Gold – Recovering the lost sheen

Gold prices started the year on a positive note with strong gains in January but have turned largely sideways since then on conflicting drivers. Even as the upward trajectory faces headwinds on prospects of a potential Fed rate hike this year, unexpected weakness in US data in Q1 provided a floor to prices. The net effect is that prices have held up pretty well so far in 2015. Looking ahead, we expect gold prices to retain a positive bias in the short to medium term. Yet, as economic data improve and US interest rate expectations move closer, the dollar will continue to have a stronger underpinning which will be negative for gold in the second half of the year.

In terms of overall demand, unlike jewellery or industrial demand which is sticky and relatively price inelastic, investment demand tends to be very nimble-footed as hot money gets poured in and out of gold pretty quickly responding to swings in global macroeconomic sentiments. The steep drop in investment demand was one of the major factors that contributed to the rout in gold prices in 2013 and 2014. However, the weather related slump in US growth, persistent worries over a Greek exit from the EU and relatively benign prices helped investment demand to pick up in Q1.

Global ETFs saw a positive net inflow after two years, as ETF assets increased by 25.7 tonnes supported by benign prices and economic uncertainty. Looking further at April and May data, it is clear that ETF holdings are stable and we expect them to remain that way as the liquidation trend has slowed down unlike the past two years suggesting that global investor bearishness for gold has waned considerably. Broadly, we believe that since investment demand typically follows price, only a sustainable increase in price will alter the investment scenario in a constructive manner and start a new trend. The key risk from the investment demand perspective, however, is the equity market performance, especially in India and China. Stock markets in these largest consumers of gold have been buoyant and will weigh on investment demand for gold.

On the policy front, gold prices remain overly sensitive to US economic data since the Fed changed its language in March investors’ speculation over the timing of the a rate hike has caused some increased volatility. In October 2014, the Fed ended its quantitative easing and made its forward guidance on rates more data-dependent. Following that, earlier this year, the Fed is preparing the markets for a possible rate hike towards the end of 2015 which put a lid on gold price. The minutes of the latest FOMC meet show that Fed officials are not yet convinced of a lift-off in June. However, the Fed seems to be still on track to start raising rates later this year.

On the macro-side, US macroeconomic data over the past few months has been particularly weak with growth slowing down in Q1 after a strong numbers towards the end of 2014. Hence, Q2 data has to be decisively stronger for markets to start pricing in a liftoff in interest rates. Until then, gold may continue to have positive momentum. Also, the spectre of Greece exit from the Euro zone remains a key upside risk with the potential to cause global market volatility. In Asia, Chinese economic growth remains a concern and expectations of further rate cuts by the PBOC remain high. Additional stimulus by China may support the commodities complex in general and gold in particular.

The writer is Associate Director, Head – Commodity & Currency, Motilal Oswal Commodities. Views are personal.

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