Gold: from neutral to positive

We upgrade our view from neutral to positive. Gold prices have undergone an impressive rally in the first quarter of 2016 and gold seems to have fully recovered its safe haven status. Both fundamental (supply and demand) and technical factors lead us to conclude that the gold price trend has turned for the better and could continue to rise in the coming quarters. Gold is also interesting as a portfolio diversifier. As the rally has been strong and rapid, bullion was overbought at the end of March. The ongoing retracement could offer attractive medium-term entry points. We adjust our 12-month trading range to USD 1150 – USD 1400/oz.

Recent change

After having reached a peak of $1921 per troy ounce in 2011, the price of gold declined in the last four years to reach a low of $1050/oz. in December 2015. While gold did not play a safe haven role during the stock market turmoil in 2015, it has risen by 16% over the first quarter of 2016 as the influx in gold ETFs reached record-breaking heights. The price per troy ounce stood at $1,234 on March 31.

Our analysis

Supply

The focus on cost reduction has led to significant cuts in gold mines’ capex and exploration. This should support gold prices over the medium term. The global gold production is expected to fall by 3% in 2016. Gold production tends to lag discoveries by around 20 years. Data shows that production steadily increased from 2008 to 2014. It may be that 2015 was the year that gold production peaked – 20 years after the 1995 peak discovery. There was a dramatic fall-off in new discoveries from 2008 even as prices surged to record nominal highs in 2011 when one would expect the search for new deposits to have intensified.

Demand

In Europe and Japan, investor concern over negative interest rates appears to have lent some urgency to western investment demand.  Physical buying by emerging countries, China, India and Russia in particular, has recovered since 2H 2015. Central banks have also increased their reserves.  There has clearly been an uptick in general investor concern about the eroding effectiveness and potential overreach of global central bank policies. We expect this concern to remain an important component of the investment landscape in the coming quarters, with positive implications for gold and gold shares.

Technical buy signal

We have just had a so-called “golden cross” (rising 100 days moving average crossing the 200 days mav.) which is viewed as a buy signal as it often precedes a bull market.  Gold seems to have fully regained its safe haven status:
 

• Gold was not a good safe haven asset during the market turmoil in 2015 as a strong dollar, the prospect of multiple Fed funds rate hikes and the absence of inflation were major headwinds. Since then, the dovish tone of the Fed, a somewhat weaker USD and risks of inflation shock after a period of ultra-low oil prices are helping the precious metal.
  
  
• If risks (geopolitical, economic or financial market instability) intensify, gold could continue to attract safe-haven interest.
  
  
• Gold can play an important portfolio-diversifying role especially during periods in which faith in U.S. financial assets is being challenged. Historically, the performance of the S&P 500 index and gold shares displays strong inverse correlation.

Risks

Gold ETFs have seen a huge inflow during the first quarter when the global equity market was trending lower. If volatility decreases and confidence in risky assets returns, the risk is of seeing a switch out of Gold ETFs.

Strong economic figures could trigger new speculations on additional Fed funds rate hikes and push the US dollar higher. The prospect of a better remuneration of the USD could be detrimental to gold prices. Investors having chosen gold as a hedge against hazardous monetary policies could also revert their trades.