Each Quarter FastMarkets and Sucden Financial produce an analysis and forecast report on the precious and base metals – The Sucden Financial Metals Reports, Oct 2015.
Below is the Gold report, to read the full report covering all the metals in pdf form click here.
Subscribers have access to these reports before they are published through the research tab in FastMarkets Professional.
Gold – Navigating an unsupportive macro environment
Gold prices came under selling pressure in the third quarter amid an unfriendly macro environment stemming from divergence between emerging market (EM) and advanced economies. Although we believe that this tough environment will continue to undermine gold prices in the fourth quarter, near-term appreciation is possible because of several potential tailwinds, including renewed interest in safe-haven assets amid heightened uncertainty, a more dovish Fed, and a strong seasonal period.
Overall trend – Gold prices fell about three percent in the third quarter to a 2015 low of $1,078 per ounce, reflecting weak sentiment, but a recovery seems to have emerged since August, supported by factors including heightened uncertainty following the PBoC’s decision to let the yuan depreciate, lower Fed tightening expectations following the FOMC’s decision in September to leave rates unchanged and a pick-up in physical demand out of Asia due to seasonal patterns.
Divergence between EM and developed economies: bearish for prices – Gold, despite its good performance earlier this year, has remained in a downward trend. The divergence in growth between EM and developed economies has produced an increasingly unsupportive macro environment for prices. Generally, gold has an inverse relationship with the dollar and US real interest rates while it is positively correlated with global inflation expectations. Although the US economy has returned to moderate growth after slowing in the first quarter, the dollar and US real interest have moved higher, reflecting growing Fed tightening expectations, which in turn have spelled trouble for gold prices. In contrast, EM economies have continued to experience a broad-based economic slowdown this year, with China the epicentre. This has weighed on commodity prices and generated disinflationary pressure in the rest of the world, in turn pushing gold lower.
Weak speculative and investor sentiment likely to persist in Q4 – The weakness in gold prices stemming from this challenging environment is reflected in the decline in the net speculative length as well as gold ETF selling. Net speculative long positions on COMEX have fallen about 8 million ounces so far this year, while ETF holdings have dropped by roughly 9 million ounces. We expect speculative and investor sentiment to remain weak while global growth divergence persists – the continuing improvement in the US economy will prompt the Fed to reduce monetary accommodation, which in turn will tighten financial conditions in EM countries and dampen economic growth further.
But potential tailwinds could warrant near-term appreciation in gold prices – The strengthening in gold since August could continue early in the fourth quarter thanks to some bullish factors. First, gold tends to perform well in times of uncertainty, as it did in August when the PBoC let the renminbi depreciate, triggering severe turbulence across financial markets. While we do not expect China’s central bank to let the yuan weaken much further, its unexpected move has made investors more anxious, which could persuade them to turn from higher-yielding assets such as equities to safe-haven assets such as gold. Second, the Fed left interest rates unchanged at its September FOMC meeting, which has pushed the greenback and US real interest rates lower, triggering a short-covering rally. The Fed’s dovish stance is likely to continue to provide some short-term support to prices. Third, with the festival season coming up in Asia, physical demand could rise, particularly given weak domestic prices. In India, jewellery demand for gold could be solid ahead of the wedding season and Diwali in November, especially if the annual monsoon season proves better than expected. China’s gold reserves as a percentage of its total reserves are around 1.6 percent, gold makes up an average of 67 percent of the reserves of the US, Germany, Italy and France.
ETF investors sold 68 tonnes of gold in the third quarter after selling 25 tonnes in the second and buying 20 tonnes in the first. We attribute this to multiple headwinds resulting from the overall macro environment.
The net spec length has fallen about 90 percent this year, with money managers turning net short in mid-July and net long again in August. While there may be some short-covering in the near term, spec interest should remain low in the fourth quarter.
Gold prices and US real interest rates tend to have a strong negative correlation (-0.86 from 2012 onwards). The steep rise in real interest rates in the third quarter coincided with a sell-off in gold. Similarly, the pause in the upward trend in real interest rates after the Fed made no change to interest rates seems to have supported gold’s recovery since August.
The world’s central banks, net buyers since 2010, have continued to buy this year albeit at a less aggressive pace than the 2012 peak. CIS countries were the largest buyers in the second quarter, especially Russia, reflecting a diversification strategy. But EM countries could slow the pace of buying this year should their FX reserves come under pressure from tighter US monetary conditions.