Gold set to fall in first half of 2017, before bouncing back

Last Updated: Tue, Jan 17, 2017 12:21 hrs
Gold set to fall in first half of 2017, before bouncing back

I find myself increasingly pessimistic about gold going into 2017. I never felt like this even during this time last year around when prices hit a six-year low after the announcement of US Fed rate hike. But, gold retraced higher subsequently, thanks to weak stock markets and doubts over further hikes.

A very similar announcement of a US rate hike was made this month as well, but the difference is that, it is accompanied with negative fundamentals for gold. When we describe fundamentals for gold, what are focusing on is gold consumption and production. Gold production has been on the rise but consumption has been declining rapidly in India and China, the biggest two consumers, with China also being the largest miner of gold.

India as a country, meanwhile, has more trust in gold as adornments, than as an asset and it is reasonable to expect demand to suffer more till the first half of 2017, as Indians get used to buying gold officially. However, in a country where the appetite for gold is insatiable, demonetisation may have slowed down the gold demand only for a couple of quarters and I feel the demand will be back on track and so will the gold imports.

Looking back in 2016, gold received a kicker since the beginning of the year, after reaching its nadir right towards the end of 2015, where it sank to around $1050/oz. But what appeared to be a rapidly deteriorating economic environment characterised by negative interest rates in many developed countries, led to the yellow metal rising by almost $300/oz or slightly above 20% since the start of the year.

By the middle of the year, predictions of $1500-$1900 started appearing from many of the reputed banks and institutions across the world purely based on hope that the US Fed might not hike rates for a long period of time. Even Brexit did not evoke the kind of reaction that it would normally have been expected to from gold. Then came the Trump shock which ate away any bullish meat left in gold.

Since then, prices have fallen for six straight weeks, the worst streak in a year, as prospects for higher US borrowing costs damped demand for gold, a for a zero yielding asset like gold. Markets now don’t seem too optimistic about the outlook for 2017. Hedge funds cut their bets on a rally to the lowest since February, while outflows are ramping up from exchange-traded funds.

So, how would gold prices fare in 2017? Given that stock markets, are becoming very bullish, gold could lose its safe-haven appeal. In the early days of 2016, markets were driven by fear, which is the reason gold rallied so strongly, but that has changed recently. Add to it Eurozone woes, the never-ending doubts over the fate of the Italian banking system, and general concerns over the health of the global economy. More so as Chairwoman Janet Yellen has indicated that the US central bank could introduce another three rate hikes over the course of 2017. This for a central bank that has only hiked twice in the last decade.

With that in mind, we see gold moving towards the lows at $1045-50 (MCX: 25000) as of now, and a strong long-term support comes in around $990 (MCX: 24000). By the second half of 2017, prices could be around 900 USD, which is exactly the peak of 1980, after which it will turn around and evolve into a new and strong bull market. This could happen, as more rate hikes could derail the economic recovery of US and once again revive bullion's appeal as a safe-haven asset.

Prospects for silver

Unlike gold, silver futures were at one point 39% higher on an annualised basis, with the Comex silver contract spiking from $13.841 an ounce on January 4 to $21.00 on July 4. From there on, US Fed sentiment and lower industrial demand knocked the stuffing out of silver bulls, taking the precious metal down to its current low of $15.59.

Silver has a stronger fundamental outlook which may see the commodity strengthen again. Silver is suffering from its relationship to gold presently. In the modern era, Gold and silver have traded at a relationship of 15 or 16 to one. This ratio shows us that silver has a lot of ground to close - price-wise - which is why investment advisors often recommend allocations in both gold and silver and are excited about silver's prospects. But now that we have gold in a bear market, there's less enthusiasm from investors in silver.

Half of the silver supply is used to make things. Demand is picking up as economic growth fuels sales of electronics and solar panels from China to the US. Physical demand remains strong and as only a quarter of silver is produced from dedicated silver mines. Supply prospects remain weak. Nonetheless, despite a strong fundamental outlook, we may see silver soften in the first few months of 2017 as the commodity suffers from a strong dollar and a US interest rate hike.

But I still believe that we are still in a precious metals bull market that began some 15 years ago but has temporarily abated. See opportunity in adversity and do not give up. The strategy for 2017 will be to look for a turnaround in gold sometime during the second quarter. Use that direction to buy more of silver.

Wishing a happy and prosperous 2017 to all the patrons and readers!

Gnanasekar Thiagarajan is a Director at Commtrendz Research and a consultant to commodity bourses and corporations both in India and the overseas. He has more than 20 years of experience in commodity and forex trading and was formerly a forex dealer with the Bank of Nova Scotia.

**Investors are requested to consult their financial advisors before doing anything based on the above recommendations.


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