Precious Metals Watch – Time to bottom out

by: Georgette Boele

In this publication: Precious metal prices have dropped towards or below our expected levels. We think it is time to bottom out as we expect limited upside in the US dollar, a stabilisation and some recovery in the Chinese yuan and speculative net-longs are cut back. But a strong recovery/rally will take time. We keep our forecasts unchanged.  We expect a recovery in gold, silver and platinum prices for the remainder of the year.

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Introduction

In our report of 3 July we stated that weakness in precious metal prices was not over yet, but that prices would be close to the bottom. We expected gold prices to bottom out between USD 1,200 and 1,250 per ounce and silver prices between USD 15.2 and 15.6 per ounce. We thought that platinum prices had overreacted and prices should bottom out close to USD 800 per ounce.  We were the most negative on palladium prices and expected that prices would revisit the April low of USD 898 per ounce.  What has happened since then? Gold prices have broken the USD 1,200 per ounce level, silver prices have approached 15 USD per ounce, platinum prices have hovered just above USD 800 per ounce and palladium prices have dropped below USD 900 per ounce. Precious metal prices are down 8-16% year-to-date. In this report we focus on what we expect going forward.

Prices should bottom out…

We expect precious metal prices to bottom out in the coming days and weeks for several reasons. For a start, we expect that Chinese authorities will try to avoid a further sharp weakening of the yuan from current levels. We even expect some recovery of the yuan before the end of 2018. This should support gold prices because the direction of the Chinese yuan versus the US dollar is one of the most crucial factors. In the past, movements in USD/CNY have been relatively limited but recently the movements have been considerable. We think that the weakness in the Chinese yuan (versus the US dollar) has played a crucial role in the recent precious metal price weakness.

 

Weakness in the yuan is on the one hand a reflection of the tensions between the US and China and on the other hand concerns of investors about the Chinese economy. China is a crucial consumer of precious metals. So if the outlook on the Chinese economy deteriorates it is likely that the outlook of precious metal demand from China also deteriorates. Moreover, we think that the US dollar will peak in the coming weeks against the euro and a basket of currencies. This should be supportive for precious metal prices as well.

Finally, speculative short positions in gold, silver and platinum are at an all-time high, while the net-positions in gold and silver are close to zero and at an all-time low (negative) for platinum. Even the excessive speculative long positions in palladium have been unwound completely. All in all, we think there is not much room for a further decline in these speculative net-positions. In fact, we think that speculative short positions could be reduced resulting in a recovery in precious metal prices, since it is likely that investors who want to be short precious metals already are. ETF positioning in precious metals has been large and reduced recently as well. We think though that the speculative positioning on the futures market is a better guide for the direction in precious metal prices.

 

…but a strong recovery/rally will take time

Even though we expect prices to bottom out and to recover, it will take time to materialise. This is because the technical outlook is negative and investors will probably sell precious metals on every uptick in prices. Moreover, we expect 2y US real yields to rise by another 30-40bp. This will be a headwind for precious metal prices. Nonetheless, we keep our year-end forecasts in place expecting a recovery in gold, silver and platinum prices.

The gold safe haven question

Since the introduction of ETFs in the gold market in 2004, gold prices have behaved differently. Gold transformed from a safe haven asset to a financial asset that is very sensitive to the behaviour of the US dollar. It has a strong negative relationship with the US dollar. This means that if the US dollar rises when investor sentiment deteriorates, gold prices fall. The fact that gold prices behave like a safe haven asset is very much entrenched into the thinking of most investors. Therefore, they have likely been disappointed that heightened trade tensions between the US and China, an FX crisis in Turkey and weakness in EM FX have not resulted in higher gold prices. As a result, they have likely sold a large part of their positions (and speculators have sharply increased short positions). We are of the opinion (already for quite some time) that gold is no longer a safe haven asset but that if the US dollar allows it, it could have the appearance as a safe haven asset.