As macroeconomic and geopolitical conditions worsen, gold prices have rallied significantly. Will the precious yellow metal continue to shine?

SINGAPORE (Nov 25): In the past two years or so, gold prices have been relatively muted as the precious yellow metal traded largely between US$1,240 and US$1,350 an ounce. This occurred amid an environment of sustained global growth and buoyant equity markets.

But right now, the US has progressed further into the economic cycle. It is also in the midst of a trade and technology war with China. Against this backdrop, investors are seeking safe haven assets. As a result, prices of the precious yellow metal broke past the US$1,400 level in June, before hitting a five-year high of US$1,552.55 an ounce in early September. Gold has since pared some of those gains, but it is up 15% so far this year at US$1,471.61 an ounce on Nov 20.

Heng Koon How, head of markets strategy at UOB Bank, says the rally in gold prices can be attributed to the reduced investment opportunity costs of holding gold. As the precious yellow metal is known as a non-yield asset, investors tend to favour yield assets such as dividend-paying stocks and bonds. Nevertheless, as major central banks around the world have begun cutting interest rates in response to slowing global growth and geopolitical risks, gold has become more attractive.

Sim Moh Siong, currency strategist at Bank of Singapore, says gold prices were also driven by concerns of a potential currency war a few months ago. US President Donald Trump had threatened to devalue the US dollar to improve the country’s balance of trade. In particular, the Trump administration was poised to intervene — or at least gave the impression of doing so — to prevent the appreciation of the US dollar. Yet, as the US Federal Reserve in July slashed the federal funds rate for the first time since 2008, other central banks, such as the European Central Bank and the People’s Bank of China, followed suit. This led to the weakening of other currencies, says Sim.

Amid this “race to the bottom” to devalue currencies, gold emerged as an obvious winner, as it is not owned by any sovereign nation. “So, if you want a good store of value, your confidence in US dollar is not great. It is eroding. And confidence in other major currencies’ store of value is eroding [too]. Then gold tends to benefit as well,” Sim tells The Edge Singapore.

Notably, the accumulation of gold by central banks also pushed up its prices. According to statistics by the World Gold Council (WGC), demand from central banks and other institutions leapt 12% y-o-y to 547.5 tonnes in the first nine months of the year. This was despite demand from central banks and other institutions having tumbled 38% y-o-y and 33.3% q-o-q to 156.2 tonnes in 3Q2019. “[A] major reason for the sustained rally in gold prices has been the increased purchases made by global central banks, which continue to remain broadly dovish,” Siraj Ali, chief operating officer of AJ Capital Asset Management, tells The Edge Singapore.

The demand push on gold prices was offset, however, by the decline in global demand for gold jewellery. According to WGC, sales of gold jewellery fell 4.6% y-o-y to 1,520.9 tonnes in 9M2019. In 3Q2019, sales of gold jewellery declined 16% y-o-y and 15% q-o-q to 460.9 tonnes. In Singapore, jewellery demand fell 12% y-o-y and 4% q-o-q to 2.5 tonnes during the quarter.

Part of the decline can be attributed to the weak demand from Indian consumers, who are traditionally big buyers of gold when it comes to festivities and weddings. “It must be noted that Divali sales were somewhat disappointing, given the weakness of the rupee vis-à-vis the yellow metal,” says Davis Hall, global head of foreign exchange and precious metals advisory at Indosuez Wealth Management.

Global gold demand for technology purposes also slipped 3% y-o-y to 243.2 tonnes in 9M2019. This comprised lower demand from electronics manufacturing, dentistry and other industrial sectors. In 3Q2019, the figure fell 4% y-o-y, but was up 1.5% q-o-q, to 82.2 tonnes.

Rob Carnell, chief economist and head of research at ING Bank in Asia-Pacific, says gold is used in many electronic devices. But there has been a “slump” in demand because of declines in 4G mobile phones, electronics used in cryptocurrency mining and poor global car sales. “So, if the demand for electronics and the stuff that contains electronics is down, so too should demand for related products, like gold,” he says.

