In recent months, gold prices have failed to rise despite dollar weakness. Some catch-up is likely.
In our view, the main driver for gold’s “surprising weakness” has been liquidation and capitulation out of gold as an investment vehicle. It is true that sharply declining real bond yields, EMU tensions and a rising equity risk premium all combined to help gold from early 2009 until mid-2011. At that point, gold had become over-owned, given that there were no signs of inflation, and further nonconventional monetary actions failed to benefit the yellow metal. From August 2011 until early 2013, the dollar dominated gold movements. Since then, gold has “underperformed” what would have been predicted based on the dollar, real bond yields and EMU bank stocks.
We do not anticipate a return of tail risk in the next few months now that U.S. fiscal negotiations have had at least a reprieve. However, gold ETF holdings already have fallen dramatically and the yellow metal should soon be able to take advantage of a falling dollar. We would view any bounce in gold as a countertrend move, as the “number of months to liftoff” for the start of Fed interest rate normalization draws nearer.
The bottom line is that we see no change to the cyclical and structural backdrop for gold prices, given that tail risks are ebbing and the prospects of “even easier liquidity settings” are dim. However, gold is oversold and a potential rally could extend as far as $1500/oz if the dollar continues to lose ground.