In this publication: 2016 was a year with two halves for gold prices: a strong rally in the first half of the year and a sell-off in second half. Gold prices had a positive start to the year as often happens, but we expect weakness to return in H1 2017 before a consolidation in H2 2017. We keep our year-end target at USD 1,100 per ounce.170105-Precious-metals-watch.pdf ()
2016: the year of two halves
2016 was a year of two halves for gold prices. The first half of the year was far more positive than many would have imagined. This was mainly the result of financial markets’ expectations that a rate hike by the Fed would come at a later stage because of weaker US economic data and uncertainty on financial markets. This weighed on the US dollar and gave support to gold prices. Moreover, accommodative monetary policy elsewhere and political uncertainty also pushed gold prices higher. When investor sentiment on financial markets recovered quite remarkably after the Brexit vote on 23 June 2016 and the US dollar failed to weaken further, the outlook for gold prices slowly started to change. We recognised this and changed our outlook to negative on 12 October 2016 with the remark that a Trump election outcome would be supportive for gold prices. This support was extremely short-lived (a few hours). The failure of gold prices to move and stay above USD 1,350 per ounce set off alarm bells. The Trump reflation trade resulted in an aggressive sell-off in gold prices as investors dumped their gold positions and moved into more attractive options. Since the US elections gold prices have declined by 8%.
The aggressive sell-off in gold prices and position liquidation have been more substantial than we had expected. For example net-long speculative positioning in the futures market has been reduced considerably to just below the average level of net-long positions of 100,000 contracts (see graph on the left above). We had expected such a reduction in the first half of 2017. Moreover, there has also been quite a reduction in total ETF positions (see graph on the right above), which tend to be stickier. For the full year of 2016, gold prices increased by 8%.
January effect in gold prices?
Since 2000 gold prices have had a tendency to have a positive start to the year with prices rising in January 65% of the time. The positive starts to the year happened regardless of whether the year before had ended on a positive or a negative note. 35% of the time, prices declined in January. What is remarkable is that these January price declines followed a positive performance the year before. The first few days of this year have started positively for gold prices, which has happened in the most of the preceding years. Gold prices have recovered since 15 December when the rise in US 10y Treasury yields lost momentum. This has continued. The gold market is now more focussed on inflation. Higher-than-expected US inflation numbers will probably support gold prices. However, if US data (excluding inflation data) continue to come in strongly as we expect, this positive short-term momentum is likely to fade.
We remain negative on gold for 2017
We expect the outlook for gold prices for the first half of the year to remain negative. Investor demand remains the most crucial driver pushing gold prices lower. From an investor point of view there is little reason to hold gold as an investment. For a start, rising inflation expectations are more than countered by the rise in US Treasury yields and expectations about upcoming rate hikes by the Fed. A further rise in US nominal and real yields is likely to continue to weigh on gold prices (see graphs below).
As long as US real yields rise and there are no major inflation fears, gold prices will go lower and not higher. Moreover, the last leg of a powerful rally in the US dollar is currently in full swing. This is a powerful cyclical rally in which higher US equities, expectations of further Fed rate hikes and expectations of a strong uplift in the US economy drive the US dollar. If US economic data in the coming weeks and months surprise positively as we expect it is likely that investors will continue to liquidate gold positions. In such an environment, gold prices could drop below USD 1,100 per ounce and approach the 2015 low of USD 1,046 per ounce. However, as the net-long speculative positioning in the futures market is already below the average level and ETF positions are slightly more sticky, the decline in gold prices may come at a slower pace than was seen in the last weeks of 2016. We expect prices to bottom out in the USD 1,046 – USD 1,100 per ounce range.
At some point in 2017, the Fed rate hikes we expect (three of 25bp each) will be fully reflected in the gold price and inflation expectations may start to rise more quickly pushing US real yields lower. What is more, we expect a recovery in industrial and jewellery demand for gold. So despite the negative outlook for gold prices in the first half of 2017, we expect prices to stabilise during the remainder of the year. It is likely that events in 2017 will form a basis for gold prices to rise in 2018.