Still, gold investments surged 31.4% y-o-y to 1,005.9 tonnes in 9M2019. Gold investments more than doubled y-o-y and was up 38% q-o-q to 408.6 tonnes in 3Q2019 — driven mainly by paper gold investments such as exchange-traded funds (ETFs). This gain was offset, however, by double-digit declines in physical gold investments, such as bars and coins.

Stefan Graber, head of commodities strategy at Credit Suisse, says: “As recession fears flared up earlier this year and the [Fed] has been cutting rates, investors rushed to rebuild previously trimmed gold exposure. Falling real rates are particularly relevant in this context, as they represent the actual opportunity cost of gold investments.”

Now, as recessionary risks increase, with no signs of abating, will gold prices continue to soar? Will it trade near its all-time high of more than US$1,900 an ounce or even surpass it?

Rising economic risks

Gold prices typically react in response to world events, especially those that are economic and/or political in nature. As gold was once used as a currency, it is often used as a hedging instrument against risks because of its ability to store value. So, when things go south, investors typically rush into gold, sending prices through the roof. Yet, recent developments around the world could dampen gold’s ascent.

According to Bank of Singapore’s Sim, Brexit has recently seen some “light at the end of the tunnel”. In particular, UK Prime Minister Boris Johnson has managed to persuade the UK Parliament to dissolve itself with the aim of holding a general election on Dec 12. This came after the European Union granted the UK’s request to extend the Brexit deadline from Oct 31 to Jan 31. The return of a stronger Conservative Party into a government led by Johnson could ease the path to a Brexit deal.

Trade negotiations between the US and China also appear to be reaching an early deal. Officials from both countries are “close to finalising” some parts of an agreement, following high-level telephone discussions on Oct 25.

“What is happening on the Brexit front and US-China trade war is promising,” says Sim. “There is lower perceived political risk, which could pave the way for a mild recovery in the global economy by early next year. One of the obvious signs to hit the global economy is business confidence. The [Purchasing Managers’ Indices] have been slowing for a while now in response to the political risk and trade tensions. We may be at a point in time where PMIs may stabilise and point to a recovery next year.”

The further easing of monetary policy may also help. As widely expected, the Fed cut interest rates for the third time this year at its Federal Open Market Committee meeting in October. The US central bank reduced the federal funds rate by 25 basis points to between 1.5% and 1.75%. In a press conference, Fed chairman Jerome Powell said the interest rate cut was insurance against risks, but gave no hints on further cuts. He also noted that a significant rise in inflation is required for the Fed to start raising interest rates.

Tai Hui, Asia chief market strategist at JP Morgan Asset Management, says the latest US interest rate cut was the “least surprising” part of the FOMC meeting. “[The Fed] strongly hinted that this round of insurance cuts is coming to an end for now. This was a small surprise, facilitated by an ongoing negotiation between Washington and Beijing on trade,” he says in an Oct 31 emailed commentary.

Despite these positive developments, uncertainties still abound. Brexit has in the past proven to be a complex and long-drawn-out affair, resulting in the postponement of the Brexit deadline multiple times. Similarly, the apparent progress in the US-China trade talks will take time to hammer out a complete resolution. This is because phase one of the agreement is likely to be a “narrow” one, says Sim. “So, it is likely that trade tensions might flare up at some point in time.” In short, a resolution to both events is still far off, as much uncertainty still remains.

On top of that, the US — the world’s largest economy — is in the late cycle of a prolonged expansion, Sim notes. That means a downturn in the US will occur — sooner or later — which, in turn, will drag the global economy down. Unfortunately, central bank easing may not be enough to cushion such an event, he adds. “Given that there is policy awareness that central banks may be running out of ammunition, I think the growth concerns are unlikely to disappear anytime soon. Therefore concerns of a recession will continue to linger in the background, although it may not be acute now because of the [recent] developments,” he says. As such, he reckons gold prices could hit as high as US$1,600 an ounce in the next six to 12 months.

