Photo: Bloomberg
The second half of 2021 is expected to be a lot different from the conditions that precious metal traders found themselves in around the same time last year.
In July last year, gold prices were surging higher into levels last seen many years ago. The Covid-19 pandemic had ravaged every nation, dumbfounding all to its devastation to personal and economic health.
Central banks and government were extremely lavish with stimulus programmes in hope that it may arrest the rut that the coronavirus had brought as nations were fast slipping into recession.
Few would dare accurately forecast what lied ahead and gold prices thrived in the uncertainty. Gold and other precious metals were seen as the preferred asset class in investing.
Fast forward to July this year and the world looks a lot different. In a number of countries, there are no takers for vaccines and health authorities have to resort to incentives to get a majority of their citizens to take their vaccinations.
Nations are also pulling out of recessions. Now, central bankers and governments are locked in debates as to how to dry the monetary and fiscal liquidity that had been primed into economies.
Herein lies the dilemma currently faced by gold traders — how can gold prices perform in such an environment where countries are emerging out of the recession and there is much public discussion about tapering stimulus programmes. Yet, there is fear as these countries are totally not out of the woods as the pandemic has not been eradicated, forcing nations back into lockdowns.
Investment and physical buying of gold had been driving prices higher since gold failed to break below US$1,000 an ounce in late 2015 and safe-haven buying born out of the uncertainty resulting from the pandemic accelerated gold prices to the highest level above US$2,070 ($2,797) an ounce in August last year. The economic fallout from the pandemic and negative bond yields have made gold one of the most attractive financial assets.
Since then the bullish technical picture of gold has deteriorated with prices below major 200-day and 50-day Exponential Moving Averages (EMA) on daily charts and most technical indicators are in the negative on daily charts but a bear trend for gold has not been proclaimed yet.
It is too early to tell if there is a major change in trend although minor tops and bottoms had been lower until a “double bottom” chart pattern was formed in March. The price of gold has been recovering since then. A breach of the key support level would however lead to massive long liquidation of positions by investors and necessitate a rethink of the bullish trend of gold.
Fundamental drivers
My take is that the bullish trend of gold is still intact although there are a number of analysts that would beg to differ as the fundamental drivers that affected gold last year, would still be a major driving force in the second half of this year.
If I can rightly place these drivers in terms of their influence on the price of gold in the second half of the 2021, real rates would take the key pole position, followed by the US dollar, risk factors and supply demand dynamics.
How intensely these factors drive gold prices higher would of course depend on a trader’s perception of its efficacy versus other asset classes like bonds which are interest bearing unlike bullion and have made the asset class seem less attractive to investors.
The dollar has also strengthened due to rising US Treasury yields but lately both asset interest in both asset classes have waned and interest has shifted back to the yellow metal.
The role of gold as a safe-haven in times of a crisis has also diminished lately, with tensions between world superpowers considered as being minimal and at a comfortable level for investors to not increase their holding of such assets.
Supply and demand dynamics is also seen to not play a greater role going forward, with physical demand from buyers in India being stagnant. Central banks thus are expected to play a greater role in the physical market as they regain their appetite for gold. In fact, central banks from Serbia, Ghana and Thailand have already started adding on their holdings of gold as more funds reserved for the fight against covid-19 become available.
Central banks have always played a role in determining the price of gold. These bankers also influence monetary policy and often set the tone for interest rates. The Federal Reserve at the Federal Open Market Committee (FOMC) — a committee within the Federal Reserve System charged under US law with overseeing the nation's open market operations — meeting in June surprised financial markets when their forecasts showed they pulled forward their expected timing and pace of interest-rate increases from the current near-zero level.
This also kicked in a discussion of when the bank intends to taper asset purchases from their current US$120 billion monthly pace. This turn of events, though totally not unexpected, sent gold prices into a tailspin before buying emerged US$90 lower.
Gold spot and futures markets have steadied somewhat after being buffeted by a moderate hawkish tilt in the Fed’s policy outlook. Officials had since sought to emphasise that the central bank will continue with the current pace of asset purchases until the US economy has made the necessary progress toward employment and inflation goals.
The Fed Chair Jerome Powell had repeated his views that inflation pressures will be transitory and that a notable increase of inflation is to be expected to be transitory. Price pressures are arising from bottlenecks in supply chains struggling to cope with demand in an fast recovering economy reopening after months of pandemic-suppression is normal but that price pressure would subside as supply chains normalise.
There are yet some Fed officials though some of them are not members of the rate setting FOMC, clamouring for the need to raise rates even in 2021 and remarks from these officials have had the effect of pushing yields on the 10-year note higher. Higher yields had also attracted interest back to the US dollar and had supported it from the effect of currency debasement.
The Dollar Index which is a measure of the value of the dollar against a basket of currencies of its major trading partners had arrested its decline to lows last posted in 2018 and had come-off the 90 level in anticipation of higher interest rates ahead due to inflationary pressures. The Dollar Index is often used by traders as a means to gauge the value of gold as prices tend to move inversely to the Index more often than not.
Inflation
With the threat of inflation raising concerns, central bankers from not only from the Fed but also the European Central Bank (ECB) have reiterated that raising interest rates is still “way off in the future”. These bankers want to see additional employment gains and increased economic activity for the next several months before assessing whether their economies have achieved the progress required to even to taper bond purchases let alone increase rates.
The gold market in the next few months would focus on central bankers’ views on interest rates and tapering. The next ECB Governing Council meeting is in mid-July, though expectations of market moving factors to emerge from the meeting are not worrisome.
Traders would definitely look forward to the ECB’s monetary policy committee meeting in September just before the FOMC meeting. Expectations are that the bankers would paint the same economic picture as they did in June but with improving economic conditions that yet do not warrant any pull-backs of the massive stimulus that been injected to sustain their economies.
Gold markets seem to have calmed down after the dollar retreated from its recent rally and 10-year Treasury yields appeared subdued. A clearer picture of where gold is heading may be more apparent as the immediate trend of the two key drivers of gold become clearer.
The effects of the recent tilt of the Fed towards hawkishness had begun to wear-off with the Fed calming markets. At the time of writing, spot gold prices had formed “double bottom” patterns this year that are visible (see chart) which is a healthy sign for gold bulls.
Expectations are the price of gold rises up from the bottoms but slowly with frequent pullbacks. Prices may also likely be dominated by technical trading rather than structural drivers in a wider range between US$1,860 and US$1,780 an ounce until mid-September in the absence of any tail-end risk factors.
Investors would then again debate the immediate trend in the light of the monetary decisions by the major central bankers for the next quarter.
Avtar Sandu is senior commodities manager at Phillip Futures
