Since its 6-year low in early December, gold has risen by over $90. In this article, we assess the prospects for the gold price over the next twelve months or so and whether this does mark the beginning of a new bull market. We also look at the implications for some of gold’s key supply and demand segments, paying close attention to the retail investor market for small bars and coins.
The current rally can be traced back to late last year. The immediate aftermath of the first US interest rate hike last November demonstrated that the move had been largely priced into the gold market for some time. Although gold did subsequently face selling pressure (from investors) after the announcement, its price decline was modest.
Turning to the start of this year, the sell-off in global equities has clearly provided a boost for gold, with safe haven demand, to some extent, returning to the market. Concerned about the outlook for the global economy and especially the prospects for a hard economic landing in China, some investors have switched their focus back towards gold. In particular, this has helped lift gold demand of both exchange traded funds and in the futures market. This in turn has contributed to a 9% rise for the yellow metal, which has surpassed $1,140 (at the time of writing) for the first time since early November last year.
Given our expectations of rising gold prices for much of this year, we could be tempted to interpret recent moves marking the turning point for the gold market. In particular, our expectations for US interest rates, which we only see rising to around 1% by end-2016, should eventually help gold prices to move higher.
In the meantime, though, some near-term weakness in gold prices may still merge. For example, participation by institutional investors on the long side of the gold market has so far been relatively modest, which in turn suggests a lack of conviction towards gold’s upside prospects. One reason for this is that expectations for the pace of US interest rate increases could quickly change. For example, a series of better than expected economic data releases in the US could see equity markets recover leading to a rotation out of gold, sending prices lower.
Even so, based on all of the above, we believe that gold prices will gradually move higher over the course of 2016. Against this backdrop, we expect to see a benign outlook for gold’s core supply and demand fundamentals. Starting with mine production, we believe this will plateau this year. It is worth noting that we continue to see only limited price-related closures, as the effect of lower dollar gold prices has been offset by weaker gold mine producer currencies and other cost reductions (such as reduced exploration expenditure).
Moving to the demand side in the gold market, and focussing on the world’s largest gold consuming market, China, the country faces another challenging year. Slowing economic growth, troubled equity markets and, perhaps most important of all, poor sentiment in the country are clearly impacting demand, in line with other discretionary spending.
One sector that performed relatively well in 2015 and should remain quite strong this year is retail investor demand, where the focus is on small minted gold bars and bullion coins. Globally, the largest retail markets are China and India. Bringing the discussion closer to home, in the west the largest markets are Germany and the US. Exploring these markets in a little more detail, the profile of retail investment in each country varies considerably. Looking first at Germany, small minted gold bars account for roughly 70% of the retail market. Some of the most highly desired sizes include the one kilo bar, 500g, 250g and 100g, with German brands noticeably popular. In terms of the retail coin market in Germany, arguably the most sought after bullion coin is the South African Krugerrand.
Turning to the US, the market share split between gold bullion coins and bars is effectively reversed, with coins accounting for around 70% of the country total. The most popular coin is the US Eagle, although other pieces in high demand include the Canadian Maple Leaf. In the US retail bar market, the 1oz bars arguably the most popular, with Swiss made pieces dominating the retail landscape. Turning to the UK, the bar : coin spit appears slightly in favour of bars, with an estimated 55-60% share of retail sales to small investors. This segment is also dominated by Swiss brands, as well as locally produced pieces. Unsurprisingly, the most popular gold bullion coins in the UK are those struck by the Royal Mint.
One common theme across most Western retail investor markets is the relatively “sticky” nature of retail purchases. In other words, there can often be a reluctance to liquidate holdings. This buy and hold mentality largely reflects a key buying motive, namely wealth preservation, rather than wealth accumulation. This explains why retail investor demand took off during the 2008/09 financial crisis as small investors looked to diversify investments, at the expense of more traditional investment vehicles (such as equities) and in favour of precious metals.
Fast forward to the current market and although the level of retail gold buying, for example, in the UK, pales against volumes purchased during the banking crisis, the recent sell-off in equities has once again boosted gold’s appear as a safe haven. This in turn explains the low level of liquidations among retail investors, that we are now seeing. However, this in itself will do little to push gold prices higher. Instead, what is required is more sustained buying by professional or institutional investors. After all, this is where the real weight of money lies in the gold market. Once this occurs, gold prices should then enjoy more pronounced gains, which should extend well beyond 2016. In spite of this performance, we need to put the expected bull market into perspective as we do not expect gold to come close to the 2011 high of $1,900.
By Philip Newman, of Metals Focus, London based independent precious metals consultancy
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