Gold has enjoyed its best start to a year in three decades, climbing more than 20 per cent. The advance has attracted some of the world’s most sophisticated hedge funds but can it be sustained without a pick-up in physical demand from the world’s two biggest consumers — China and India? As gold trades around $1,300 a troy ounce, here are five things to watch for curious investors and gold bugs alike:
Last year bullion traders anxiously awaited the Fed’s first interest rate hike in almost a decade, which limited gold’s gains in spite of rising geopolitical turmoil. Now that’s out of the way, the Fed has signalled it will move cautiously on further rate rises because of sluggish growth, providing another boost for gold, which traditionally does well in a low-rate environment since it provides no yield.
However, even if the Fed does raise rates the key for gold is to look at real interest rates, according to James Luke, a fund manager at Schroders.
“Even if you have a situation where the Fed does raise rates two or three times but inflation has already taken root real rates can remain low or even negative so there’s no reason that gold can’t move higher,” he says. “Particularly with the amount of negative yielding assets in the investment universe and serious concerns over post-QE stock market health.”
The US dollar has tumbled this year against major currencies from an eight-month high it reached in November. Weakness in the US currency is traditionally good for gold, since the precious metal is priced in greenbacks.
The metal is also benefiting from increasingly desperate attempts by central banks to boost growth. In January the Bank of Japan introduced negative rates for the first time. Negative interest rates are now the norm in the eurozone, Sweden, Denmark and Switzerland.
“There’s a gradual loss of confidence in central banks’ ability to help or control the economy or control the money supply and gold is a form of money so it competes with other forms of money for consumers,” says Jim Rickards, author of The New Case for Gold. “As you begin to lose confidence in central bank money, that leads to increased interest in gold.”
Gold — our dangerous obsession
While they have cooled in recent weeks, ETF flows into gold have grown at their fastest pace since 2009 this year.
“The key price determinant for gold is whether the growth in investor interest thus far in 2016 will continue and, perhaps more importantly, if it is resilient,” analysts at Standard Chartered say. “Investment demand has been fuelled before; can it last this time?”
One supporting factor they note is that gold ETF holdings are still one-third below their peak in December 2012, suggesting prices can hold about $1,200 a troy ounce.
Still other analysts expect more outflows the closer we get to June, when the Fed is expected to increase rates.
“We are bearish short term on the gold price as we expect investment demand to pull back as expectations of Fed rate hikes become more hawkish,” analysts at Macquarie say.
China and India
Strangely absent in this year’s advance has been China.
Even as traders in the country have poured billions of yuan into trading in steel, iron ore and other commodity futures, the Shanghai Gold Exchange has seen little growth in volume, with prices trading at a discount to the global price.
According to data released last week from Thomson Reuters GFMS, in the first quarter of this year China’s gold jewellery buying fell 27.3 per cent. That helped push global physical gold purchases to their lowest level since the first quarter of 2009.
Higher prices may have deterred Asian buyers, according to analysts. But if prices persist in going higher that could see them come back to the market.
“I think the potential for a major move into gold by Chinese investors at some point as and when domestic financial stresses become more real is extremely large,” says Mr Luke at Schroders.
And a wild card … Brexit
Gold could get a bit of a boost if the UK votes to leave the European Union next month.
Along with the Swiss franc, gold could benefit from a “sizeable safe haven bid” by investors, according to HSBC. Both could receive some of the capital outflows from the pound and the euro, the bank said.
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