Philip Newman: Gold price expected to strengthen this year

Following the price decline in gold during the last two months of 2016, the mood in the market is understandably cautious on the yellow metal. It is important to remember, though, that most factors that boosted precious metals in the first half of 2016 are likely to remain relevant through this year. 

First, regardless of whether there are two or three policy rate hikes in the US, real short-term rates there will almost certainly remain negative for some time to come. Second, so will real and, in some cases, even nominal rates across some other key reserve currencies. Third, many of the tail-risks that encouraged safe-haven purchases of precious metals are, if anything, of greater concern at the start of 2017.

This year, we expect to see firmer prices, in large part, driven by the return of investor demand. Gold prices have already strengthened this month, although this reflects a rebound from oversold market conditions in late December and, subsequently, some short covering. We believe there are more sustainable reasons to expect prices will improve this year. 

The most important among these concerns is the US Federal Reserve’s interest rate policy. Despite the hawkish sentiment, nominal rates will almost certainly remain historically low this year and negative in real terms. Inflation creeping up, albeit modestly, should also guarantee this outcome. Negative policy rates outside the US are also likely to remain a theme. While Donald Trump’s victory is still, on balance, seen as a positive towards US growth, we believe the new President’s “wild card” approach will eventually proliferate global uncertainties. This will, in turn, boost safe-haven demand. Finally, in our view, there remain significant risks of equity market corrections.

There also remains a question mark as to how much price support the physical markets will provide. For gold, 2016 was exceptionally difficult, especially for the biggest consuming markets of India and China. This year could remain challenging, given the ongoing crackdown in India and the pessimistic mood across much of the Chinese jewellery trade. 

Focusing on India, though we expect gold prices to strengthen this year, the increase will be modest. As a result, this is unlikely to have much impact on the country’s gold jewellery and bar demand. Far more significant, in our view, will be the impact of government policy. In particular, the ongoing crackdown on undeclared income and the interplay between a new goods and services tax and any changes in import duties. The former, in particular, is likely to add uncertainty to the domestic gold market. 

Even so, following an extremely challenging 2016, we do expect this year to deliver a recovery in Indian gold demand. That said, business there is likely to adopt a more cautious approach, given the events of last year. For example, we would expect to see the retail sector, especially chain stores, implement a much slower pace of new outlets. As a result, given the potential for the government to surprise the market, it is too early to say if the Indian gold sector, enjoying a healthier 2017, will be able recoup all the losses it sustained last year. 

Overall, therefore, this should not prevent gold from recovering, on the back of healthy investor interest. We are forecasting its price to average $1,285 an ounce this year, a rise of three per cent year-on-year.
 

The author is founding partner at Metals Focus, a London-based independent precious metals consultancy