Precious Metals Watch – Close to the bottom

by: Georgette Boele

  • Hawkish central bank officials and higher US real yields have sent precious metal prices lower
  • Gold, silver and platinum prices are close to the bottom in our view
  • We have downgraded our gold, silver and platinum price forecasts
  • Our new year end gold forecast is USD 1,210 (was USD 1,300)
  • We expect higher gold, silver and platinum prices in 2018
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Introduction

There is currently a tug war going on between US real yields and the US dollar for the most dominant driver for precious metal prices. Higher US real yields have tended to be negative for precious metal prices while a lower US dollar has tended to be positive for precious metal prices. Since 2004, the introduction of ETFs into the gold market, gold and other precious metal prices have increasingly been driven by financial market drivers rather than traditional supply and demand dynamics.

  

Since mid-June, precious metal prices have fallen sharply (5% gold, 9% silver, 6% platinum, 2% palladium), despite dollar weakness. There are several reasons for this. For a start, the Fed and other central bank officials have turned more hawkish and that has wrong-footed financial markets. As a result, government bond yields have risen, expectations about monetary policy have been adjusted upwards and currencies of countries with hawkish central bank officials have risen with the exception of the US dollar. Moreover, inflation expectations have moved lower as inflation data have surprised on the downside. With higher nominal yields and lower inflation expectations, real yields have risen. This has been a major negative force for precious metal prices. Higher real yields have more than overshadowed the effect of the lower US dollar on precious metal prices. In this report we review our precious metal price forecasts taking into account our downward adjustment in our Fed view, US treasury yield forecasts and US inflation outlook.

New dynamics…

We think that the dynamics behind the drivers of precious metal prices have changed substantially. Whereas in the past US real yields and the US dollar moved in tandem, recently this pattern has broken down. US real yields and the US dollar will likely diverge for longer. This is because although US real yields have risen, real yields in other countries have risen even more. As a result, the US dollar has had a disadvantage. For precious metal prices, real yield developments are currently the driving factor. We expect that we have seen most of the rise in US real yields for this this year. As a result, the sell-off in precious metal prices should ease.

  

Even though we now expect less rate hikes in 2018 (2 instead of 3), our Fed view of one 25bp rate hike this year and two rate hikes next year is still above what is priced in by financial markets. Therefore, higher official rates in the US will probably weigh on precious metal prices. What is more, we expect the US dollar to remain under pressure, because yield spreads with other currencies will probably not move in favour of the US dollar. Usually this is a positive factor for precious metal prices. This is still the case for gold and palladium prices. So a weaker US dollar dampens the downside in gold and palladium prices in an environment of higher US real yields rise and Fed rate hikes. However, for silver and platinum this relationship with the US dollar has switched to positive. This means that US dollar weakness goes hand in hand in weakness in silver and platinum prices. Therefore, silver and platinum prices have been weakest performers since mid-June.

…leading to new gold, silver and platinum price forecasts

We have downgraded our gold, silver and platinum price forecasts to reflect the above dynamics. Gold, silver and platinum prices could fall under some pressure in the coming weeks and months as financial markets will price in the prospect of a 25bp rate by the Fed this year and two 25bp rate hikes next year. However, the downside in gold, silver and platinum prices will be limited as we have seen the rise in US real yields in our view and we expect more US dollar weakness. This means that we expect the relationship between silver and platinum versus the US dollar to turn negative again. In short we think that gold, silver and platinum prices are close to the bottom and this is reflected in our new price forecasts. For 2018 we expect more US dollar weakness and a less favourable US/inflation mix. It is likely that these factors will result in higher prices.

Palladium looks expensive

Palladium has always been the most cyclical precious metal. Therefore, financial drivers as mentioned above have had a relatively modest impact. Palladium prices tend to rise when investor sentiment is positive and vice versa. They tend to rise if investor sentiment is constructive and equities rise (see graphs below). They tend to move lower if central banks are more hawkish. Even though fundamentals and technicals appear to be very supportive for palladium prices, the huge position overhang would make us nervous. We think palladium is expensive. We decided to leave our palladium forecasts unchanged.