Defensive assets such as gold are likely to face pressure in the second half of 2017 as US interest rates continue to rise. Metals with more industrial applications such as silver platinum are more likely to increase.
Following a 12.5 per cent rally from end of 2016 to mid-April 2017, gold has lost 9 per cent in the past month. A rate hike in June by the US Federal Reserve is currently priced into futures markets as a near certainty. Bond yields have risen substantially since the Fed’s last meeting which has weighed on gold prices
We have developed a model that explains gold price movements. In contrast to most commodities, gold behaves like a monetary asset, with exchange rates and bond yields driving its price more than the movements in physical supply and demand. Our model indicates that changes in the gold price (in US dollars) are driven by the following:
1. Changes in the trade-weighted US dollar
2. CPI inflation
3. Changes in nominal yields on 10-year US Treasuries
4. Investor sentiment (measured by speculative positioning in the futures market)
In the first four months of the year, gold was supported by multiple factors:
Firstly, although the Fed raised rates in March it also adopted a dovish tone, leading the market to expect little tightening activity from the central bank despite signs of inflationary pressures gaining momentum. Bond yields fell from 2.6 per cent in mid-March to 2.1 per cent in mid-April. Given gold’s inverse relationship with bond yields, gold prices rose.
Secondly, geopolitical concerns were elevated. The fear of far-right candidates winning the Dutch and French presidential elections drove demand for gold higher. Gold is seen as a haven asset and its demand increases in times of investor anxiety. Other geopolitical events included the US missile strike on Syria and the sabre-rattling between the US and North Korea.
At the Fed’s FOMC meeting in May, it emphasised that weaknesses in the labour market and inflation were transitory and the market is now pricing in a strong chance that it will continue to raise rates in June. US 10 year bond yields rose from 2.28 per cent to 2.40 per cent within a week of the meeting. The higher-rate environment is likely to cap gains for gold.
The passing of the Dutch and French elections without a win for any of the far-right candidates has eased some of the geopolitical concerns on investors’ minds. We note that the issues around Syria and North Korea remain unresolved and could provide some support for gold.
Gold is likely to trade within a narrow corridor, around $1,230 an ounce (approximately where it is right now), for the remainder of the year. Geopolitical concerns will provide a floor for prices while tightening monetary policy will cap its gains.
Although silver, and to a lesser extent platinum, are correlated with gold, they are less defensive and more cyclically oriented than gold. We expect improvements in the global industrial cycle to bode well for the demand for both of these metals. The demand for both silver and platinum outstrips annual mine supply. This supply deficit means that the existing inventory is likely to be drawn upon, spurring prices
The supply of these metals is unlikely to improve in the near future. Most silver (75 per cent) is mined as a by-product of other metals. A dearth in mining investment amid weak metal prices in recent years means that the expansion of mined silver supply is unlikely. Almost 80 per cent of platinum is mined in South Africa. Such mine concentration mean that the supply of platinum is vulnerable to local shocks such as unionised worker strikes.
Platinum is used in vehicle autocatalysts (devices that convert pollutants from the combustion of fuel into harmless gases). Globally, tightening emission standards will favour higher loadings of platinum group metals in these devices. Platinum also has a strong correlation with the South African rand. We expect a modest rand appreciation to support platinum prices.
We believe silver’s fair value price by the year end is around $20 an ounce (+20 per cent) and platinum’s fair value price is around $1,020 (+10 per cent).
Nitesh Shah is commodities strategist at ETF Securities
