World Gold Council: Price drop likely to spur demand

The following is an edited market analysis released by the World Gold Council in early October. For more information, please visit www.gold.org.

After a remarkable performance year-to-date, the gold price fell over 3% on Oct. 4, taking it below US$1,300 per oz. for the first time since the Brexit announcement in June 2016. The move seems to have been driven by speculation of a scaling back in the European Central Bank’s (ECB) asset purchase program, combined with rising expectations of a U.S. interest rate hike in December. The move was exacerbated by technical levels, tactical positioning in derivatives markets and a national holiday in China.

The price dip could offer a buying opportunity for consumers and long-term investors. In addition, even though central banks may normalize monetary policies, the prolonged extraordinary measures have led to a structural shift in asset allocation that will linger.

In this new normal of lower returns and higher uncertainty, gold has a role to play in the portfolios of investors large and small.

Gold dips below US$1,300

For the past three months, the gold price traded from US$1,310 to US$1,370 per oz. gold.

In the early hours of Oct. 4, the price consolidated near the lower end of the range. This was driven by slightly better-than-expected economic news in the U.S. and recent bullish commentary by some of the U.S. Federal Reserve’s Federal Open Market Committee members.

The media also reported that the ECB might scale back its €10 billion monthly bond purchase program.

Once the gold price pushed below US$1,310 per oz. — representing gold’s 100-day moving average — technical selling increased sharply, exacerbating the fall and triggering stop-losses, and more tactical selling.

Meanwhile, Chinese investors, who have historically bought on dips, were celebrating the Golden Week national holiday, leaving domestic markets closed.

Rates may not sink price

A shift in monetary policy need not signal lower gold prices. Although negative nominal rates are unprecedented, there are many historical precedents for negative real rates, which give rise to the following stylized facts:

• When real rates are negative, gold returns tend to be twice as high as the long-term average.

• Even if real rates are positive and as long as they are not high (4%, in our analysis), average gold returns remain positive.

• Falling rates are linked to higher gold prices, yet rising rates aren’t always linked to lower prices.

A buying opportunity

Despite the decline, gold is one of the best performing assets this year, rising 20% in dollar terms.

Consumers and investors may see the price decline as a buying opportunity, as many have waited for a price pullback before entering the market. Third-quarter 2015 served as an example, when a 7% decline in the gold price triggered a spike in demand for jewellery and bars and coins.

Data already points to an uptick in consumer interest. The top-five countries where consumers searched online for gold after the price drop were in the Middle East, with the United Arab Emirates being number one. Anecdotal evidence suggests that consumers held off purchases in previous months, so this may well trigger an increase in demand. The price correction also comes at a good time for Indian consumers. With a good monsoon, the upcoming wedding season and Diwali and Dhanteras festivals, demand could pick up after subdued activity year-to-date.

Volumes in the physically gold-backed exchange-traded funds picked up in the secondary market as the price fell, and they haven’t resulted in large redemptions so far. This could indication that there is an appetite for gold amongst the investment community.

Central banks, a major driver of gold demand, are still strong buyers of the metal to diversify their reserve asset holdings, considering the shrinking universe of non-negative yielding assets.

The Russian central bank recently said that it had no target for its gold holdings and buys regularly every month. Meanwhile, a recent survey of 19 central bank reserve managers — conducted by the World Gold Council — shows that nearly 90% of them will either increase or keep current gold reserve levels, indicating a strong floor of support for gold demand.

Gold fundamentals solid

Market fluctuations will occur from time to time, but the fundamental environment for gold remains strongly supportive. The broader market environment of low and negative interest rates — coupled with political, economic and policy uncertainty — remains unchanged, and are generally positive for gold.