Anne-Laure Tremblay, precious metals analyst, commodity derivatives, at BNP Paribas

Is the 10-year gold rally finally running out of steam?

Wed, 01/08/2012 - 10:42

By James Williams – “The big story for gold and silver is basically over. We think gold is nearing the end of its 10-year price rally. Our central scenario is that gold and silver will peak in H2’13, based on our assumption that there will be no further large-scale monetary accommodation, notably by the Federal Reserve, next year,” suggests Anne-Laure Tremblay (pictured), precious metals analyst, commodity derivatives, at BNP Paribas.

This time a decade ago gold was trading at USD300/oz. Aside from a dip in 2008, prices have consistently trended upwards, reaching a record high of USD1884/oz last August as the Greece situation unravelled.

This year, however, prices have levelled off. Admittedly, compared to other commodities gold has fared well and is practically flat for the year, which illustrates that diversification story for gold still holds up, but there’s no denying that its price profile has confounded analysts and economists alike.

“Gold’s performance has been disappointing in H1’12. The price fell at times of high risk aversion, unlike the US dollar, which benefited from safe haven flows. However, gold held up relatively better than other commodities,” says Tremblay.

According to Julian Jessop, Head of Commodities Research and a director at London-based Capital Economics, in the global macroeconomic context it’s really a case of two very different scenarios for where gold could head in H2’12 and beyond. “If you believe the eurozone will break up then gold has a lot more upside. It might be a bit boring holding gold until this happens but if countries start leaving the euro then I think it will quickly jump.

“If, however, you think the eurozone will hold together then I think the price of gold will drift and behave more like a risk asset.”

Eurozone uncertainty and the fact that the Fed has yet to engage in QE3 has kept confidence high in the greenback at the expense of gold. Also, on the demand side, there are signs of weakness in jewellery demand in India and other emerging markets and perhaps signs of malaise among western investors with Jessop conceding: “Since prices peaked last year gold has been more volatile which has undermined its appeal as a safe haven.

“However, I don’t think the gold price has peaked. Given the extreme uncertainty that a breakup of the eurozone would create, even though the US dollar would likely do well, gold would do even better. Our forecast for Q4 is USD2000/oz.”

Suki Cooper is a precious metals analyst at Barclays Capital in New York. Cooper notes that whilst physical demand in China and India this year has been “inconsistent and lacklustre”, it’ll be interesting to see how solid that floor is “as we head into a seasonally-strong period.” Another key demand dynamic will be in gold ETPs. As Cooper explains: “They have remained remarkably resilient despite price swings we’ve seen in gold. Whether that continues or we start to interest waning will also be an important factor.”

Cooper is less bullish on gold price than Jessop, forecasting a price of USD1665/oz for Q3 and USD1720/oz for Q4. “We are working on the basis that prices find support from the physical market during a seasonally strong period and expect them to move higher, but only gradually.”

The best-case scenario is that there is no further quantitative easing, which Cooper confirms is the house view. She says that in terms of how the price profile plays out for gold they are forecasting an average price of USD1750/oz in 2013 and that the inflection point will come when real interest rates show signs of turning positive. In that sense, she agrees with Tremblay on the gold rally nearing its end.

“Given the importance of real interest rates to the gold market and the interest rate guidance, gold prices could start to come under further pressure by 2014.”

Moreover, Jessop believes the eurozone crisis will be a rolling one that could support gold prices over a number of years. “If Greece were to leave the euro and then recover strongly I think it would impossible for governments of other countries like Portugal to say it’s worth staying in there. Our working assumption, therefore, is that Greece leaves by the end of 2012, followed by Ireland and Portugal in 2013.”

What is clear in 2012, as far as Tremblay is concerned, is that gold price has become a market liquidity issue. Without further liquidity, gold prices aren’t going to do much, and if anything could fall further as investors get increasingly disappointed with performance.

“Further monetary accommodation is key to our positive price scenario for gold in H2 12. If the Fed disappoints, if there is no QE3, then gold’s outlook would turn negative.

“Our US economist expects Bernanke to announce QE3 at the end of August and that should trigger a strong rally not only for gold but for other precious metals. Our Q4 average price forecast for gold is USD1800/oz.”

The demand story is more acute across the rest of the precious metals complex.

Silver has seen investor demand drop off a cliff in 2012, and at USD27.54/oz (as at 25 July) is way off its April 2011 high of USD47.94/oz. From the supply side, silver is in a worse position than other precious metals because two-thirds of it is mined as a by-product. Unlike platinum, the silver spot price is not a concern to producers and as such is still a market in surplus.

