Precious Metals Weekly – Outlook 2016

by: Georgette Boele

Precious-metals-weekly-1-December-2015_.pdf ()

Substantial price weakness in 2015…
…and weakness to continue in the months ahead
We maintain our negative outlook for gold prices in 2016…
…followed by a recovery in 2017
Cyclical precious metals to recover in 2016 and 2017

Substantial price weakness in 2015…

So far this year, cyclical precious metal prices such as platinum and palladium have weakened substantially; by more than 30%. Meanwhile, silver and gold prices have only lost around 10%. This has been the year in which all precious metal prices fell. Why have platinum and palladium prices declined by such a large extent? For a start, investors have aggressively liquidated open positions (speculative and ETF positions) in both precious metals. Investor sentiment has deteriorated because of the worries about the demand outlook in major platinum and palladium markets. In addition, the emission scandal has also given a blow to the near-term investor sentiment and the demand outlook. Last but not least, the prospect of a Fed lift-off in December and strength of the US dollar have weighed on all precious metal prices.


…and weakness to continue in the months ahead

We expect investors to continue to liquidate positions in the months ahead because of a higher US dollar and higher US rates. It is likely that new lows in prices will be reached before the end of the first quarter of 2016. We expect gold prices to break below USD 1,000 per ounce in the coming months. Silver prices could drop to USD 13.5 per ounce while platinum and palladium prices could drop below USD 800 per ounce and USD 500 per ounce, respectively.



We maintain our negative outlook for gold prices for 2016

Gold is the precious metal that has the closest ties to developments in monetary policy in the major economies such as the US. The upcoming Fed lift-off has weighed on gold prices because the divergence on what is paid on gold and on US dollars increases. In an environment of optimistic investor climate, investors search for better yielding opportunities and assets that are sensitive to global growth. Gold as an investment asset does not hold these attributes. It is often in demand when investors worry about global growth, (geo) politics, the US dollar and inflation, a so-called safe haven. Gold prices may be supported in waves of risk aversion. However, when there is systemic risk in financial markets it will not behave as the ultimate safe haven asset. For example, at the height of the global liquidity crisis (when there was a shortage of liquidity) gold prices dropped sharply because investors valued cash more than gold. This suggests that at times of severe crises, gold could not live up to its safe-haven status.

We expect the Fed to raise rates very slowly in 2016, but even this scenario is not priced into markets. A rise in US Treasury yields should push gold prices towards USD 900 per ounce or even below in 2016 mainly because of investor position liquidation. Some may wonder why investor liquidation has such a substantial impact on prices. The graphs below show the physical demand sources for gold. Jewellery still accounts for the most important source of demand but it has declined over the years. In September 2015 it accounted for slightly more than half of the demand, while it was around three-quarters in March 2000 (quarterly data). This decline has being felt in gold prices. Moreover, gold’s use for industrial purposes has also decreased. In general, the most stable forms of demand are jewellery and industrial demand. Meanwhile, retail investment has risen sharply. This is the most volatile and fluid form of demand. Over the recent years, retail demand has pushed prices to the peak in September 2011, but also to the current levels close to USD 1,050 per ounce.


…but a recover in 2017

For 2016, the direction in Fed policy compared to market expectations and the US dollar (higher) will mainly be negative for the gold price denominated in US dollars. However, as we expect the US dollar to peak we also expect the gold price to bottom. Therefore, we expect gold prices to pick up in 2017. Lower mine supply and healthy jewellery demand should also provide support to gold prices in 2017.

Over the coming years we expect retail investment share in total gold demand to increase further. As a result, gold prices will become more sensitive to the behaviour of investors. Gold is not only bought as a protection for uncertain times but also for speculation. The latter goes completely against gold’s safe-haven character and at times it more than overshadows it. Significant investor activity could indicate that it is used for speculation rather than safe haven. If you were to buy gold for safe haven purpose you would invest in physical gold and not in a gold-related product.

Cyclical precious metals to recover in 2016 and 2017

Currently investors are unwinding their positions in the cyclical precious metals and this will likely continue in the months ahead. Below the surface fundamentals continue to improve. We are constructive about domestic demand outlook for the US and the eurozone for 2016 and 2017. In addition, we expect the consumption in China to remain relatively stable. Therefore, we expect demand for autocatalysts, industrial and jewellery demand from these countries to increase. When investors start to focus on these underlying fundamentals, investor demand will also turn positive again, especially when the US dollar starts to weaken in 2017. The low platinum and palladium prices have triggered efficiency waves with major mining companies. Therefore, mine supply will likely decrease in the coming years. This should also provide support to prices.