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- Gold prices rise on increased uncertainty
- Price has been rallying sharply since May
- Key drivers likely to push the metal even higher
Gold has been on a tear ever since enthusiasm for the U.S. Dollar waned back in May and global bond yields continue to decline.
Gold prices have risen from around $1279 per ounce to highs of $1452 in only 10 weeks.
Global uncertainty, fears the Dollar will weaken as the Federal Reserve cuts interest rates and perennially low bond yields are the root causes of the appreciation, but are these factors likely to sustain further upside?
“Beyond a period of near-term consolidation we think gold should rise again,” says investment bank UBS in a note on the precious metal. “Over the longer term, the dollar and real rates are the two key drivers for gold prices. While the dollar may not provide much help, yields remain skewed to the downside, and should support the yellow metal.”
UBS expects gold to hit $1450 by end 2019, and then rise modestly to $1500 by end 2020.
Whilst the metal is now registering as above their fair-value estimate, economists at UBS put this down to the increase in demand from portfolio diversification, which is not a variable in their model and thus probably accounts for much of the difference.
But what of the other drivers? Could an analysis of the reasons provide clues as to whether the rally will continue?
A prime reason for gold’s gains is its safe-haven qualities which means that in a crisis it tends to hold its value better than any other financial assets.
This has become especially pertinent today with the high level of political, economic and geopolitical uncertainty faced by the world.
Trade wars are escalating, the outcome of Brexit is more uncertain than ever, Iran has become a potentially dangerous rogue state, and the global economy is subject to what economist Nouriel Roubini recently described as “deglobalisation” and the “disruption of tech global supply chains.”
Fears of a U.S. economic slowdown are also rising, with the New York Federal Reserve recession model having risen to 33%.
All in all the outlook for the global economy looks less assured, and certain factors like the disruption to tech supply chains is probably irreversible because of the threat the free passage of technologies across borders pose to national security.
The use of gold as a safe-have appears to be backed up by anecdotal evidence from gold brokers on the ground, even if it offers zero yield to an investor's portfolio.
Josh Saul, CEO of the Gold Investment Firm, says clients are buying physical gold because of its safe-haven qualities:
“There is a heightened state of anxiety from our clients as they remove exposure to banks and equities to purchase physical gold. They perceive the US/China trade war, Iranian sanctions and Brexit uncertainty as severe threats to global markets, and fear any or all of them could escalate in the coming months.”
Brexit risks are especially key, says Saul, as investors lose faith in the “unpredictability of the UK leadership, and their ability to steer the country through Brexit effectively.”
The pace at which professional investors are piling into the precious metal is a warning sign in itself, adds the broker.
“Over 64% of investors purchasing gold this month have been financial professionals who believe a market crash is likely. We have seen people remove exposure to falling equities and take cash from vulnerable bank accounts at a pace not seen since the collapse of Lehman Brothers and Northern Rock.”
Indeed Saul cites three ex-Lehman Brothers employees who had purchased UK gold coins from The Pure Gold Company in 2019, “citing concerns comparable to the crash of 2008 but on a larger scale and with more variables.”
Most investors are not buying gold for the ‘growth potential’ or as a naked ‘put’ or bullish trade, but as a hedge for their assets against future market uncertainties.
Low real yields are another factor supporting gold. This is the return above inflation an investor receives from a government bond.
At the moment most real yields are negligible: moribund inflation and negative or near negative interest rates offer little margin in between.
This does not directly lead to a draw on gold but it does lower the opportunity cost of holding gold, which is the return an investor misses out on if his or her money is tied up in the precious metal rather than an interest-bearing investment like a bond.
Yields are unlikely to go up for a long time. Most major central banks are planning to increase monetary easing not decrease it and this will further reduce yields.
The record levels of public and private debt in the world mean the cost of debt is unlikely to rise - if the cost of debt did substantially increase the biggest debtors in the world - the U.S, Japan and much of Europe included - would struggle to make the repayments and default.
The Dollar Hedge
The negative outlook for the Dollar is a further driver of gold demand since gold acts as a hedge partly because it is priced in Dollars so it automatically rises when the Dollar falls.
Whilst this factor is less important given the Dollar’s recent resilience it could still come into play should the greenback start going lower again.
Chart Indicators: Where Next for Gold Prices?
Gold’s price chart is also showing technical signs an extension higher is on the horizon.
“Gold, which had consolidated for the past few days, looks like it is about to break further higher after it worked off its ‘overbought’ conditions through time,” says Fawad Razaqzada, an analyst with a technical bent at broker Forex.com.
Razaqzada posits the same reasons as UBS for the sudden hunger for gold.
“The underlying trend is bullish.. due to the falling government bond yields and the recent struggles for the dollar and stocks. So, as things stand, these are good times for buck-denominated and noninterest-bearing precious metals,” says Razaqzada.
The momentum indicator on gold’s chart - the RSI is also giving the green-light to buyers.
Previously it was in overbought territory (above 70) but then prices pulled back and consolidated. Now it has ‘worked off’ its overbought condition and this might give investors the confidence to buy in and drive the rally higher.
“With the metal breaking out of the consolidation, a push to new 2019 highs could be on the cards, potentially as early as later today (Thursday). The bulls’ next target could be the underside of the rising trend capping the prior highs, which comes in around $1460, with the psychologically-important $1500 hurdle being the subsequent objective,” says Razaqzada.
Still Room For More
Another case for expecting the rally to go higher is that investor exposure to gold is still relatively minimal, suggesting there is still space for more buyers to pile in.
“Exposure to gold remains relatively lean, suggesting there is plenty of room for this trend to continue and help sustain a move higher in prices,” says UBS.
On the negative side, however, several elements that were present during former big gold bull trends are missing in the current cycle, says UBS.
These include producer buybacks and a lack of interest from Chinese investors.
There are also no new innovations such as the gold ETFs during the last gold bull run.
There is also competition from cryptocurrencies, which are absorbing some of the demand that would have gone into gold.
In addition, unlike previous bull cycles retail demand for ‘gold coins’ remains soft.