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.

Gold May Regain its Safe Haven Status

In January, precious metal prices peaked. Since then they have fallen substantially by 9% (gold prices).

In recent weeks, the sell-off has accelerated. There are several reasons for this price weakness.

Trade War - a looming trade war between the US and China has weighed on prices, especially cyclical precious metals such as platinum and palladium.

US Dollar - Rising U.S. Fed rates and rising real interest rates – up 20% from the start of the year as measured by 10-year bonds — are supporting the dollar. While the dollar remains strong, gold is being depressed.
To some effect, the metals markets are experiencing the same depressing impact on prices.
 The recovery of the US dollar is negative for all precious metal prices.

Euro - a downshift in expectations about the euro zone economy has been a negative for precious metals.

Global Markets - weakness in emerging markets has lowered all precious metal prices as well. More recently the substantial fall in the Yuan has accelerated the decline in precious metal prices. Yuan weakness reflects the heightened trade tensions between the US and China and nervousness about Chinese corporate bond defaults. China is a crucial consumer of precious metals. So fears of lower Chinese demand are negative for prices.

But this may not be the end as markets believe that this downfall may continue. The US dollar is expected to strengthen further due to strong economic data and ongoing Fed Hike.

Furthermore, markets look negative for gold as the 10y US Treasury yields is expected to rise.
Gold and other precious metals are highly sensitive to these issues and hence analysts believe the gold, in the near-term, is expected to fall.

In addition, trade tensions between the US and China will probably linger on and there may be more volatility in the Chinese Yuan in the near term. These are also negatives for precious metal prices.
Finally, it is likely that concerns about Italy will return if Italy’s fiscal balance will get into focus again later in the summer. This will weigh on the euro but also on platinum prices as the euro zone is an important market for platinum

In such an environment, holding gold is seen as a cost, not an opportunity. Although market turnover has been high, the bulls have not been in evidence and prices have remained depressed.
BUT HOPE STILL PERSISTS.

Though precious metals are expected to fall, hope still prevails over the factors that support gold prices.

U.S. - By the end of the year US dollar and 10y Treasury yields are expected to peak. Which further pours in the thought that it might pull down from its peak? Lower US growth could result in a downward adjustment in demand.

Moreover, we expect the fall in the Chinese Yuan to come to an end as Chinese authorities will probably intervene to calm sentiment. We find it hard to imagine the Chinese authorities letting the Yuan drop in an uncontrolled manner. However, in the near-term, Yuan weakness may yet continue. In addition, our base case scenario is that a significant escalation of the trade conflict is averted. This should support all precious metal prices.

We expect gold prices to bottom out between USD 1,200 and 1,250 per ounce and silver prices between USD 15.2 and 15.6 per ounce. We see these levels as an opportunity to position for higher gold and silver prices next year.

If sentiments were to change and, for example, growth was to slow in the U.S. in reaction to trade concerns, then gold could make headway. But while the dollar is king, gold will remain lackluster despite rising tensions.

In the near term, we expect weakness in gold to persist, before investors flock to gold’s safe haven status in light of the ongoing trade and geo-political tensions – and the attendant negative consequences that might ensue

Gold expected to be markets favorite soon

Last week we saw divergence in U.S and European Monetary policies. European politics too witnessed similar events. This affected gold prices and it hit a six month low as the dollar hit an 11 month high.

Gold prices are down for the second consecutive week with the precious metal off more than 0.70% to trade at 1269 ahead of the New York close on Friday.

The Federal Reserve hiked U.S. interest rates again this month, while the European Central Bank said its benchmark rates would not rise until after the summer of 2019.

Rate hike strengthened the US dollar while. Gold is trading at a six-month low in the global market.
The decline came in alongside losses in global equity markets this week as mounting geo-political tensions regarding a looming trade war continue to weigh on risk appetite.

TRADE WAR - The intensification of rhetoric between China and the U.S. has continued to weigh on market sentiment as investors weigh the impact of an all-out trade war between the world’s largest economies. While these concerns would typically be supportive for the yellow metal, expectations for higher rates and persistent strength in the US Dollar have kept prices under pressure with gold breaking to fresh yearly lows this week.

US Data - things have been quiet on the data front but look for that to change next week with U.S. Durable Goods Orders and the third and final read on 1Q GDP on tap. Highlighting the economic docket will be the May read on Core PCE (personal consumption expenditure) on Friday. Consensus estimates are calling for an uptick in the Fed’s preferred inflationary gauge to 1.9% y/y. A strong print here would likely see traders continue to price in a fourth rate-hike from the central bank this year- a scenario that would weigh on gold prices.

Gold prices edged up on Friday from six-month lows as the dollar slipped, but the modest nature of the recovery suggested speculators might still be poised to punish the metal further.

Gold tumbled last Friday after repeatedly failing to surmount the $1,300 level as speculators rushed to liquidate long positions and others put on bearish positions.

The dollar pulled back from an 11-month peak against a basket of major currencies on Friday, as the euro strengthened after a survey showed euro zone private business growth recovered in June. A weaker greenback makes dollar-denominated gold cheaper for holders of other currencies.
Now a matter of concern is that even though the dollar weakened, gold did not react much to it. Now we need to keep an eye on the movement of the yellow metal as too many powerful forces are expected to drive gold prices higher.

Geopolitical fear is the major force that is expected to exert its pressure on gold.  The crises in Syria, Iran, the South China Sea, and Venezuela are not going away. Despite Trump’s summit with Kim Jong Un, don’t expect the North Korean nuclear issue is over.

The headlines may fade in any given week, but geopolitical shocks will return when least expected and send gold soaring in a flight to safety.

Moving on to Italy. Italy’s debt to GDP ratio is amongst the highest in the world.  As the new government in Italy seeks to stimulate growth through increased borrowing, gold’s attractiveness as an asset which is not replicable and is no one’s liability will become more apparent.

Gold is the most forward - looking of any major market. It may be the case that the gold market sees the Fed is tightening into weakness and will eventually over-tighten and cause a recession.

At that point, the Fed will pivot back to easing through forward guidance. That will result in more inflation and a weaker dollar, which is the perfect environment for gold.

Meanwhile, there are numerous risks such as international trade conflicts, political crises, the dispute over Iran sanctions and high-priced stock markets that could be ripe for corrections.