OPINION: Gold bulls: beware the mighty greenback

By Ryk de Klerk Time of article published Nov 15, 2018

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JOHANNESBURG – Gold bullion has again shown that it is a store of value during uncertain times. Since October 1 the yellow metal outperformed emerging markets as measured by the MSCI Emerging Market Index in terms of US dollars by more than 10 percent and developed markets as measured by the MSCI World$ Index by nearly 9 percent.

Gold is still up by $15 since October 1, despite retreating from a recent top of $1 232 (R17 795) per fine ounce.

The price of gold is mostly watched and quoted in US dollars and the underlying trend is, therefore, blurred by the strength or weakness of the greenback against other currencies.

In order to get a more balanced view of the global price of gold, I calculate a weighted gold price index by using the official index of the dollar against other currencies to calculate a gold price index for the world excluding the US.

After indexing the gold price in dollars both indexes are equally weighted to establish a world price of gold.

My indicators suggest that the gold market was supported by increased investment and specifically more speculative demand (bars, coins exchange traded funds and similar products) up to 100 tons in the first few weeks of the current quarter. That is in stark contrast to the third quarter, that according to the World Gold Council saw a fall of nearly 87 tons in speculative demand compared to the second quarter of this year.

Speculative demand is typically event-driven. Strong demand was evident during the euro-crisis from 2010 to 2012, which led to a surge in the gold price. Demand tapered off as worries about the euro-zone eased and the price of gold fell sharply.

A similar trend emerged during the early stages of Brexit, where speculative demand increased sharply while the gold price spiked momentarily before pulling back as speculative demand fell.

Time and time again the advance in the gold price is capped by an increase in recycled gold, which over the past few years ranged between 25 percent and 30 percent of total supply. That per se is one of the main reasons why long-term price growth in the yellow metal is limited.

The action in the gold market during the current trade war between China and the US compared to the euro-crisis and early stages of Brexit is rather mundane – to say the least. Perhaps it was telegraphed so long before the event – the same with Washington’s new sanctions on Iran.

The mundane action, in fact, leaves the gold market vulnerable to a correction as speculative positions may be liquidated in favour of more risky assets such as equities, especially after recent sell-offs. The major risk for the gold price in terms of US dollars is that the dollar has found new strength and could even test the highs attained in the first quarter of last year.

Even if the gold supply and demand equation stays the same and the gold price in other currencies as measured by my gold price index for the world excluding the US marking time, the strength of the dollar to last year’s highs could shave off nearly 6 percent or $70 per fine ounce off the current gold price.

It certainly does not augur well for gold shares and emerging market currencies, though. For global investors the iShares MSCI Global Gold Miners ETF outperformed developed market equities as measured by the MSCI World$ Index by more than 7 percent since the end of September this year, while the FTSE/JSE Gold Mining Index outperformed the South African market as measured by the FTSE/JSE All Share Index by nearly 17percent.

But what are the fundamentals behind a stronger US dollar? US long-dated bonds are getting more attractive by the day.

The yield gap between the US and German 10-year government bonds has increased further from 2.61 percent to 2.78 percent, the fall in the price of crude oil is likely to ease inflationary expectations in the US, the US has ample spare capacity to sustain strong economic growth over the next two quarters.

Figures for Germany point towards a weak development in Germany, Europe’s largest economy, while China is pump-priming its economy to stave off slower demand growth. The US economy is also likely to outperform Japan as cracks as a result of the trade war are already appearing in the latter’s economy.

In my view the inclusion of gold in an investment portfolio is justified when the aim is to guard against downside risks of risk assets such as equity portfolios in uncertain times - whether it be increased sovereign or financial risk such as stretched equity valuations. However, one needs to realise that at some stage the downside risks will subside and gold will under-perform. So, yes, gold also carries downside risks caused by factors such as a rampant US dollar.

Ryk de Klerk is an independent analyst. Contact [email protected] His views expressed above are his own. You should consult your broker and/or investment adviser for advice.

The views expressed here are not necessarily those of Independent Media.


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