The current environment of ongoing economic expansion and central bank’s broader monetary unwinding is likely to remain negative for gold, according to M&G Investments’ Ritu Vohora. 
Although there is a case for a more constructive longer-term macroeconomic environment for gold prices, the investment director said it is unlikely to manifest in the near term, especially as short-term rates continue to move upwards.
“At the moment, gold looks more heavy than precious,” she said. “If, however, the economy starts to slow or global risks start to pick up and if rates hikes start to get priced out, this would be supportive for the precious metal.”
As such, Vohora (pictured) said it is worth keeping an eye on the US Federal Reserve. After rising interest rates twice this year, the US monetary authority has hinted at two further hikes before the end of 2018.
Although this year’s increases are already priced-in, an acceleration in inflation could lead the Fed to hasten the pace of its hiking cycle, leading investors to turn to safe havens such as the precious metal.
Over the past 10 years, the gold price – as represented above by the Bloomberg Gold Sub index – is up by 46.95 per cent, in US dollar terms.
As Vohora noted, gold has traditionally been a safe haven asset, often sought in times of investor anxiety.
“From escalating trade tensions to geopolitical risk, there are plenty of reasons to expect gold’s heightened appeal,” she said.
Performance of index over 10yrs
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Source: FE Analytics
However, as the above chart shows, the gold price – as represented above by the Bloomberg Gold Sub index – after climbing to 139 per cent gain in 2010 has fallen somewhat more recently and returned 46.95 per cent over the past decade, in US dollar terms.
This year, despite rallying during the first part amid heightened political risks – including Brexit, US president Donald Trump’s tariffs and the Italian elections – gold has since slumped back. Indeed, it has fallen by more than 9 per cent year-to-date, in dollar terms.
But what has been behind its decline? Have investors fallen out of love with the yellow’s metal lustre, asked Vohora.
Among the main reasons behind the loss of appetite for the precious metal, Vohora noted a stronger US economy and an increase in interest rates, with investors keeping away from gold and other so-called “safe havens” and flocking instead to the dollar.
“Dollar strength has helped spark gold’s decline this year,” Vohora explained. “Gold is priced in dollars and is therefore sensitive to swings in the exchange rate.”
Indeed, the M&G investment director noted that, over the past six months the price of gold has been negatively correlated to the rising US dollar index, a basket of competing currencies.
“Nervousness around Europe’s political stability has seen investors favour the dollar over the euro,” she said. “Not only that, but the latest trade disputes have further aided the greenback’s strength.
US dollars vs euro YTD
Source: FE Analytics
“As inflation remains contained around the world and there is currently no driver there to buy gold, the strengthening US dollar will be a key factor weighing on the prospects for gold, as a strong dollar makes the precious metal more expensive for users in other countries.”
Monetary policy hasn’t been of a much help for the yellow commodity this year either, with rising interest rates and the Fed’s hawkish tone contributing to the greenback momentum and therefore acting as a headwind for the metal.
Indeed, in July the Federal Reserve’s chairman Jerome Powell said the US economy was currently running at a fast-enough pace to justify continued interest rate increases.
“On an interest rate differential basis, you would therefore expect further dollar strength,” Vohora explained.
Another headwind for the gold so far in 2018 has to do with the rise in US Treasury yields earlier this year, offering investors a better return than safe-haven assets such as gold and cash.
“Real bond yields are a dominant market driver and serve as the opportunity cost of holding a zero-yielding asset,” said Vohora. “Real yields have only partially unwound their valuation distortion and will likely remain a headwind.”
Regarding gold demand, the M&G investment director highlighted a recent report by the World Gold Council, a trade body for the wider gold industry.
The report revealed that demand stayed weak during the second quarter of the year. Not only that but jewellery, bar and coin sales were flat, while central banks bought 7 per cent less of the yellow metal over the second quarter than the first.
The report also showed that, although gold demand rallied in the closing months of 2017, full-year demand of the yellow metal fell by 7 per cent.
Q2 2018 gold demand
Source: World Gold Council
“While prices have stabilised near the $1,200-mark, speculative traders continue to boost their net short positions on the precious metal and are now short the equivalent of 670 tons, which is the biggest bearish position in 25 years,” Vohora added.
However, the gold prices could prove an attractive valuation for fund managers.
Indeed, the Bank of America Merrill Lynch Global Fund Manager Survey revealed in July that a record 17 per cent of fund managers felt that gold was undervalued.
And PIMCO fund manager Mihir Worah also noted recently, that the precious metal could make an attractive risk-off hedge for portfolios ahead of the end of the market cycle.