Benjamin Yeo, head of dealing — global derivatives and commodities at Phillip Futures, forecasts gold prices will trade at US$1,500 to US$1,600 an ounce in the next 12 months. “While short-term price fluctuations are driven by headlines, long-term prices are based largely on fundamentals, which have been weakening steadily over the past year. This, in turn, boosts demand for precious metals as a safe haven asset,” Yeo tells The Edge Singapore.

Heng of UOB Bank is slightly more bullish. He predicts gold prices could reach US$1,550 an ounce in 4Q2019, US$1,600 an ounce in 1Q2020 and US$1,650 an ounce in both 2Q and 3Q2020. His confidence stems from a technical standpoint of how gold prices had broken past a multi-year resistance level of US$1,400 an ounce, which had capped previous advances since 2013. “UOB has maintained a positive outlook for gold [since the start of the year],” he says.

Continued central bank buying

So, what will gold demand trends look like? For a start, central banks could continue to accumulate gold as they attempt to diversify away from the US dollar, says Carnell. There are several reasons for this.

First, as expectations of further monetary easing by the Fed will weaken the US dollar, gold usually rises in US dollar terms, he says. By accumulating gold, however, central banks are able to preserve their reserves. Second, central banks could be concerned that all major liquid fiat currencies are being debased by unorthodox monetary policies, he says. So, by accumulating gold, its near-currency status will provide a good hedge against that risk.

Third, central banks could be attempting to bypass increasing attempts by the US to weaponise access to its financial systems to control foreign state behaviour and relationships, says Carnell. So, central banks transact in other currencies, as well as gold, away from the US dollar. “In other words, if you don’t want to be as exposed to the US dollar, but don’t like any of the other alternatives, then gold is a sort of shiny yellow metallic US dollar substitute that is literally as good as gold,” he says, noting that it could be a mixture of some or all of these reasons too.

Lee Eun Young, analyst at DBS Group Research, agrees. “Uncertainties surrounding [the] global economy and dampened growth outlook, expectation [of] limited strength [in the] US dollar and a lowering of interest rates have supported such [a] trend,” she says.

According to WGC, the US had the world’s largest reported official gold holdings of 8,113.5 tonnes, 77% of its reserves, as at Sept 30. In second place was Germany, which held 3,366.8 tonnes, or 73% of its reserves. The third-highest ownership of gold was the International Monetary Fund with 2,814 tonnes. Russia and China, reportedly big buyers of gold in the last few years, were ranked sixth and seventh respectively. The former owned 2,241.9 tonnes, or 20% of its reserves; the latter held 1,948.3 tonnes, or 3% of its reserves. Singapore was ranked 29th, holding 127.4 tonnes, or 2% of its reserves.

Meanwhile, gold jewellery, which constitutes the largest segment of gold demand, may see a further decline. Bank of Singapore’s Sim says if gold prices continue to climb, customers may hesitate to buy jewellery, albeit in the short term.

Over the long term, jewellery demand will continue to be supported by India and China, given their large population size and cultural affinity for gold, adds Sim.

Lee of DBS concurs, saying that India will continue to have a “high appetite” for gold jewellery, as the South Asian giant is expected to record strong economic growth over the next decade, despite a slowdown in many developed countries. “Gold demand for jewellery has been in line with economic growth over the years,” she says.

A decline in demand may also be recorded in gold used in the manufacturing of electronic chips, dentistry and other industrial requirements. “I don’t see this turning around until 5G kicks off in earnest. That is likely to be a 2021 story, not earlier and maybe later. [It] depends on the trade war,” adds ING Bank’s Carnell.

DBS’s Lee has a more bullish timeline, though. “Demand will pick up in 2020, as newly launched smartphones with 5G service initiation will attract customers and [the] outlook for semiconductors is improving,” she says.

Paper versus physical gold

What about gold investments? Will physical gold continue to lose its lustre to paper gold? According to Wayne Gordon, executive director and commodities strategist at UBS Global Wealth Management, the availability of gold ETFs, futures and other structured products could put a dent in appetite for gold bars and coins. “Focusing on physical [gold] demand beyond ETFs is most interesting when counterparty risks become a real topic in financial markets. There is no real stress in the global banking system at present,” he tells The Edge Singapore.

