Robust global demand for gold on ETF and Chinese demand
Central banks with long-term goals to increase their gold allocation may also decide to wait for more attractive prices
GOLD prices have stabilised at historically high levels since mid-April, but demand momentum has slackened because of the high prices. In particular, the reduced affordability of gold and unsupportive seasonality should ensure jewellery demand remains weak until end-August.
Central banks with long-term goals to increase their gold allocation may also decide to wait for more attractive prices.
Finally, Chinese physical demand for gold, as proxied by the spread between the international (London) gold price and the gold price on the Shanghai gold exchange, has abated recently.
Other sources of gold demand have been holding up, though. For example, exchange-traded fund (ETF) demand has improved thanks to rising chances that the United States Federal Reserve will start its easing cycle in September.
Demand from the futures markets has also remained strong, and reported demand from central banks is only a portion of official demand. While little is known of current buying, institutions such as sovereign wealth funds eagerly bought gold in the first quarter of the year.
Overall, although we have seen a relatively mild decline since mid-April, there is little evidence that high gold prices have significantly dented global demand for the yellow metal, meaning the bullish case for gold remains intact.
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ETF and Chinese demand likely to strengthen
Beyond ongoing strong demand from the official sector, there are two main reasons, in our view, to keep a medium-term positive view on gold.
First, we see scope for further improvements in ETF demand after months of disinvestment. The start of a Fed easing cycle should fuel some of this demand for gold as the opportunity costs to own gold would likely decline in line with interest rates.
Second, Chinese physical demand for gold is likely to strengthen again. Depending on whom the next US president is, the threats of higher tariffs on Chinese exports to the US could lead to downward pressure on the renminbi and therefore fuel stronger Chinese demand for gold.
Also, the Chinese economic outlook remains subdued and domestic monetary policy is unlikely to be tightened soon given low inflationary pressure. The policy mix is therefore not supportive of the renminbi.
The increasing number of countries considering curbs on Chinese exports may also add to the downward pressure on the renminbi. Overall, we expect Chinese demand for gold to pick up again in the coming quarters.
The US elections may in reality have a mixed impact on gold prices. As there has not been a strong case made for fiscal consolidation, growing concerns over the US’ fiscal sustainability may eventually favour gold – which does not bear any default risk.
At the same time, Republican presidential candidate Donald Trump’s proposals for higher tariffs and reduced immigration could lead to significantly higher inflation and higher interest rates. This may weigh on gold prices through punitive opportunity costs.
Gold’s medium-term outlook remains positive
Our 12-month projection of US$2,550 per troy ounce symbolises our medium-term bullish outlook on gold. The spot price was US$2,422 on Jul 15.
Historically high nominal prices are cutting into demand, however, and may mean that gold has little upside potential in the short term. It is also worth noting that prices for other precious metals are currently less robust than for the yellow metal.
We suspect that the recent falls in US short-term interest rates and the US dollar have been helping gold prices to be more resilient. Given our base-case scenario, however, gold may not benefit much more from these two drivers in the short term.
The key risk is obviously that new all-time highs in the gold price kindle another rise in demand from momentum investors.
Unlike in March, however, when gold prices surged, positioning in the futures market is already at very elevated levels, suggesting marginal new demand may be limited.
That said, we acknowledge that with the Fed easing cycle and US elections getting closer, a strong decline in gold demand looks increasingly unlikely.
The writer is currencies strategist at Pictet Wealth Management
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