Neutral on gold price | The Star

IN 2020, investors generally turned to safe-haven assets that protected their portfolios from the volatility due to the turmoil in global financial markets induced by the Covid-19 pandemic outbreak.

One of the classic example of such asset is gold. The precious metal commodity was on a strong footing after it rose to a level of more than US$2,000 (RM8,328) per ounce during early August for a short period of time, and then retreated back to around US$1,800 (RM7,495) per ounce for the rest of 2020. By the end of 2020, gold climbed by more than 24% compared to during early of the year.

The expansion of fiscal policy and extremely cheap cost of money which helped reduce the opportunity cost of holding gold over competing assets such as bonds and fiat currencies, drove investment flows into gold higher.

Driven by these two factors, the pandemic and ultra-low interest rates, demand for gold-backed exchange-traded funds (ETFs) in 2020 surged to a record of 877 tonnes, the equivalent to US$48bil (RM199bil). And the magnitude of these flows contributed to the gold price rocketing throughout the first three quarters of 2020.

However, moving into 2021, the gold market has become less sanguine albeit the price remained elevated compared to the pre-pandemic level.

As a perspective, the average gold spot price during the year 2019 was around US$1,393 (RM5,800) while the average year-to-date 2021 price is at US$1,797 (RM7,482) per ounce.

As the global economy clawed its way back to recovery, supported by the encouraging vaccination rates and reopening of economies, riskier investment options allured investors on through the lens of higher returns prospects.

Improving consumer confidence and business conditions prompted market participants to reevaluate their portfolios and perhaps move towards risk-on arrangements.

As a result, on multiple occasion, stock markets rallied to record highs and rebounded even stronger after every intermittent pullback.

By Nov 8, the S&P500 soared by 25% while the Dow Jones surged 19% compared to early 2021.

It is also worth to note that during the third quarter of 2021, gold demand dropped 7% year-on-year to 831 tonnes driven by the significant outflows in ETFs, which had healthy growth in 2020.

The outflow outweighed other sectors’ growth; jewellery, technology, bar and coins, and central banks buying. Surging inflation could drive demand towards gold

The reopening of global economies comes at cost, and it is the surging inflation.

This elevated consumer price notion is caused by the great mismatch of supply and demand dynamics in the economy.

Pent-up demand has been filling up the market as a result from being stuck at home, while the supply side could not cope with the excessive demand, which can be attributed to the disruptions in global supply chain networks.

Lead time delivery increased to an unprecedented level, empty shelves became apparent in shops including supermarkets, and larger backlogs in critical ports.

In addition, the recent surging commodities’ prices could also partially be responsible for rising inflation.

Crude oil touched more than US$85 (RM353.60) a barrel, which is the highest level since 2018.

The price of coal is soaring, with the coal price in China regularly breaking records and Australian ore doubled in price since the spring.

The price of natural gas is sky-high, especially in Europe, where it has roughly doubled since the summer and is four times more expensive than a year ago.

Against the backdrop of raising inflation and low-interest rates, the real yield has been in the negative zone, making gold an attractive option.

In the United States alone, the real yield curve for Treasury five-year rates hovered around -1.80%.

Therefore, to diversify their portfolios and guarding it against the corrosion effects of inflation, aside from the inflation-linked treasuries created primarily by sovereign governments, gold is certainly one of the options that investors can consider especially for longer-term investment duration.

Crucial factors

Yet, there are few things that we need to consider in analysing gold. First, the demand for gold could be dampened by the stronger dollar as it has become more expensive for investors outside of the US to invest in gold.

Sentiment on the dollar is usually boosted by the flight-to-safety, bearing in mind that the US Treasury is widely known as the safest investment in the world.

Gold prices and the greenback have an inverse relationship. As the dollar gets stronger against other currencies, gold prices will fall as it becomes more expensive in other currencies, driving down demand.

Second, the persistently high inflation is prompting central banks to reverse back the “transitory” inflation narrative and depart from their super-accommodative policies to prevent the economy from overheating.

Recently, the Federal Reserve (Fed) decided to cut back their monthly US$120bil (RM500bil) asset purchases by US$15bil (RM62.4bil) and the process is projected to end by mid-2022.

Only then, the Fed will start to raise interest rates as most officials have previously suggested that the interest rate hike should only happen when the taper ends.

Although the narrative could change if inflation continued to surge and unemployment has stabilised during the taper process, which in this case, the interest rate hike could happen concurrently with tapering.

Hence, if we are taking the Fed’s stance as a baseline, we can expect that the demand for gold will be tepid somewhere in mid-June.

And real yields will “go less negative” and that means more downside for gold. When real yields go up, gold prices go down, and vice versa.

In such a scenario, the opportunity cost of holding gold, a non-yielding asset, is higher as investors are foregoing interest that would be otherwise earned in yielding assets.

We can expect outflows from the gold exchange-traded funds and futures markets.

For now, we are projecting that the 2021 full year gold price average to hover around US$1,800 (RM7,499) per ounce, and US$1,700 (RM7,083) for 2022 and expect gold price to remain elevated in the coming years compared to the pre-Covid levels.

For FX enquiries, contact: ambank-fx-research@ambankgroup.comFor Fixed Income enquiries, contact:

Be the first to comment

Leave a Reply

Your email address will not be published.