Gold & Silver

Gold: Exercise caution on bullish bets

G Chandrashekhar | Updated on January 06, 2020 Published on January 06, 2020

Representative image   -  AP

Gold put up a stellar performance in 2019, rising by close to a fifth over the year, reaching at one point $1,550 a troy ounce. The metal ended the year slightly above $1,500/oz, but remember, its price-performance was nowhere near the $1,600/oz as forecast by many experts.

Now, in the first week of the new year, the eruption of geopolitical tension between the US and Iran, including a drone attack in Tehran, has given the metal a new fillip. On Friday, gold closed at $1,549/oz, up smartly from $1,510 a week earlier and sharply rising from $1,477 a month ago.

Outlandish forecasts

This fabulous beginning has given rise to some outlandish forecasts that may eventually turn out to be wishful thinking. Incurable gold bulls and investment strategists are predicting that the metal will display in 2020 a performance similar to or even better than the one seen in 2019. Many are talking about an easy breach of $1,600 and a test of $1,700.

It is here that a word of caution becomes necessary. The tendency to forecast commodity prices based on events which may have a short shelf-life is dangerous and, therefore, best shunned. By their very nature, geopolitical conflicts do not drag on for a long time and are prone to de-escalate steadily, if not quickly.

In the present case, Iran has pledged a strong retaliation. Whether rhetoric will translate into military action is hard to tell. Yet, until tempers cool down, gold will remain supported by the ongoing tensions.

Volatility in offing

Any sharp price rise caused by geopolitical developments is sure to come in for equally sharp correction when tensions abate or near-normalcy is restored. History has enough and more evidence of this. So, gold will necessarily fall back when tensions begin to ease.

Analysts also cite other factors such as Fed rate cut and depreciation of the dollar to buttress their bullish forecast. It is increasingly becoming clear that the Fed may not cut rates at all in 2020, or cut it once at best, perhaps in June. Policymakers are confident the economy is in reasonably good shape.

From here on, in the US, gains on the employment front may ease and consumer spending may moderate. The dollar risks weakening slightly from the current levels; but competitive depreciation of other major currencies (euro, yuan) would act as a floor for the greenback.

After phase one of the deal between the US and China, slated to be inked mid-January, there is growing optimism that the trade war is set for a denouement and reconciliation sometime in the second quarter of this year, coming closer to the US Presidential election. A good trade deal will be negative for gold as it removes an important element of global uncertainty.

Weak demand

Critically, most forecasters ignore the demand side, which has had a significant bearing on the gold market in 2019; and will continue to exert equally significant impact in 2020 too. Two of the world’s largest consuming markets, China and India, are decisively slowing down. Their currencies are weakening. Domestic prices in both markets are rising to unaffordable levels.

We saw in 2019 how enervated physical demand growth was. There was a clear demonstration of demand destruction at higher price levels. Price elasticity of demand kicked in. 2020 is going to be no different. There is nothing to suggest the Chinese or the Indian economy is going to perform markedly better in 2020.

In India, one can actually expect even tougher policy controls on gold, largely perceived as a demerit good that drains vast sums in foreign exchange. The possibility of the rupee weakening in the coming months will add to the cost burden. Physical demand is most unlikely to trump investment demand in 2020, and this will have price implication.

The author is a policy commentator and commodities market specialist. Views are personal.

Published on January 06, 2020
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