Gold, the yellow metal, has been touching new highs in India. But the international price in dollars has been largely flat since the beginning of this year. Nikos Kavalis, Strategist in the Commodity Research Team of RBS feels “By 2015, we expect the gold price will average significantly below its current levels, at $1,200/oz. As the road-map to more normal macroeconomic conditions is laid, we believe that more attractive opportunities will emerge for investors and, eventually, higher interest rates will also reduce gold’s appeal.”
In this interview he speaks to Vivek Kaul.
The price of gold has been largely flat in dollar terms since the beginning of the year. Why is that?
For most of last year, gold behaved like a “safe haven” asset and was negatively correlated with risk. For example, it rallied by 28% from end-June to its all-time-high of $1,920/oz in early September, whereas the S&P500 fell by around 15% over the same period. Aft/er the sharp September correction, when gold dropped to a $1,600-1,650/oz range (per ounce, where one ounce equals 31.1grams), the story changed dramatically. Since then, gold has been trading in line with risk.
Can you explain that further?
2012 so far can be divided in two periods. The first period was the euphoria of the first two months of the year. A series of good economic data and hopes that the worst of the Eurozone crisis was behind us, pushed investors to risky assets. This helped gold, which was also boosted by a weakening US dollar at the time – gold has traditionally been negatively correlated with the US currency. By late February, gold had rallied to $1,790/oz, from around $1,560 at the start of the year. The period since the end of February has been the mirror image of the first two months. The first hit for gold came after Ben Bernanke’s speech at end-February, which hurt market expectations of QE3. Renewed concerns about the Eurozone crisis, poor economic data out of Europe and concerns that China’s growth is slowing boosted risk aversion over the following few weeks. Greece’s election added fuel to the fire and intensified fears of a break-up of the Eurozone. Gold trended downwards and by the end of May its price had virtually erased all the previous gains, returning more or less where it started the year. The price rebounded somewhat in early June, but remains far below the late-February high.
But it’s been going up in terms of rupees…”
Since its peak in September, the gold price has declined by 15%, in dollar terms. In rupee terms, and here I am looking at the nearest gold futures contract on the MCX, the price has recently made new highs! The story here is one of currency depreciation. As you know, the Indian rupee has been under pressure, partly because of fundamental reasons and partly due to the wider “risk off” environment hitting emerging markets currencies. It has depreciated by 5% against the US dollar since the beginning of the year and by more than 27% since the summer of 2011. This has boosted the Indian rupee denominated gold price. The rise in the rupee-denominated gold price has hurt Indian demand. High inflation eating into disposable incomes of local consumers has not helped either. This is evident in the World Gold Council data, showing weak jewellery and bar investment demand in the country, both in the fourth quarter of 2011 and the first three months of 2012. You no doubt will have also seen the numerous anecdotal reports that suggest demand has remained weak over the course of the second quarter.
How do you see the performance of gold in dollar terms during the course of the year?
I am moderately bullish towards gold for the rest of 2012. I think that the current uncertain macroeconomic environment still provides good reasons to own it, particularly against the backdrop of negative real interest rates. Moreover, we at RBS commodity research expect that the wider commodities sector will move upwards later in the year. We expect Chinese commodity demand to accelerate and I think that the latest interest rate cut and other steps taken by Chinese authorities towards a more accommodative stance will help in this. As risk appetite grows, flows into the space should also emerge. We believe that all this will benefit gold. Specific to the gold market, continued central bank buying should also help gold, both directly, by taking metal out of the market, and indirectly, by boosting investor sentiment. Lack of producer hedging and limited growth in scrap supply, are other positive factors.
Any target?
Finally, I want to note that at the moment speculator positioning in gold is very light. Look at the CFTC data on net positions in Comex futures for example – the net investor long is at the lowest since December 2008 and short positions are significant. When sentiment changes, I think this situation will be reversed and therefore believe there is some very good upside to be had. Our projections see gold average at $1,800/oz in the fourth quarter of this year.
What about the performance in terms of rupees?
We have a team of Emerging Markets economists at RBS and their outlook for the Indian rupee is cautious, owing to the imbalances (fiscal & current account) that weigh on the currency. The recent reduction in the petrol subsidy and the possibility for further fuel subsidy cuts are all steps in the right direction and some better news in Europe could also help, but our economists cannot see a material appreciation any time soon. Based on this and our forecast for a higher dollar-denominated price, we expect the rupee price to also rise in 2012.
What is the scene on the investment demand for gold?
