In this publication: Sharp rally in prices since the Brexit referendum and we expect higher prices in Q3 2016. But profit taking in Q4 2016 and Q1 2017 because of anticipation of Fed rate hikes in 2017. We expect such a sell-off in prices to be temporary and to be an opportunity to position for higher prices afterwards as the overall longer-term outlook remains bullish.
160706-Precious-metals-watch.pdf (2 MB)
Sharp price rally since the Brexit referendum
We have been asked three questions lately. Why have gold and silver prices rallied sharply? Why has silver outperformed gold? Do we expect further upside in prices? Gold and silver prices have rallied substantially since the Brexit referendum and silver has considerably outperformed gold prices. Safe haven demand, the market pricing out of Fed rate hikes this year and next year and more BoE and ECB monetary policy easing are the main reasons behind the price rally. In addition, silver’s outperformance is mainly a catch-up to gold in thinner market conditions as silver prices were relatively more attractive. Our forecasts for the end of September (USD 1,350 per ounce gold) and end of December (USD 20 per ounce silver) have been reached. This has resulted in a sharp drop the gold/silver ratio (in line with our view). What is more, speculative net long positions in both gold and silver are excessive and make prices vulnerable to an abrupt change in sentiment. Though the overall outlook is positive.
Replay of April-May?
There are some concerns that we may see a replay of the end of April’s price action. The month of May brought sharply falls in both gold and silver prices because financial markets started to anticipate for Fed rate hikes this year. Will this also happen in July, August or September? We don’t think so. We don’t expect Fed rate hikes this year (in line with market consensus) and the anticipation of possible Fed rate hikes in 2017 is still 3 to six months away. There is a risk that stronger-than-expected US data and/or surprisingly hawkish Fed commentary would start this process earlier. But this is not our base case. In addition, the environment remains very supportive gold and silver. For a start, we don’t expect a strong rally of the US dollar (only versus sterling) and this will help gold and silver prices as they are proxy currencies. Moreover, demand for safe haven assets will likely be alive in the short-term.
Any sell-off to be temporary as longer-term outlook remains positive
The overall bullish outlook for precious metal prices will not change in our view. The reason behind the Fed rate hikes is crucial for its effect on the US dollar. We expect moderate US growth and some pick-up in inflation expectations triggering the Fed to hike rates. This is not a major bull-case for the US dollar as US real rates will unlikely move higher. This will remain a supportive driver for gold and other precious metal prices.
In addition, as the graphs above show gold and silver prices are still at relatively attractive levels despite the rally so far this year. They should continue to attract investors as central banks globally (such as the BoE and the ECB) continue to have accommodative policies and prices of other assets with some safe haven characteristics are more expensive. Net-long speculative positions in gold and silver may be extreme, but total positions in gold ETFs are far from extreme and still have room to increase (see graph below).
Moreover, slowly but surely we expect global growth to improve modestly over time and this should result a some upward adjustment in cyclical demand expectations for silver, platinum and palladium. This and the relatively attractive price levels of cyclical precious metals compared to gold should result in an outperformance of silver, platinum and palladium compared to gold.
To reflect all the dynamics above we have adjusted our precious metals forecasts. We now expect more strength in gold and silver prices in Q3. We have adjusted Q4 2016 and Q1 2017 forecasts to reflect the temporary impact of expectations of Fed rate hikes in 2017. This would be an opportunity to buy precious metals as the long-term trend remains positive.