Performance of gold over 10yrs
Source: FE Analytics
The silver price has been dragged down with gold, and platinum and palladium prices have been affected by China growth concerns as domestic liquidity has been squeezed.
We believe the price corrections have been excessive and have returned precious metal prices to attractive long-term accumulation levels.
The main trigger for the recent sharp fall in the gold price was a more hawkish-than-expected commentary from Fed chairman Ben Bernanke at his post-FOMC press conference on 19 June.
Fears of a more rapid-than-expected scaling back of quantitative easing led to a knee-jerk sell-off of gold and other perceived beneficiaries of the easy money policies that the Fed has been pursuing since the 2008 financial crisis.
A number of key technical barriers have been breached, which has led to further selling. Silver, which has been trading like a high-beta version of gold, has fallen even more sharply.
Performance of gold and silver over 3yrs
Source: FE Analytics
In the near-term, it is difficult to see any immediate catalysts for a sustained rebound in the gold price. Gold will likely face headwinds as long as US interest rates continue to rise, inflation expectations continue to fall and the US dollar continues to strengthen.
However, we believe these are cyclical factors that are temporary. We believe the reaction of bond markets to Fed comments has been overdone, and ultimately real interest rates will fall back from current levels.
Interest rates need to remain structurally low to keep government debt interest costs in check, support the recovery of the real estate market and consumer balance sheets, and offset fiscal drag. The Concluding Statement of the IMF Article IV Mission to the US released on 14 June supports this view.
The correlation of silver and gold price movements has been strong over the long-term and this correlation has risen sharply over the past nine months. We don’t see any immediate reason for this relationship to change and expect that silver’s directional outlook will remain tightly tied to that of gold.
Platinum and palladium, however, are far more sensitive to industrial demand – particularly China demand. Therefore the recent sharp spike in short-term interest rates in China has been the main factor behind their price declines. We expect China’s liquidity conditions will ease and growth fears will dissipate over the course of the year, removing this hindrance to platinum and palladium price performance.
Given the technical nature of the recent sell-off, short-term moves in the gold price are difficult to predict. Further declines can’t be ruled out.
However, at these levels, strategic buyers – central banks, Chinese and Indian consumers, long-term investors – are likely to see value.
In addition, with short-term interest rates expected to stay low for the foreseeable future, the opportunity cost of holding store-of-value assets such as gold should remain low.
Of course, in the near-term, gold needs a positive impetus – a reduction in US real yields, a weaker US dollar, renewed sovereign crisis in Europe – to sustainably resume its bull market climb.
However, with COMEX speculative short positions at an all-time high, physical demand re-emerging, and the gold price now trading well below the average marginal cost of production, we believe gold provides substantial potential upside, as well as continued tail risk insurance, for long-term investors.
Silver will likely continue to trade as a higher-beta version of gold. Platinum and palladium offer particularly attractive longer-term value at current levels in our view, with prices now substantially below their marginal costs and supply cuts already underway.
Nicholas Brooks is head of research and investment strategy at ETF Securities. The views expressed here are his own.