Gold prices are down by 3.5% so far in March after a strong start to the year. Despite this we think that gold prices have been relatively resilient as the dollar failed to rally substantially as a result of the behaviour in US real yields. US real yields will continue to drive gold prices and the US dollar.
There has been a lot of focus recently on the sell-off in precious metal prices including gold prices. Since the start of March, they have lost between 7% (platinum prices) and 0.5% (palladium). Gold prices have fallen by around 3.5%, following the strong start to the year. In this report we focus on the reasons behind the sell-off in gold prices and assess whether we were too early or not to upgrade our gold price outlook on 2 March 2017.
Despite the recent sell-off we think that gold prices have been very resilient, given the circumstances. For a start, financial markets have now fully priced in a rate hike by the US Fed in March. As a result the 2y US Treasury yields have risen beyond the peak in December 2016 of 1.30% and currently are just below 1.34%. In December, gold prices made a low of USD 1,121 per ounce. So despite the higher 2y US Treasury yields gold prices currently are about USD 90 higher than in December 2016. However, financial markets have not yet fully priced in the 3 rate hikes that Fed has communicated (also our base case). In addition, US equity markets have risen strongly this year. Often, a strong rise in equity markets coincides with considerably weaker gold prices. This has not been the case this year. Interesting to note is that the pull back in the Dow Jones has coincided with the pull back in gold prices.
The relative resilience in gold prices can be fully explained by two crucial drivers. First, the behaviour of US real yields and, second, the c (which is also affected by US real yields). US real yields are the dominant driver for gold prices and the US dollar. In January and February, US real yields (based on inflation expectations) declined, pushing the US dollar lower and gold prices higher. However, over the recent days these real yields have edged higher, supporting the US dollar and weighing on gold prices. This modest pickup in real yields may continue in the coming weeks but we expect them to peak later in the year, which will probably result in a rebound in gold prices. In the near-term, there is a risk that slightly higher US real yields may push gold prices temporarily below USD 1,200 per ounce, but this would not make us doubt our outlook. In fact, some pullback after the strong rally at the start of the year doesn’t come as a surprise to us. Having said that, it will be interesting to see the reaction of the US dollar to important US data releases this week, such as the US employment report on Friday. If hourly earnings come in around expectations and the rest of the US employment report is strong, the US dollar will probably profit. However, if hourly earnings are much higher than expected and the rest of the report is also strong investors may start to worry that the Fed is behind the curve. It is likely that this will weigh on the dollar and support gold prices.
– Georgette Boele – ABN AMRO
Next week’s potential U.S. rate hike continues to be an overhang on the gold market, but according to one precious-metals analyst, gold prices might have fully priced it in. – Sarah Benali – Kitco
“In late November and early December, gold slumped from $1,280 to below $1,130 while the yield on the active 30-day Federal funds futures contract climbed from 0.565% to 0.645%. Both moves ended after the December FOMC meeting and gold subsequently embarked on a strong recovery,” said Tom Kendall, head of precious metals strategy for ICBC Standard Bank, in a report Friday.
“So in the short term, those who are long gold might not have to suffer too much more downside; we would put the first key technical support line at $1,180.66,” he added.
Gold prices have fallen from a $1,260 peak to just under $1,200 an ounce as rate-hike expectations have grown. Investors are pricing in a 93% chance that the Federal Reserve will tighten next week. At the same time, April Comex gold futures last traded at $1,200.10 an ounce, sitting near five-week lows.
However, Kendall pointed out that gold may be set up to fall under pressure over the longer term.
“Contrary to what gold bulls might believe, the Fed’s median forecast for the Fed Funds rate at year-end is more hawkish than the market…The market is one hike less hawkish than the consensus of Federal Reserve members and may fall further behind next week when the Fed will release an update to its economic projections,” he explained.
“[T]he key point is that if you believe the Fed is already behind the inflation curve, then the market is even further behind. The result of a repricing of rates would, all else being equal, be a sharp move upwards in real interest rates, and that would tend to weigh heavily on gold.”
For that reason, Kendall says he is sticking with his not-so-positive outlook for the yellow metal this year.
“We are content, therefore, to leave our Q2 average gold forecast of $1,140 unchanged for now, on the basis that Fed funds futures are currently only pricing the probability of another hike in June at 50% and that the Trump administration has not yet offered anything of substance on fiscal stimulus,” he said.
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