Aside from lack of investor demand, the biggest change in 2012 is that industrial demand has waned against fears of global economic recovery. This, says Cooper, has been seen most clearly in the solar energy industry.

“Last year there was a lot of talk regarding subsidies for the solar industry but in 2012 we’ve seen those subsidies being scaled back. China is one of the world’s largest producers of solar cells, with Europe being a large end-consumer. The slowdown in silver consumption in photovoltaic cells in China is not necessarily due to lower Chinese consumption but rather a slowdown of demand in Europe.”

Weak demand and a supply surplus currently makes silver highly vulnerable and has the largest downside risk. Nevertheless, given that gold should see further upside in H2 12, Cooper thinks that silver will likely piggyback off that.

“Our forecast is USD31.5/oz for Q4, which is quite positive from where we are at the moment but it’ll remain the most volatile precious metal.”

Tremblay is even more bullish on the potential for silver, given that it’s a geared play on gold. “Our assumption that QE3 will be announced at the end of August is underpinning our view that silver could well be the outperformer of the precious metals complex in the last few months of 2012. “We forecast a Q4 average of USD39.45/oz.”

Jessop thinks that today’s fragile macroeconomic environment and the demand for safe haven assets suggests that gold has the potential to do better than silver. Two features underpin Capital Economics’ forecasts for metals generally: firstly, a breakup of the eurozone; secondly, sluggish economic growth in the US and China.

“I think demand for metals for industrial uses is going to be disappointingly weak. Over the medium to longer-term China’s GDP growth rate is naturally slowing because of adverse demographics and a rebalancing of the economy that needs to take place away from commodity-intensive investment. We’re not expecting a hard landing but I think Chinese demand will fall well short of what people are anticipating.

“Even if additional policy stimulus leads to a rebound in demand in H2’12, as we expect, a lot of that demand will be satisfied by existing stockpiles without the need to go out and buy more on global markets.” Accordingly, Jessop’s view is that silver could reach USD32/oz by year-end.

The only thing saving platinum according to Tremblay, given that demand is poor, is its correlation with gold. Currently, platinum is trading at USD1400/oz – flat for the year – having spiked at USD1707/oz in February. However, given that it is so highly dependant on Europe, where it is mainly used in the catalysts of diesel vehicles, prices have suffered, with Tremblay noting: “The European sector is in bad shape and has been contracting for a number of months. The only reason we are bullish on platinum for the remainder of 2012, with a Q4 average forecast price of USD1600/oz, is because gold will go up.”

Tremblay thinks that the surplus in the platinum market will extend into 2013 and beyond. Another important reason for this surplus, aside from waning European demand, is that crucially palladium is being used as a cheaper substitute for platinum in diesel car catalysts.

Cooper agrees that the demand picture doesn’t look good but argues that, aside from the gold dynamic, upward price momentum in H2’12 could be supported by the fact that prices are currently too low to incentivise mine supply, certainly in Greenfield projects.

“We will likely see operations being scaled back which will support higher prices. Also, the response we’ve started to see coming through from China following lower platinum prices bodes well for demand. Given our GDP outlook for H2’12, by Q4 we could see much healthier price levels for platinum. We’re forecasting USD1615/oz.”

Jessop has a more bearish stance, forecasting USD1350/oz for platinum and USD540/oz for palladium. In his view, not enough macro risks are being priced into these precious metals.

“For platinum and palladium, where there is a large industrial demand component, I wouldn’t be too positive on price.”

As palladium is being substituted for platinum in diesel catalysts, from a supply perspective it is the only precious metal in deficit in 2012. Tremblay observes that palladium has performed well at times of higher economic growth in recent years:

“Our bullish view for palladium is underpinned by a rebound in economic growth in Q4, and beyond into 2013. We have a Q4 average price forecast of USD710/oz. Palladium though is not a short-term play like silver. Silver’s downside could potentially be great once the gold rally ends.”

Whilst the demand picture is relatively more robust than platinum, with continued growth in the US and Chinese gasoline-biased auto markets, there are also expectations that Russian state stock releases will slow down. However, as Cooper says, the market still needs to see more concrete evidence of this. “We expect demand to recover in H2’12 and we forecast prices to average USD695/oz for Q4.”

Cooper thinks we could see a divergence across precious metals going forward. Silver is likely to be in surplus for the next two to three years and will be highly vulnerable to downside exposure. For Platinum Group Metals (PGMs), they could see further price traction.

Says Cooper: “Significant uptake of electric vehicles poses a key risk for PGM demand. However, this is not our base case scenario.”


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