Gold Will Soon Shine Again

Why has gold suffered recently?

The Trump trade wars with the rest of the world are having negative effects on recipient countries, in particular, emerging economies, Europe and Japan. The introduction of harsh trade tariffs could mean slower global growth and that has had a negative impact on prices of base metals and commodities in general. Sentiment that the US economy will power ahead, stimulated by domestic tax cuts whilst the rest of the world struggles with the trade tariffs has boosted the US dollar. The strength of the US currency is burdensome for emerging economies with current account and public deficits, in particular if a large proportion of their debt is US dollar denominated (e.g. Turkey).

The renminbi and other emerging currencies have depreciated significantly, raising the risk of currency wars. Meanwhile, Italian political uncertainty and Brexit jitters weigh heavily on the euro.

A strong US dollar and further expected US rate hikes are detrimental to gold (quoted in USD per ounce) which pays no interest/dividend. Within this context of intensifying trade wars, the US dollar appears to be a better safe haven than gold.

What do we expect?

Our Strategy team maintains the view that Trump’s principal agenda is to demonstrate to his constituency and fellow Republicans that he is delivering on his campaign promises and that he can accomplish better trade deals for the US. His primary objective being to secure the Republican majority at the House of Representatives and Senate at the midterm elections in November. To enhance his chances, he needs good stock market performances and some diplomatic successes.  Trade tensions should, therefore, deescalate around the midterm elections.

Trump’s negotiation technique is brutal and highly disturbing for his trade partners,  but the affected markets should recover rapidly as things calm down since global growth fundamentals remain solid.

What’s our view on the USD?

Our view on the dollar remain bearish:

•At 1.15 versus the euro, the US dollar is still overvalued (the purchasing Power Parity computed by the OECD is at 1.28) and the euro is supported by a strong current account surplus.

•Next year the ECB will begin hiking its REFI rate while the Fed will have already completed its normalisation process.

•US growth should slow down next year  (from ±3% in 2018 to ±2% in 2019). So growth and interest rate differentials between US and Europe should narrow .

Since the beginning of August, increasing trade tensions have had a positive effect on the US dollar. But Trump’s recent comments accusing China and Europe of being currency manipulators as well as his critics of the Fed have had the opposite effect.

In conclusion, we expect a weaker dollar as the US economic cycle should weaken after the effects of fiscal reform are absorbed. This should assist gold prices. However, in the very short term, trade tensions could again push the US dollar temporarily higher.

Gold fundamentals remain positive

Historically, gold prices have largely been driven by just three main factors: central bank policy, changes in longer dated energy prices and changes in central banks’ gold reserves.

•Real bond yields matter for gold as the precious metal does not provide any income. The  competitive power of US Treasury bonds remains weak as 10-year yields are close to the inflation rate (US CPI was at 2.9% in July while the 10-year UST remains around 2.85%). Real interest rate expectations remain low. Real bond yields are expected to be remain negative in Europe and Japan for a while.

•Energy prices matter for gold as 50% of gold mines’ production costs are closely linked to energy prices. Energy prices have risen quite a lot this year.

•Since 2008, emerging market central banks have been net buyers of physical gold. This will continue especially for countries like Russia that seek to diversify their reserves away from US Treasury bonds .

•Furthermore, a new dynamic is the increasing popularity of gold ETF’s among Chinese investors. Bosera Gold Open-End ETF, listed in Shenzhen, has taken the equivalent of 1 billion US dollars this year, making it the second-most popular ETF backed by a precious metal.  

•Gold mines’ supply remains constant due to the lack of investment in recent years.

•Geopolitical risks have receded but not disappeared (North Korea, Syria,...)

Market positioning

Speculative short positions on COMEX gold futures exceed, for the first time in 17 years, long positions.  The net short positions in gold futures on 14th August reached 1.16 million ounces. This occurrence usually precedes a strong rally.

Summary of the strategy view

Although we cannot exclude a new period of increasing trade tensions in the short term and a stronger US dollar which could weigh temporarily on gold prices, we do think that the recent gold price weakness is exaggerated and out of line with the precious metal’s fundamentals. We maintain some exposure to gold in our portfolios as a hedge against tail risks, be they inflation or geopolitical and we reiterate our expected trading range of 1200-1350$/oz.