Wings clipped
The gold price has since our last review, in April, of the ETFS Physical Gold ETF (ETF) (ASX:GOLD), faced some major headwinds. Inflation as a compelling story in 2018 has yet to fully playout and deliver the tailwind as expected. Meanwhile, a stubborn United States Dollar (US) has proven to be a headwind for the gold price over the same time. Moreover, the physical gold market has been less supportive of a price rally in recent times. The following chart shows the gold price:
Source: Index mundi
The gold price is currently trading around US$1,226 an ounce, which is 8.1% lower when compared to the US$1,334 an ounce at the time of our last review (April 2018). A stronger US Dollar has since our last review of ETF, been the dominate headwind for the gold price.
The US Dollar has since April, been propelled higher by a growing uncertainty around global trade wars, weaker competitive currencies such as the Euro, and rising US interest rates lifting yield differentials in favour of the US Dollar. The following chart shows the US Dollar Index:
Source: Bloomberg
We expect the US Dollar will continue to move higher over the remainder of 2018 as many of the factors mentioned above will continue to remain in play. The US Dollar will likely continue to buffet the gold prices.
Gold as a “safe haven” has seen this premium diminish in recent weeks and adding further downward pressure to the gold price.
The global trade wars and sanctions appear to have not raised the concerns of investors, while many of the global geopolitical tensions are receding, including the most recent in the Korean peninsula. Geopolitical events are becoming more prevalent, but “safe haven” increases in the gold price are not lasting.
One of the forces we expected to drive the gold price higher in 2018 was inflation, and on this front the scenario is playing out, but the upward momentum remains in question. The following chart shows the US Core Inflation over the past five years (year-on-year percentage change):
Source: Trading Economics
As Members can see from the above chart that the sceptre of inflation is creeping into the US economy in 2018, but remains the subject of US Federal Reserve (Fed) action to contain it. The US Fed has raised cash rates seven times since the 0.25% historic lows of 2016. US cash rates now sit at 2.00%. The Fed remains committed to a paced out increase in US cash rates over the remainder of 2018 and 2019 to combat any inflationary pressures that arise.
US instigated tariff war first in steel and aluminium imports and now more broadly on Chinese imports and now Russian imports may further add to the costs and hence inflation in 2018 and beyond. The upshot of these wars will see cost increase and do so rapidly, as the tariff impacted items feed into pricing within the US economy.
We expect to see an escalation in the inflation rate at a pace akin to that seen in the latter part of 2016, and remain persistent in 2019. A higher inflation rate and a perception of it accelerating will add a significant tailwind to the gold price over the remainder of 2018.
Turning to the physical gold market, we have seen little assistance toward a higher gold price from this quarter, with demand in key metrics remaining subdued in early 2018, while supply has remained adequate.
On the supply side, the total supply of gold rose for the March quarter 2018 when compared to the March quarter 2017 by 3.1%, to 1,063.5 tonnes. The following chart shows quarterly gold production:
Source: World Gold Council
Unfortunately, mine production which had been pushing higher over the past five years from 2,744 tonnes in 2011 to 3,298.4 tonnes in 2017, continued the upward trend in the March quarter. Mine production rose by 1.4% compared to the March quarter 2017, to 770 tonnes. Weak local currencies compared to the US Dollar drove the higher production. Going forward, we anticipate the total supply of gold will grow at a modest pace and therefore act as a headwind on any gold price rally.
The demand for gold has been somewhat disappointing, with the firmer gold price curbing demand; as would be expected. The following chart shows quarterly gold demand:
Source: World Gold Council
Total gold demand compared to the March quarter 2017 fell by 1.9%, to 496.3 tonnes. The uncertainty of trade wars and the impact on the global economic outlook and hence lower consumer confidence drove the result. We expect the sector will return to modestly grow over the remainder of 2018. We expect a lower gold price will improve demand.
The fall in demand came from investments, as the “safe haven” and “inflation proofing” premiums receded in investors’ minds. Demand in this sector fell by 23% on the March quarter 2017, to 32.4 tonnes. Our expectation is for the “inflation proofing” premium to return over the remainder of 2018 and positively impact the gold price.
The upshot of the movements in gold demand and supply for the March quarter 2018, kept the overall gold market in surplus by 81.5 tonnes, compared to a deficit of 29.5 tonnes for the year earlier quarter.
In our 2018 forecast that was published at the beginning of the year, we expected the gold price to close the year out in the range of US$1,550 to US$1,600 an ounce; our view remains unchanged, we will however be reviewing this forecast post the middle of the year.
With the broader macro factors in play in the global economy, do in our view, remain positive for the gold price over the remainder of 2018.Recent price action has however put a question under our year-end forecasts.
We will, in view of maintaining a positive outlook on the gold price continue to recommend the ETFS Physical Gold ETF (ASX:GOLD) as a buy for Members with no exposure to the vehicle.
