Gold started the new year with a bang, rallying to its highest level since mid-September 2017.
It was boosted by a variety of factors: continued geopolitical tension between the US and North Korea, President Trump’s decision to recognise Jerusalem as Israel’s capital and the tensions this created across the Muslim world, and, most recently, the threat of a political and economic crisis in Iran. These destabilising events have driven concerned investors to seek the safety of gold, even though gold’s status as a hedge against geopolitical turmoil has not been very reliable in the recent past. It may nevertheless still be the safest place if any of these situations do blow up into fully-fledged crises.
An additional and probably more likely support for gold’s rally was the recent slide in the US dollar to its lowest level in three months and the flattening of the yield curve.
Strangely enough, gold started staging its rally in mid-December just after the Federal Reserve raised interest rates for the third time in 2017, while the 10-year US government bond yield was flirting with the 2.50% level. This signalled not only continued and synchronised global economic growth but also that the recently approved tax reform bill could give an additional boost to the US economy and inflation in the years to come. The higher yields were also supported by the prospect of increased debt to finance the tax reform, which will drive up the ratio of budget deficit to GDP from 3.5% in 2018 to 5.5% in 2020 according to the Congressional Budget Office.
The minutes of the 12–13 December FOMC meeting, which were released on Wednesday, confirmed that most FOMC members remain optimistic about the US economy and are “continuing a gradual approach to raising the target range”. For 2018, the Fed is expected to keep reducing its balance sheet and deliver three rate increases, as currently projected by the dot plot.
Some members nevertheless expressed concerns about the risks of a faster pace of key rate hikes, such as “the possibility that inflation pressures could build unduly if output expand[s] well beyond its maximum sustainable level”. This could occur as a result of fiscal stimulus (as the tax reform plan should provide a boost to consumer and capital spending) or be made more likely by the favourable conditions still prevailing on the financial markets.
For these reasons we remain very prudent on gold as we believe it will be driven above all by the Fed’s tightening cycle and the resulting impact on the US dollar. Lately the geopolitical tensions and the softness in crypto-currencies have underpinned gold as a safe-haven investment; add to that support from traditional buying in China ahead of Lunar New Year. For the longer term, though, we stand by our conviction that gold will remain range-bound between USD 1,100 and USD 1,350 with limited upside for the next several years. But we are enjoying this ride on the higher ground while it lasts.
Névine Pollini – Senior commodity analyst – Union Bancaire Privée (UBP)