Precious Metals Watch – Gold: Good start, but weaker finish

by: Georgette Boele

In this publication: Gold prices have rallied by 3% year-to-date. Gold prices have a tendency to have a good start of the year, but this is not a guarantee for a positive year. Gold prices look toppish around current levels and a recovery of the US dollar could push gold prices below USD 1,300 per ounce again.

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Introduction

Gold prices had a good start to 2018 and prices have rallied by close to 3% so far this year. Since 2006, in nine out of thirteen years, gold prices had a positive start to the year; but in only four of these occasions (30%) the year ended in higher prices as well. More often a positive start to the year saw an overall price decline that year or years with weak starts ended on a positive note. What will 2018 bring? We discuss this below.

Positive start, but now what?

As indicated above gold prices have a tendency to start positively in the new year. The start of 2018 has not been any different, but gold’s price behaviour is rather remarkable. Most of the relationships between gold prices and other financial markets have broken down. For example, gold prices generally decline if 10y US real yields rise. This is because the rise in 10y US Treasury yields more than compensates for the rise in inflation expectations. Therefore, there is no appeal as inflation hedge and investment asset without an income component such as gold is suffering. So far this year, the rise in 10y US Treasury yields (nominal and real) has not weighed visibly on gold prices. Moreover, higher expectations of Fed rate hikes in 2018 and 2019 and positive equity markets have also not weighed on gold prices.

So what is the overriding theme behind gold price strength so far this year? In three words: US dollar weakness. The strong negative relationship between the US dollar and gold prices has remained in place, so US dollar weakness has been behind the rally in gold prices this year. This is also visible in gold’s performance versus the euro and the yen. This proves once more that out all of the drivers, the US dollar is the variable to watch.

The outlook for the US dollar has deteriorated since the start of 2017 because the US political situation has become more uncertain. Furthermore, economic growth (in 2017) in especially the eurozone but also in Japan has surprised more strongly on the upside than US growth. This provides a positive momentum to the euro and the yen versus the US dollar. Even though the longer-term outlook for the US dollar is not positive, the US dollar can still recover from time to time. We think that the US dollar has been beaten up too much and that US fundamentals remain pretty sound. Furthermore, the odds for more Fed rate hikes are increasing. Moreover, financial markets have become too optimistic about the ECB and the BoJ. If investors scale back their expectations about the timing of ECB rate hikes in 2019 and a possible change in BoJ policy, the euro and the yen will suffer and it is likely that the US dollar will profit. This will most likely go hand in hand with a more constructive view on the US. Indirectly these developments will filter through to gold prices as well. So a recovery of the US dollar versus major currencies should also result in lower gold prices.

If investor sentiment in financial markets were to deteriorate from time to time, we think that gold prices will fall and not rally. In short, as gold prices rallied in a risk-on environment with a weaker US dollar, a risk-off environment will probably result in a dollar recovery and lower gold prices.

All and all, we think that gold prices are toppish at current levels and we expect prices to move below USD 1,300 in the coming weeks.