Over a longer timeframe though, higher inflation expectations tend to be supportive of gold which means that gold could eventually benefit in an inflationary environment once the short term jitters are done.
Motilal Oswal Commodities Brokers
The second half of 2016 is displaying a sharp contrast to the first half, as gold prices have corrected sharply from their peak in July. One big driver for gold this year has been the ultra-loose monetary policy of major Central banks. However, central banks like ECB and BOJ seem to have nearly reached a dead end in terms of their ability to ease further from here. The Fed on the other hand is all set to raise rates in December and the path of rate hikes over the next year is likely going to be steeper than what markets expect given the potential of fiscal expansion in the US. Considering this, gold could find itself on a very slippery ground as lack of incremental liquidity injections will take away a major support for prices.
On the demand side, jewellery and global Central bank demand has been subdued this year while investment demand has been the only pillar on which gold prices have sustained. Investment demand has however started to moderate and if it starts to decline, gold could see a bigger correction in the coming months. The impact of ETF flows on price has been evident this year and poses a big downside risk to prices if investment sentiment falters. The last five months gave us a glimpse on potential price vulnerability. Gold prices flattened out as ETF inflows moderated from July and we believe we could see more liquidations as prices have dipped below $1200.
The next big focus of global markets and gold investors will be on how fiscal policies change, especially in the US, where the election of Donald Trump as President has brought in a whole lot of uncertainties. While Trump is widely expected to introduce expansionary fiscal policies, his views on other economic policies and the US monetary policy are less clear which muddles the outlook for gold in the coming months.
We believe that it may be difficult for gold to make big incremental gains over the short to medium term given that downside risks are more pronounced in the current circumstances. Over a longer timeframe though, higher inflation expectations tend to be supportive of gold which means that gold could eventually benefit in an inflationary environment once the short term jitters are done.
The other important factor to watch going forward will be dollar strength. The dollar index is already near highest in a decade and weakness in other currencies will keep gold attractive in non-USD terms. Importantly, even as Donald Trump intends to provide a fiscal stimulus, his policy in case of excessive dollar strength isn’t very clear. We have seen anti-China rhetoric during his campaign and we believe he wouldn’t favor an excessively strong dollar to help US manufacturing and exports. In that event, if the dollar rally starts to fade, gold prices will start to rebound and geo-political pressure due to anti-globalization rhetoric will provide gold prices further support. In terms of price, we believe that $1120-1150 will probably provide a strong floor to prices, given that much of the negativity has been already priced in. Gold will need a major catalyst to re-enter its bull phase and therefore we expect a prolonged period of consolidation before the markets get more clarity on US fiscal policies and their consequent impact.