There are a few different “segments” of gold investment and activity in them has varied. Investment in physical gold continues, although at a slower pace than last year. You still have the risk-averse retail players buying bars and coins in Europe and North America and of course the Indian and Chinese demand. We are seeing a lot less large scale metal account buying than in 2011 and before, but on the positive side, we have also not really much selling from these positions. We had some good inflows into gold ETFs earlier in the year, but these were in large part offset during the recent liquidations. Finally, as I mentioned earlier, positioning in Comex futures is very low and has declined year-to-date. Our outlook for investment demand in gold is positive and this assumption is an essential part of our bullish outlook for the price of the yellow metal. We think that, for reasons discussed earlier, investor appetite for gold will continue and actually grow later in the year. A very important driver for this growth will likely rising speculative investment in gold futures. These guys have actually been net dis-investors in 2012-to-date and many of them are now short gold (based on CFTC data).
Quantitative easing carried out by countries all over the world was one reason for the bull market in gold. Is that still a reason? I think that the expectation of QE3 in the US has been a very important driver of gold investment in the past. This was illustrated by the sharp correction following Ben Bernanke’s statement in late February that dampened expectations of further quantitative easing. Recent developments continue to suggest that QE3 is very much in gold investors’ minds. For example, look at the early-June rally (from ~$1,550/oz to ~$1,640/oz); it came after the poor US payrolls data on 1st June and dovish comments by Federal Reserve officials, which rekindled QE3 expectations. Similarly, the sharp correction that followed was triggered by Ben Bernanke’s latest testimony, which, again, lacked any clear indication that QE3 is on the way.
What are the chances of QE III happening, and that in turn pushing up the price of gold?
Our US economists ascribe better than even (60%) odds of Federal Reserve action, but think that an extension of “Operation Twist” is more likely than outright QE3. Having said this, if QE3 were to materialise, I think that gold would clearly benefit, for a number of reasons: the risk-on trade that would follow; the negative impact on the US dollar; and rising inflationary expectations (perhaps to a lesser extent now than in the past).
What can be the newer reasons for a bull market in gold?
As I mentioned earlier, we are only modestly bullish on gold, for the reasons I explained earlier. Moreover, our projections see the end of the gold bull market is in sight and we see a downtrend emerge from next year onwards. By 2015, we expect the gold price will average significantly below its current levels, at $1,200/oz. As the road-map to more normal macroeconomic conditions is laid, we believe that more attractive opportunities will emerge for investors and, eventually, higher interest rates will also reduce gold’s appeal.
If a country like Greece were to decide to leave the euro zone, do you see that having any impact on the price of gold?
Absolutely. I think the immediate reaction would be for gold to fall sharply, as investors sell all risky assets and there is a flight to cash. Further down the line, “after the dust settles”, I would expect that such an event would re-ignite safe haven buying of gold and as such drive the price higher.
What can pull down the price of gold?
I think the biggest headwind for gold at the moment is the strength of the US dollar. If the US currency continues to strengthen, gold will remain under pressure. Further into the future, there are a number of potential factors which we indeed expect will push gold down, such as flows into other asset classes and, eventually, higher interest rates.
Do you see more central banks buying gold in the time to come?
Yes, we expect central banks will continue to be net buyers of gold and that purchases will amount to 400 tonnes overall in 2012. As I mentioned earlier, we think that this is supportive for the gold price both directly, as these purchases take bullion out of the market, and indirectly, as central bank buying confirms gold’s status as a key reserve asset and boosts investor sentiment towards the metal.
What sort of retail consumption of gold does China have?
Chinese demand for high-carat gold jewellery and for investment products is huge and in 2011 was the second largest, after India. Chinese jewellery demand amounted to nearly 500 tonnes and bar investment to 250 tonnes last year. Importantly, it is a market with potential for further growth and I would not be surprised if in 2012 Chinese demand surpassed India, particularly given the recent weakness of demand in the latter.
There is a lot of speculation about how the Chinese central bank is quietly buying up gold. How true is that?
In 2009 China did publish revisions to its official gold reserves which suggested it had been buying and there indeed is much speculation that this continues. In April, net imports of 67 tonnes were one of the highest figures on record and twice the average of the previous three months. As I do not believe there was a similar increase in jewellery and investment demand, this does suggest more gold entered the country than was consumed privately and one possible explanation for this could be official sector buying, although it is also possible that local commercial banks were building inventory. Ultimately, I can only comment with certainty on published information and, as you know, there is no data or announcements confirming Chinese official sector purchases of gold have taken place recently.
(The interview originally appeared in the Daily News and Analysis (DNA) on June 18,2012)
(Interviewer Kaul is a writer and can be reached at [email protected])