Gold has been having a wonderful spell since the markets opened for trading this year, but the trading action on the yellow metal on Tuesday suggests that the bullish rally for gold might be slowing down. A quick glance at gold charts show that the bullion has been up more than 12% in the first five weeks of 2016 to erase the 10% losses that it recorded in 2015. Last week, gold futures were on a supersonic flight as the bullion recorded its biggest weekly gain since the 2008 financial crisis with a 7.1% rally.
This piece seeks to examine the outlook of gold in the light of current changes it market dynamics.
Goldman Sachs thinks you should short gold
One of the main reasons behind the decline in gold prices is the bearish note released by analysts at Goldman Sachs. The note released to investors on Tuesday suggests that the renewed interest in the safe-haven status of gold might be short-lived. A group of analysts led by Jeffrey Currie, Global Head of Commodities at Goldman Sachs said it is high time you sold or shorted gold because a crash in gold prices is imminent.
To start with, the Goldman Sachs analysts think that the safe-haven status of gold has been stretched to its elastic limit even though oil prices are down and the equity markets are in turmoil. The analysts noted that “financial markets have overreacted to the point that current inflation breakevens would require oil prices to keep declining for the next 7 years.” The analysts think that oil has found a bottom and that China will rebound. In their words, "we believe that these fears ignore the facts that systemic risks from oil, China and negative rates are very unlikely.”
The analysts also noted that the expected increase in demand for physical gold by Chinese and Indian buyers is taking the rationale behind the Chinese and Indian demand for gold out of context. The demand for physical gold by Chinese and Indian buyers is mostly in jewelry form "which is residual demand that is extremely price sensitive."
Hence, an increase in gold prices would not increase the demand for physical gold because gold jewelry will become more expensive for Chinese and Indian buyers and they will delay buying gold jewelries in the hopes that the price will fall.
The analysts think that it doesn’t make sense to be bullish on gold because they expect the bullion to crash. In their words, “we maintain our view of rising U.S. rates and hence lower gold prices, with a 3-month target of $1,100 per once and 12-month target of $1,000 per ounce... We are recommending shorting gold through a GSCI-style (Goldman Sachs Commodity Index) rolling index."
Investors are back into stocks and other asset classes
Gold has outperformed stocks in the year-to-date period; the bullion had gained 16.96% while the S&P 500 has declined by 7.27%. However, on Tuesday, that rally seems to be slowing down as new factors start to bear on the general outlook of the yellow metal. Gold for April delivery was down 2.5% or $31.20 to close at $1,208.20 – the weakness recorded in Tuesday's session marked the largest drop on a point basis since March 2015.
Following the bearish note released by Goldman Sachs, some of the stock investors who made a rush for the exits in equities last week (to seek safety in gold) are coming back to equities. U.S. equities had a splendid session as investors returned to stocks on Tuesday.
As at market close on Tuesday, the Dow Jones was up 1.39%, the S&P 500 was up 1.65%, and NASDAQ was up 2.27%. Asian stocks were also up as China's Shanghai opened with 0.05% gains this morning, Japan's Nikkei 225 was up 0.19%, and Hong Kong's Hang Seng was up 0.37%.
Forex traders will also find tailwinds in USD currency pairs because gold is priced in U.S. dollars and weakening of gold prices alters the dynamics of the market. A forex trader on 10Trade website thinks that the stories about gold as a better form of "currency" over fiat money are interesting, but it is not relevant under the current economic clime.
Miguel Perez-Santalla, sales and marketing manager at Heraeus Metals in New York opines that investors are starting to ignore the "safety" of gold because things aren’t as bad as they thought in other asset classes. In his words, “The big run up in gold started with China having issues, and now China comes back from vacation and the first step is on the upside and everyone thinks things aren’t that bad… The more comfort there is, the lower gold will go and the worse it is for gold miners.””
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.
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