Treasure Chest | Nov 13 2017
Fed tightening, US tax reform and elevated speculative positions all make the gold price potentially vulnerable in the December quarter.
– Gold beholden to US monetary/fiscal developments
– Gold positions elevated
– Chinese demand the swing factor
By Greg Peel
The US dollar gold price was weaker in the December quarters of 2016 and 2015 on expectations of Fed tightening, a subsequently stronger US dollar and rising US bond yields. As we enter the December quarter of 2017, Macquarie’s commodities analysts see a very similar picture.
The Fed delivered rate increases in both of the past two Decembers and the market is currently pricing in a 97% chance of 2017 being no different. But despite popping several basis points last night, the US ten-year yield has not much risen this year given low inflation and persistently low yields in both Europe and Japan.
Rather, the US yield curve has flattened, meaning short term yields have risen on Fed expectations but longer term yields have not. Even if US inflation were to start picking up, the same would have to occur in other regions, where to date QE remains stubbornly in place despite economic growth, or US yields will remain beholden to differentials.
Macquarie believes the US will see inflation return in 2018 but unlike past December quarters, the analysts do not necessarily see the US dollar rising ahead of a Fed rate hike. The difference this time is politics. In particular, were Trump’s tax plan to be stalled, and so far a year’s delay on a corporate rate cut looks ever more a possibility, the dollar is more likely to fall than rise.
And it is possible the Fed would then be forced to hold off as well.
This would be positive for gold, which otherwise is not seeing much geopolitical support these days, despite the North Korea threat and more recently, Saudi Arabia stirring up the Middle East. Were a tax bill to be passed, without a time delay, then it would not look good for gold.
The other influence on the gold price, beyond monetary policy, is of course actual demand. This can be split into two categories – speculative, represented by positions held in gold exchange traded funds in the US and Europe, and physical, represented by jewellery and coin/bar buying in China and India in particular.
Central bank buying/selling should also be included but things have been very quiet on that front for some time.
The West dominates speculative flows and the East dominates physical flows. Speculative positions are currently elevated, which puts gold in a vulnerable position, Macquarie suggests. RBC Capital Markets notes that while the US has the biggest gold ETFs, flows into ETFs in Europe have been stronger of late.
China and India represent more than 50% of global jewellery/coin/bar demand. Europe and North America have seen declining demand over past years and even India is now seeing a downward trend. This leaves China as the primary driver, both Macquarie and RBC acknowledge.
Gold price weakness in the December quarters of 2016 and 2015, on Fed speculation, was eventually overcome heading into the (solar) New Year by Chinese physical demand, Macquarie notes, ahead of the popular gift-giving period of Chinese (lunar) New year early in the calendar. While there is no reason to suspect 2018 will be any different, Macquarie does note Chinese demand in the September quarter 2017 was actually weak by previous years’ standards.
On the other hand, mine production and scrap supply were weaker in the September quarter 2017 compared to 2016. But while this implies a tighter market, the balance remained in a large surplus. It is this surplus that leads Macquarie to highlight gold’s vulnerability in the face of monetary/fiscal developments ahead.
RBC is forecasting a December quarter average gold price of US$1265/oz (current spot ~US$1275) and a 2017 average of US$1256/oz.
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