Gold: going with the feeling

Will the Year of the Fire Monkey turn out to be the year of another gold rush? The answer lies in the hands of investors interested in this metal.

After four long years in the wilderness, gold is again aglitter. 1205 dollars/ounce^* sees it only 37% short of its all-time high of USD 1921 that dates back to 6 September 2011. Do these figures inspire belief that this precious metal will surprise on the upside this year? And will it keep portfolios safe from equity market whims?

Answers to these questions will take into account the factors that usually drive the price of gold. The first, and surest, is the US real interest rate, to which gold is – and has, regularly in the past, proven to be – inversely correlated. The minor fall in the rate since the start of the year was actually beneficial to the gold price. And now it all boils down to whether this downward trend is going to continue or not. For it to do so, the US economy would have to go into recession. Although this may well come to pass, it is not our core scenario, which leans more in favour of a recovery. Consequently, we no longer see the gold price as being supported by real interest rates. That said, there’s also little chance of a price decline. For the price to fall, US interest rates would have to spike and, for there to be a spike, the economy would have to be firing on all cylinders, a scenario which the markets are not currently anticipating.

A second factor often highlighted by analysis is the fluctuating dollar: the stronger the greenback, the weaker (usually) the precious-metal price, and vice-versa. If, as foreseen in our core scenario, the US currency does stabilise in 2016, this should still leave the gold price unscathed. Nonetheless, as US currency changes are heavily dependent on changes in the real rates, this takes us back to our opening remarks.

The level of geopolitical uncertainty is usually considered another decisive factor in the sense that gold is the safe-haven security par excellence at times of crisis. That, however, is only partly true. During the recent phase of the declining gold price, Europe experienced some genuine mini-crises without any lasting impact on this precious metal, Greece being a case in point.

Only when geopolitical uncertainties spread onto the equity markets, prompting a correction phase, does gold assume its protective mantle: unlike risky assets, gold remains stable or even goes up a notch. That’s what we’re witnessing at the start of 2016. However, the effect is not long-lasting and is not even a default occurrence of each crisis: gold was no more a safe haven in 1981-1982 than it was in 1998. In other words, growing uncertainty does not always equate to an increasing gold price.

In the commodities sector, the relationship between supply and demand is usually highly indicative of the direction in which prices are headed. In the case of gold, this ratio has only a marginal impact. In the first place, production represents only a small fraction of the available global stocktake. World Gold Council data figures show stock levels of 183'600 tonnes as at end-2014 while production levels that same year amounted to 4’400 tonnes (4'258 tonnes in 2015). 2016 foresees stable production levels. In the longer run, although certain analysts foresee production capacity trending downwards (gold scarcity), this would be a highly marginal determinant of price fluctuations, as was demonstrated by the so-called “end-of-oil” drama.

Demand, for its part, remained practically unchanged between 2014 and 2015, even if – prompted basically by the sharpened demand from central banks and investors – it did jump by 4% in 4Q 2015. The latter are having a bigger-than-ever say in matters gold, especially with the new ETPs (Exchange Traded Products) in gold, which, through being continually listed, and representing a significant volume of metal (sales of 915 tonnes from an annual production of circa 4200 tonnes in 2013), may be considered as momentum products. Gold is bought and sold on a hunch. And as the creation of ETPs on gold automatically entails the purchase of gold, that creates an upward spiral or, in the opposite case, a downward spiral. Portfolio protection is better guaranteed by opting for well-diversified strategies that can, to an extent, be defensively managed, rather than going for gold.

^*price as at 15 February 2016