Precious Metals Watch – Strong conviction in higher prices

by: Georgette Boele

In this publication: Recently precious metal prices have weakened again. Prices to set a bottom above previous bottoms and to recover again. We think that the Chinese yuan has bottomed and the US dollar and 10y US Treasury yield have peaked. Speculators seem to have lost faith in the upside potential for gold, silver and platinum… but not us

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Introduction

On 13 August we released our report “Time to bottom out”. Gold, platinum and palladium prices set a bottom on 16 August. Between 16 August and the beginning of October prices recovered substantially, especially platinum (+10%) and palladium prices (+30%). Silver prices bottomed a month later and the recovery was shorter-lived. Recently, precious metal prices have weakened again. In this report, we focus on the outlook of mainly gold, silver and platinum.

Less concern about China and a recovery in the yuan to support precious metal prices

Despite the recent weakness in precious metal prices, we expect prices to set a bottom above previous lows and to recover. First, since the Chinese yuan has had more room to move, the relationship with gold, silver and platinum prices have become stronger. This is because China is a crucial consumer of these precious metals. When China allows the yuan to decline, investors become concerned about the state of the Chinese economy. As a result they are also more negative about the demand outlook for gold, silver and platinum. Chinese authorities have taken measures to stimulate the economy and to shield its economy from the (potential) negative effects stemming from US import tariffs. Since April the yuan has been allowed to weaken by around 10% versus the US dollar. This limits the impact of the import tariffs on the Chinese economy.  However, Chinese authorities are very cautious about letting the currency weaken beyond 6.95 – 7.00 versus the US dollar, as the risk is quite high that they would lose control over their currency. A weakening of the Chinese yuan beyond 7 versus the US dollar could spur speculation of capital outflows and they would like to avoid that, at least for now. We already see a stepping up of fiscal stimulus by the Chinese authorities, as well as a ‘tweaking’ of its financial deleveraging campaign. Against that background, we expect that the Chinese yuan will stabilise and recover. This should calm investors and improve investor sentiment towards precious metals. That said, in case of a sharp escalation of the trade conflict with the US, another round of yuan weakening should not be excluded (although we remain of the view that even in that case policy makers will not tolerate too much depreciation).

We think that the dollar and 10y US Treasury yield have peaked…

We are of the view that the US dollar has peaked across the board. We also expect that 10y US treasury yield will peak around current levels and that US economic growth will peak this quarter. Next year we expect lower US economic growth and some lower 10y US Treasury yields. We also expect that our base case for the Fed of three more 25bp rate hikes until June 2019 will soon be priced in by financial markets. In addition, we expect that the pick-up in US 2 year real yields is mostly done after a rise of 90 bp so far this year. Going forward, the US 2y real yields will probably rise in tandem with inflation expectations. All these factors support our view that the US dollar has peaked and will weaken in 2019. Therefore, we expect precious metal prices (mainly gold, silver and platinum) to recover in the coming months and to rally in 2019.

Speculators have lost faith in the upside potential for gold, silver and platinum…but not us

The latest positioning data from the futures market show that there are all time highs in speculative short positions in gold and silver. Short positions in platinum are also substantial. Speculators are net-short gold and silver and roughly neutral on platinum. The speculative net-short positions in gold are at levels last seen in 2001. Meanwhile, the speculative net-shorts in silver are at all-time high. This shows that speculators have lost faith in the upside potential for these precious metals. There is always the possibility that prices could go lower. But we think the risk reward for entering precious metals positions is quite attractive. If our base scenario as described above plays out, it is likely that precious metal prices will rise this year and next on the back of a cut back in speculative short positions.

Some adjustments in forecasts

Taking all the above into account we expect gold, silver and platinum prices to recover in the coming months and to rally in 2019. We have left our gold price forecasts unchanged. However, we have adjusted our silver, platinum and palladium price forecasts. The adjustments in silver and platinum price forecasts are partly a reflection of current price levels and partly because we now expect that the rally next year will not be that strong. In the case of palladium, it is rather surprising that prices have rallied so strongly. This is not justified by the modest increase of speculative net palladium longs and the developments on the trade front and concerns about China. The US is an important market for palladium demand. As we expect the US economy to peak this year, the outlook for palladium will probably become less optimistic as well. We have adjusted palladium forecasts to reflect current price levels and these developments.