The gold price has fallen to a 20-month low amid sharp emerging-market currency depreciation, the World Gold Council (WGC) reported on Thursday.
It stated that the gold price had lost 3% in August, a downturn that was exacerbated by gold’s fall below $1 200/oz – an important technical support level – for the first time since early 2017.
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“We believe the gold price may bounce back,” it added.
Consumer demand is likely to be supportive in the second half of the year and short positioning may quickly reverse, should one of the many current macroeconomic risks materialise, increasing investment demand.
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Gold was driven down by the strength of the dollar against both developed and emerging-market currencies, particularly, a weakening of the Chinese yuan first and the Turkish lira later.
“In fact, the dollar’s strength has been one of the most important drivers of gold’s performance this year, as confrontational trade rhetoric and sanctions have played in favour of the US, so far,” said the council.
Additionally, both the European Central Bank and Bank of Japan have delayed policy rate hikes, increasing differentials between interest rates in the US.
The WGC said gold may rebound owing to both technical and fundamental reasons including a short market, financial market uncertainty remaining and natural buyers that may step in.
SHORT MARKET
In recent years, a large increase in short positions has been followed by a sharp rally in gold. “And while net shorts were more prevalent in previous decades, there have been structural changes that make these positioning levels different and likely short lived,” stated the WGC.
These changes include economic development in emerging markets, especially in China and India, that has increased and diversified gold’s consumer and investor base, as the combined share of annual demand of those two markets has doubled over the past 20 years from 25% to 50%.
For almost a decade, the expansion of emerging market foreign reserves has resulted in net gold demand by central banks – about 500 t/y – as a source of return, liquidity and diversification.
Gold production hedging has also changed dramatically, as miners have not only reduced forward sales but also consistently de-hedged their cumulative positions since 2000.
The opportunity cost of holding gold is considerably lower as nominal and real interest rates are about 3% below their average level during the 1990s, the WGC pointed out.
However, it said a bounce back in the gold price can only be sustained if there are fundamental reasons to encourage consumers and long-term investors to seek exposure to gold.
FINANCIAL MARKET RISKS
Historically, risks that have been contained within an industry or region – even with an accompanying surge in local gold demand – have not been enough to push the gold price higher in US dollar terms. Yet, when these risks become widespread, flight-to-quality flows have resulted in higher dollar gold prices and reduced portfolio losses.
The WGC said that, so far, market volatility has been relatively low, yet investors remain wary. An example of this can be seen by the increase in flows from equity to bond funds over recent months, as well as the consistent flattening of the bond yield curve in the US.
The current US expansion is the second longest in history; it has delivered the longest stock bull market in modern times, pushing valuations to multiyear highs while real rates remain subdued.
So far, the effects of trade sanctions have mainly affected emerging markets – such as China or Turkey – but expanding or maintaining sanctions for a longer period will likely damage global economic growth.
Developed market economies are heating up. Increasingly nationalistic economic policies in many countries, combined with a desire by some governments, if not central banks, to maintain competitive currencies by means of low interest rates, may result in higher inflation, the WGC said.
It noted that although European economies are expanding, risks – ranging from Brexit negotiations to financial institutions’ exposure to emerging market debt – may create a spillover effect that, to date, has been averted.
“The past has shown that any of these risks can be the catalyst that elicits strong investment demand.”
UPSIDE POTENTIAL
A period of heightened geopolitical risk with the potential to impact the global economy could be supportive of gold even if the dollar were to strengthen.
Gold could trade lower if the US dollar increases its strength, but in the light of positioning in US, and increased interest from buyers in China and India, the risks seem skewed towards a recovery.
“As such, we believe that investors can benefit from holding gold as a strategic asset,” the council stated. 