Gold is likely to fall this year but the medium-term outlook remains positive, according to Capital Economics' Simona Gambarini.
The yellow metal has been a fickle investment in recent years, after it reached a record high in 2011's eurozone debt crisis before plummeting as investors avoided it – and commodities in general – for the next few years.
However, with uncertainty surrounding China at the start of 2016, it recovered somewhat as investors leant on its safe haven appeal.
Since then, despite Brexit, US president Donald Trump’s trade war and uncertainty in Europe, the shine has largely come off the metal.
Performance of index over 10yrs
Source: FE Analytics
Indeed, since its most recent high point in July 2016, gold is now down 12.11 per cent as market-friendly results in Europe and a lack of concern (at least so far) on Brexit and Trump from the stock market has meant investors have tentatively become more risk-on.
This year, gold railed in the first half on the back of heightened geopolitical risks, but has since slumped back.
Capital Economics commodities analyst Gambarini said: “Unlike the dollar, which has appreciated significantly, it has failed to benefit from safe-haven demand despite rising trade tensions.”
Indeed, despite weakening earlier in the year, the US dollar has strengthened significantly over the past four months, as the below chart shows.
The analyst noted that she was already forecasting that the price of gold would fall in 2018 as higher US interest rates were likely to increase the opportunity cost of holding an asset like gold which bears no interest.
As such, Gambarini said the current downward trajectory for gold is unlikely to change this year. The gold price is currently around $1,186 and the analyst said she has reduced her price outlook for the end of 2018 to $1,200 from $1,300.
The first reason for this is that the dollar's strength is likely to last into 2019, having at the start of the year thought it would tread water against major currencies in 2018.
“We did not anticipate that global trade tensions would escalate so dramatically, resulting in a sharp appreciation of the dollar,” she said.
“It’s impossible to know exactly how US trade policy will develop, but we think that tensions are more likely to rise than to fall.”
This, coupled with the view that the Federal Reserve will raise rates two more times in 2018 (something she argued is not fully discounted in markets yet), means the dollar should be well supported.
Performance of currencies over YTD
Source: FE Analytics
“Since there is a close inverse relationship between the price of gold and the US currency, the yellow metal is likely to remain under pressure,” Gambarini said.
While there is the potential for investors to use gold as a hedge against inflation, she added that US inflation expectations have moved sideways because of the potential for falling oil prices.
However, over the medium term investors can feel more confident that their investment will rise as it looks set to benefit from a slowdown in the US.
“There tends to be a strong inverse relationship between US GDP growth and the price of gold,” Gambarini said.
“Since 1970 there have been 14 instances when US GDP growth has declined for more than two consecutive quarters. Gold has rallied 10 times out of 14, achieving on average gains of 28 per cent.”
She expects that, as the boost from president Trump’s fiscal stimulus fades and the Fed’s cumulative monetary tightening becomes a drag on the economy, US GDP growth will slow to 2 per cent in 2019 and 1.3 per cent in 2020.
This is a view shared by FE Alpha Manager Michael Scott, who said he is preparing his portfolio for a US-led economic slowdown at the end of next year.
Capital Economics’ Gambarini continued: “While it isn’t our central scenario, there is a significant risk of a recession occurring in 2020, particularly if current trade tensions spiral out of control.”
In such a scenario, the Fed would likely cut interest rates to help stimulate the economy, which should provide a boost to the non-yielding metal.
Secondly, slower US economic growth is usually associated with a weaker dollar and, given that the US currency and gold tend to move in opposite directions as mentioned above, this also would have positive implications for the metal.
“Even if a recession is avoided, we expect that the slowdown in US economic growth will force the Fed to cut interest rates again, with the fed funds rate dropping from a peak of 2.75-3.00 per cent in mid-2019 to between 2 and 2.25 per cent by the end of 2020,” she said.
“This is much lower than both Fed officials and markets currently anticipate and lower US interest rates should also cause both real and nominal Treasury yields to fall sharply.”
Source: Capital Economics
Again, this would likely undermine the US dollar, which should benefit the yellow metal, as the above chart shows.
As such, the analyst has an expected end of year spot price for the metal of $1,350 in 2019 and $1,450 in 2020.