Stephen Innes, chief Asia market strategist at AxiTrader, says gold bars and coins used to be a “go-to in-transit segment” in the early 2000s. To an extent, these items are still in demand today, especially the American Gold Eagle, which is the official US gold bullion coin. “They are convenient and exchanged at virtually every jewellery or gold wholesaler,” he says. “I still buy 1oz Royal Canadian Minted bars because I like the physical attraction.”

But, with the popularity of gold ETFs and other similar products, especially when backed by quality names that offer no transactional risk, Innes concedes that they remain the obvious investment choice. “[Gold] ETFs continue to gain popularity for no other reason than that paper [gold] is more comfortable for the average investor to own than bulk physical gold,” he says. “Long-term investors’ preference for [gold] ETFs… is becoming very apparent in the EU and the US. So, from an investment perspective, physical gold will continue to lose its appeal.”

Will this spell a further decline for the gold bullion industry? Not so, say bullion traders who spoke to The Edge Singapore. Brian Lan, managing director of Gold­Silver Central, says: “At GoldSilver, business was in fact better y-o-y. The geopolitical risk such as the US and China trade war and Brexit… brought more attention to gold bullion, in particular gold bars, for high-net-worth individuals and family offices.”

Joshua Thia, manager of Goldheart Bullion, admits that demand for gold bars and coins was weaker in 2Q2019, but the bullion house saw “improvements” in 3Q2019. “We are hopeful the trend will continue. The initial run-up in precious metal prices discouraged buying but, as prices continued to firm and stabilise, we noticed more buyers starting to return. With higher prices, we also noticed more sell-backs. Overall, the market is more active now than at the beginning of the year,” he says.

In any case, Gregor Gregersen, founder of Silver Bullion, says that, unlike its peers, the bullion house does not actively “strive” to increase sales of gold bullion. Instead, its role is to ensure that it has enough storage capacity. “As world events progress and people become worried about the global financial system, they tend to seek systems like ours, which were designed to protect specifically against systemic risks,” he says. “We spent the last 10 years developing storage systems that are much more transparent, sophisticated and better insured than anybody else out there.”

Besides the bullion trades, other players in the gold bullion ecosystem are poised to do better. Albert Cheng, CEO of the Singapore Bullion Market Association (SBMA), says the import and export of gold bars in Asean was flat in 1H2019, but it has begun to pick up pace in the third quarter.

According to Cheng, trading of gold scrap has increased on the back of higher gold prices. The refinery industry — Singapore has one refinery — has also seen an uptick in activity. “Business is good,” he tells The Edge Singapore.

Managing risks

In the light of higher forecasts of gold prices ahead, how can investors gain exposure to gold? Cheng says it is important for investors to allocate a portion of their portfolio to gold to preserve wealth. This is especially so for older investors, whom he says have to be more risk-averse to safeguard their nest egg. He also cautions older investors against participating in margin trading on gold as the risks of losses can be high. “Retirees can’t afford to do margin trading if they can’t stomach the risks,” he says.

Younger investors, however, can take on more risks. Phillip Futures’ Yeo says gold futures allow investors to carry out leveraged trading. With an initial margin of US$495 ($674), investors are able to buy or sell a COMEX E-Micro Gold futures contract worth US$14,900 at current prices, he says. Compared with physical gold, for which investors generally adopt a buy-and-hold strategy, futures allow investors to short the gold futures and profit from a fall in price. “While the risks are higher, it allows investors to maximise potential profits,” he says.

Ultimately, investors need to pay attention to the demand-and-supply forces of gold from a fundamental perspective. Technical indicators can also be used — for example, the Fibonacci retracement is commonly used to predict the direction of gold prices, says Yeo. Investors can choose to buy at support levels if gold prices have been plummeting or at resistance levels if gold prices have been rallying, he says. Investors should also take steps to protect their positions against events that could cause gold prices to fluctuate wildly, such as stop-losses, he adds. “Both fundamental and technical indicators should be combined to provide a holistic outlook of the market before investing in the precious metal,” says Yeo.