounces since October 2016, or 1,843 metric tons, valuing them at $74.1 billion at end-June. Globally, central banks continue to increase gold reserves, albeit at a slower pace, adding 371.4 tons in 2017, according to the World Gold Council.

However in the past too, China has spent long periods before without revealing increases in gold holdings. When the central bank announced a 57 percent jump in reserves to 53.3 million ounces in July 2015, it was the first update in six years.

So it seems that mysteriously China has been adding to its gold reserves.

RUSSIA- Russia‘s U.S. dollar reserves have shrunk from $96.1 billion in March to just $14.9 billion in May, according to the Russian Central Bank. Its governor, Elvira Nabiullina, says the decision will help protect the Russian economy and diversify the bank’s reserves.

Notably, the Bank of Russia has been buying gold every month since March 2015, overtaking China as the fifth-biggest sovereign holder of gold.

Russia added 500,000 ounces of gold (15.55174 tons) to reserves in June and bought some 106 tons of gold since the start of the year, with total reserves now approaching the 2,000-metric-ton mark. Last year, Russia added a record 224 tons of gold to the reserves.

The Russian central bank hinted that it could invest the money from the USD sale not only into gold, but also into International Monetary Fund (IMF) bonds and Chinese bonds.

But why have these economies diversifying to gold? Well, in periods of global financial or political crises, gold is much more useful than securities or cash, although gold is also prone to price fluctuations.

Moving further, it must be noted here that the gold price is affected, of course, by more factors than simply the US dollar and US interest rates. Equity markets can and do affect the gold price, oil prices too, and there is a long list of non-quantifiable factors that can have a dramatic impact on the gold price. Heightened global political and economic tensions on account of a highly erratic US President may encourage more investment demand for gold, for example. And can anyone fully rule out an Italian exit from the Euro zone and the financial crisis that would follow?

Gold - Half year analysis

We are half way through 2018 and we have already seen gold showing some interesting movements.

The first half of 2018 has been quite action packed for global financial markets. In US and Asia, most of the growth was captured by tech stocks. Equities experienced a few pullbacks during the first 3 months as geopolitical tensions increased. So far, investors seemed to have shrugged off the escalating trade war rhetoric between the US and many of its trading partners.

Gold was up by more than 4 % in the first few months of the year, but finished on a negative note by the end of June. This downward trend continued in July as gold dropped further. Though gold was volatile till the first quarter, it has been moving in a relatively low range since.

The three main reasons being-

• A strengthening US dollar
• Soft physical demand for gold in the first half of 2018
• Higher investor’s threshold for headline risk

Now coming to the second half of 2018. This year, there are plenty of factors which could lead to a medium-term gold price reset which could put that $1,400 price target back in its sights. This may sound over optimistic, but a lot of hope in being built mainly over the belief that we still have 6 months and of those, a lot of things are expected to happen over the second half.

We see a lot of factors that can reset gold price to $1400, we can broadly categorise them into 4 groups-

• Economic development and capital growth
• Global market uncertainties
• Capital flows and price trends
• Competing assets

So now where do we see the yellow metal in the coming months? Well we think that the outlook for gold will mainly be influenced by a few macro trends-

TRADE WARS AND THEIR IMPACT ON EXPORT IMPORT- President Trump’s planned tariff impositions against imports from China and elsewhere have been seen as positive for the dollar and the U.S. economy.  No matter that these tariffs are potentially inflationary in the domestic marketplace and that tit-for-tat measures being imposed on American exports could be very damaging to certain targeted U.S. exporters.

The counter tariffs being put in place could also see a downturn in export-oriented company stock prices, which could lead to a drift downwards in other equities and a drift down could spread to become a rout given the seemingly overbought state of the markets. Thus will have a positive impact on gold and may well push prices high.

EQUITIES - The long equities bull market, which does seem as though it may have come to an end this year, is seen as at least partly responsible for the lack of interest in precious metals investment.  A serious downturn in equities could thus drive investors back in the perceived safe havens of gold and silver.

An equities collapse, which many commentators have been predicting, could initially bring precious metals down with it with investors and funds struggling for liquidity and needing to sell good assets to stay afloat.  We saw this in the big market downturn in 2008, but gold, in particular, recovered any losses quickly and was rising when equities were still turning down.  This is a pattern which could well be repeated.


INCREASED GOLD HOLDINGS - Gold may well be one of the mechanisms being used to help reduce reliance on U.S. denominated reserve assets – certainly by Russia and probably by China which shrouds its central bank gold holdings in secrecy.  But even so this seems to be having little or no impact on the gold price at the moment – but it could have implications in the longer term.

In the long term we do feel that gold has a good future with falling supply and rising demand.  The big question is when will the price turn back upwards again?

Some say soon, while some still support the bears market. But we cannot ignore the fact that a lot can happen in the markets in five and a half months.  We would expect the dollar to start to fall back as the true impact of the Trump tariffs begins to be felt.  U.S. Fed Chair Jerome Powell’s latest fairly optimistic statement to Congress, seen as responsible, at least in part, for the latest gold price dip, in reality only confirmed what had been said before.

We think there’s a good chance that this will happen sometime in the final four months of the year and we might see the gold price reaching $1400 level by year end.