Metals pull back after strong rally

A widely anticipated interest rate cut by the Federal Reserve wasn’t enough to stop precious metal prices from easing in September, with the price of gold falling back below AUD 2,200 and USD 1,500 per troy ounce.

In percentage terms AUD gold dropped 3.35%, whilst USD gold declined by 3.15%. This brought an end a very strong run in the yellow metal which had seen the price rally by more than 35% (AUD terms) and 26% (USD terms) in the year-to-end August 2019.

Declines in silver were even more significant during September, with prices falling by more than 7% in both AUD and USD terms, with the gold to silver ratio (GSR) ending the month above 86:1.

September 2019 - factors influencing metal price correction

The minor correction in precious metals that we saw in September owes to several factors, including:

• An uptick in yields. The United States 10-year bond yield rising to 1.67% by the end of September, whilst 10-year Australian government bond yields rose to 1.01%, up from 0.89% at the end of August 2019. Increases in yields effectively increase the opportunity cost of investing in gold and can put downward pressure on prices.
• A slow grind higher in equity markets, with the ASX 200 in Australia and S&P 500 in the United States up by 1.27% and 1.72% respectively during September.
• Continued strength in the US dollar, which is often a headwind to gold price appreciation. The USD index was up a further 0.46% in September 2019 and is now at its highest levels since mid-2017.
• More than anything, the price fluctuation in gold and silver during September can be attributed to an element of buying exhaustion, with the 12-month rally in precious metals leading into last month the strongest we have seen in eight years. 

After such a strong move, it is only natural that the market would take a breather. We alluded to this in our August 2019 monthly report when we noted that “no market goes up (or down) in a straight line, with some volatility along the way to be expected, especially in the short term”.

To that end, the decline in prices that we have seen in the past few weeks looks like a textbook consolidation and one that could be a healthy development for the market. Going forward, the bullish case for gold is supported by many factors including:

1. Continued buying from central banks

An early October 2019 report from Bloomberg noted that the People’s Bank of China had added an additional 5.9 tonnes of gold to their reserves in September, bringing total purchases above 100 tonnes in the past 10 months. Poland, Turkey and Russia have also purchased more than 100 tonnes of gold in the year-to-end August 2019, highlighting the strength and persistence of central bank demand for gold.

2. Inflows from ETF investors who continue to accumulate gold

Data from the World Gold Council for September 2019 suggests global gold ETF holdings rose by 3% for the month, with total holdings now topping 2,800 tonnes, a new all-time high.

The Perth Mint’s own products including PMGOLD, which is listed on the ASX, and AAAU, which is listed on the NYSE, grew by more than 7% during the month.

3. Monetary easing from global central banks

This continued unabated throughout September with the US Federal Reserve delivering a cut to the Federal Funds rate. The European Central Bank reduced its main deposit rate to -0.5% and launched a new bond-buying program. Locally, the Reserve Bank of Australia left rates unchanged in September, though did deliver a cash rate cut in early October, with interest rates falling below 1% for the first time ever.

4. Negative yielding debt

While bond yields recorded a minor increase in September, there is still approximately USD 15 trillion in negative yielding debt which will continue to drive demand for gold.

5. Recession fears are not likely to abate any time soon

Global manufacturing data continues to decline in much of the developed world in a downward trajectory that has been evident since early 2018.

The problem is particularly acute in the Eurozone, especially Germany. Typically the powerhouse of the European economy, the country’s purchasing managers index for September was recorded at just 41.7, indicating a notable decrease in activity.

Analysts remain bullish about gold

The combination of these market factors makes it unsurprising that analysts are still bullish about gold. UBS recently forecasted a rise in the gold price to USD 1,730 per troy ounce in 2020, noting that ‘an environment of negative and lower-for-longer real rates, slowing growth with downside risks and elevated uncertainty strengthens the case for holding a strategic gold allocation’.

Goldman Sachs is also optimistic. According to a Kitco article from early October, its analysts predict gold will rise to USD 1,600 per troy ounce in Q4 2019 and potentially remain at this level into 2021. They also note that prices could head much higher should the US edge closer to a recession.

Importantly, Goldman indicates there is still potential for a significant increase in gold holdings by investors, noting that ‘Gold remains a great strategic allocation because ETFs and especially North American portfolio managers remain underinvested in our view. And there is a great capacity for them to enter the market if global conditions deteriorate further’.

We agree with many of the sentiments shared by Goldman and UBS and likewise remain optimistic on the outlook for precious metals in the medium-to-long term.

This is not to discount the possibility of a more meaningful correction or period of sideways trading in the weeks ahead, but rather an acknowledgement of the monetary and economic climate investors around the world find themselves in today.

As investors continue to seek to protect and build wealth, we believe an increasing number will see the benefits of allocating a portion of their portfolio to precious metals and will respond accordingly.

Articles referenced

China Gold Acquisition + Central Bank Buying
https://www.bloomberg.com/news/articles/2019-10-07/china-s-gold-buying-spree-tops-100-tons-amid-prolonged-trade-war
https://www.gold.org/goldhub/gold-focus/2019/10/dont-stop-me-now-central-bank-demand-august

Gold Prices to head toward USD $2000
https://www.cnbc.com/2019/10/03/investing-in-gold-bullion-could-soar-to-2000-next-year.html

UBS Doubles Down on Gold
https://www.forbes.com/sites/simonconstable/2019/09/30/ubs-doubles-down-on-gold--ups-its-forecast-again/#32827b5b122f

Goldman Sachs – Gold to $1600
https://www.kitco.com/news/2019-10-03/Gold-is-going-to-1-600-next-watch-the-perceived-risk-of-recession-Goldman-Sachs.html

Chris Weston - Pepperstone on Gold
https://pepperstone.com/au/market-analysis/daily-fix-xauusd

Yardeni Research on Manufacturing
https://www.yardeni.com/pub/ecoindglpmimfg.pdf