First shot of warning for gold bears

Kishore Narne | Updated on January 22, 2018 Published on September 10, 2015


Any spike in US rates will exert pressure on prices, though sustained weakness in most emerging markets may support gold

I have remained a gold bear since it made its top in 2012, though many people didn’t expect at that point.

But I looked at a possibility of $1,080 an ounce as primary target, though it took much longer (three years to be precise) than I had anticipated to reach that level, but eventually it did. So the big question is: how further it can go from here?

Before jumping on to any hasty conclusions, let us look at the ground reality. After a seemingly steady first half of 2015, price of the yellow metal nose-dived this August as Fed rate hike expectations moved closer and investors started factoring in a lift-off for the first time since 2009.

After transitory weakness in the macro numbers from US for Q1 2015 provided a floor to gold price, most of those indicators started to rebound in second quarter and caused a major headwind for gold price. Though Greece caused some jitteriness in the middle but as they accepted the fresh deal, the gold bulls received a final blow.

Demand v/s static supply

Physical demand for gold has been depleting at an astonishing pace though the price continues to trade at a five-year low. World demand for the second quarter has hit a six-year low of 914.9 tonnes – 12 per cent lower year on year.

Global jewellery demand fell by 14 per cent YoY driven by a 23 per cent decline in India. Indian consumer demand slumped 25 per cent to 154.5 tonnes largely due to a weaker monsoon and buoyant domestic equity market.

Within investment demand, Indian bar and coin demand saw a big drop of 30 per cent YoY to just 36.5 tonnes.

Chinese bar and coin demand was relatively better at 42.1 tonnes, a six per cent YoY increase as a rout in Chinese equities helped. Besides India and China, the other places that saw a big decline were the Middle East (-37 per cent) and Turkey (-70 per cent).

Meanwhile, worries over a Greek debt default kept European demand stronger. European bar and coin demand jumped 19 per cent driven by a 24 per cent rise in German demand for bars and coins.

ETF flows, meanwhile, turned negative after a bout of inflows in Q1 as a lower price environment coupled with the US rate hike expectations dampened investment prospects.

On the supply side, a three per cent increase in mine production was offset by an eight per cent decline in recycling, resulting in a net contraction of five per cent.

Overall, the gold market saw a surplus of 89.7 tonnes in Q2 which fits into the overall bearish bias for gold.

Decidedly mixed signals

Though the entire world is gearing up for a rate hike by US Fed this month, we should not over look that the considerable easing proposed by ECB, BoJ and other emerging market central banks (with the biggest one anticipated from China) could nullify the effects of any rate hike by the Fed.

The world is now split in to three major zones with respect to their broader economic conditions, the first one is the United States where the inflation is reasonably lower.

However, the economy has reached nearly full-employment levels which could now start pushing up the wage growth and eventually lead to the Fed’s targeted inflation, while FOMC is ready to tighten the monetary policy and raise the rates.

The second zone is a group of perennially deflationary economies over the last half a decade which are also anaemic on growth, especially the Euro Zone and Japan which would like to continue to ease further, creating a positive atmosphere for a gold rally in those currencies as they become weaker and that the demand for gold as an investment still has a standing across much of the euro zone.

The third is the commodity-dependent emerging market economies which are literally crushed by the collapse in the commodity prices led by the slowdown in China and fading global demand.

Time to look back at Gold

In our earlier reports, we expected prices in the range of $1,080-1,130 to hold in H1 2015 and expected gold to turn lower in the second half of this year. Our expectations have proved to be right and we currently see a limited upside in gold over the short-term driven jitters in broader financial markets, but this should limit to the maximum of $1,170 to $1,245 levels.

However, a key thing to note is that even though gold may not perform well in dollar terms, sustained weakness in most emerging markets and Asian currencies including rupee could well support gold in local currency.

Though the domestic demand may not pick up owing to a bad monsoon but other emerging economies could drive up demand in the few months to come on the back of struggling equity markets.

Though the future of gold looks foggy over short-term, we see the current conditions as the first warning shot for the gold bears.

Long-term investors in domestic markets should look at accumulating gold on dips towards ₹24,500/10 gram levels with potential to reach all the way back to ₹28,000 or more in the coming quarters.

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

Published on September 10, 2015
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