Metals, both precious and base, say a lot about the direction of the global economy. They are the foundation of economic growth, and gold—besides being used as a currency and store of value—is the original fear gauge.
Crises, quantitative easing and global macroeconomics all affect the metals market. Knowing what fundamental drivers move these markets helps metals traders anticipate where they should be priced today and in the coming years.
Every year the metals markets face a different set of challenges. This year, gold traders are plagued with the U.S. Federal Reserve and European and Far East central banks going in different directions. The Fed is looking at tightening in 2015, the Eurozone is rolling out its version of QE and China—which is now the largest gold producer in the world—is attempting to stimulate its economy.
“With the U.S. dollar spiking upward this year and the Fed expected to tighten monetary policy at some point in June or September, it’s a challenging environment for gold prices,” says Patricia Mohr, vice president, economics, and commodity market specialist at Scotiabank. She expects gold to trade lower in 2015.
China is always a factor. “A lot of metals traders are worried about China’s economy. They’re throwing their hands up in the air and saying, ‘China is going to slow down; the world is coming to an end,’ but it’s not so,” says Pete Thomas of Zaner Precious Metals.
“China’s economy is like everyone else’s; it’s going to get hot, it’s going to get cold. The thing is, people in China strongly believe they need to own gold—that demand will always be there,” Thomas says.
Gold as last resort
“Many years ago I knew this Chinese gentleman who would purchase gold coins every month,” Thomas says. “I asked him why and he said he used to be a police officer in a province in China where there was a revolution, and his home and police station were burned to the ground. He moved his family to Hong Kong. All he had when they arrived were a few gold coins. He would pay for rice, clothing and shelter with shavings from those coins. Since then he’s never been without gold coins. It goes to the underlying fundamentals of gold—that it always holds value. It can be traded anywhere, anytime for goods or services.”
Here in the West we can debate the usefulness of gold as a last resort currency, but there are enough people in the world with this gentleman’s perspective to support demand.
“Why gold? Because it’s the only real currency there ever was,” Thomas says. “The only paper money that hasn’t gone to zero at least one time or another in its history is the U.S. dollar—and our turn will come,” he jokes, seriously.
Now that Iran and the United States have created a framework for a nuclear accord, it will allow the Middle East the ability to trade gold as never before—and it’s going to lead to a monstrous shift for gold trading to the Middle East, according to Thomas.
Gold traders hedged their bets in the run-up to the framework of the deal, which Thomas expected would be positive for gold. “The Iranian people love gold and after the agreement was reached, gold turned slightly higher. Now I expect Iranians will flood into the gold market as buyers and the price of gold will [keep going higher] due to this increased demand,” Thomas says.
This could work out well for all our refiners and recyclers, as a new solid recurring source of demand will throw a floor under the metals in short order.
The U.S. dollar also is playing its role in moving the gold market. The dollar has softened from the surprisingly weak March employment situation report (see “Complex relationship,” below).
“We had a debasement of currencies due to political events in various parts of the globe,” says George Gero, vice president of Global Futures RBC Capital Markets and long-time gold trader. “This saw investors turn to gold, which is liquid, portable and has no political allegiance.”
Even New York Fed President William Dudley said the first quarter looked weak and the Fed seems to be in no hurry to raise rates, which means that instead of June, we’re now looking at September for rate increases.
When the market believes that the Fed will delay monetary policy tightening, gold prices rally.
“The Fed has recently indicated that it will look at a variety of financial and economic factors—as well as employment conditions and inflation—in deciding upon the timing of any Fed funds rate hike,” Mohr says. “This probably means the Fed has been concerned over the strength of the U.S. dollar and the negative impact on U.S. exports and employment.”
“However, the general concern over when the Fed will tighten will continue to restrain gold prices in 2015—more specifically, this is why I expect gold prices to average less in 2015 than in 2014,” she says.
The Fed will, most likely, need additional weak economic numbers to alter its course but the soft Q1 numbers have supported gold.
“This has caused gold to go up $20 alone in trading on the first trading day of the second quarter (April 6),” Gero says (see “Gold edges up,” below).
Gold performed poorly during the first quarter of 2015 because of interest rate fears and a very strong dollar. But traders looking at higher crude prices and seeing a softer dollar and continued lower interest rates are now looking at gold as an asset allocation during the first week of the second quarter, when they weren’t looking at it in this way last quarter.
Gero expects gold to trade between $1,200 and $1,300 an ounce by the beginning of the third quarter.
He says soft economic data is creating the possibility the Fed will delay the timing of the initial Fed funds rate hike, which lifted gold back to $1,185 in late March. Gold had dropped as low as $1,143 in mid-March when the euro fell just below $1.05.
Mohr sets $1,185 as an average in 2015, down from $1,266 in 2014. “Gold may stay a little bit lower in the next 12-18 months, but by 2017 gold prices could very well start rising again,” she says.
Meanwhile, Thomas expects gold prices to take one more brutal dip this year around June, but will find a floor around support at $1,000, which he expects will hold until the market starts to creep back up to $1,500 to $1,600.