Gold’s Allure Growing In Part Due To Weakened U.S. Dollar

Gold’s Allure Growing In Part Due To Weakened U.S. Dollar
new sense photo brian selzer

OCEAN CITY — Gold has been one of the few bright spots this year — and not only within the struggling commodity complex, but also among broader risk assets.

As of March 18, gold is up approximately 18%, while the MSCI World Index is flat. Gold’s appeal has grown against a backdrop of heightened market volatility, diverging global monetary policies, and rising concerns of a global economic slowdown. However, while, at current levels, gold appears fairly valued, key technical and macro headwinds may weigh on its price short-term. Looking ahead, improving fundamentals in the global gold market will remain a key driver for gold and its role as a real asset in portfolio allocations.

The start of this year has seen the return of investor demand for gold after three consecutive years of net outflows. According to BofA Merrill Lynch (BofAML) Global Research, gold is likely to find a bottom in 2016, and its year-to-date rally supports this conclusion. Assets under management for physically backed gold exchange-traded funds (ETFs) have had 11 straight weeks of inflows. In light of heightened economic uncertainty, weak corporate earnings, and diverging monetary policy, investors have returned to gold to weather the storm. Gold has also benefited from a weakening U.S. dollar in 2016, because historically, these two assets have had a negative correlation.

Gold tends to be negatively correlated to real interest rates — as these rise, the opportunity cost for holding gold increases and investors, looking to take advantage of higher rates, sell. However, investors have been dealing with negative real interest rates for several years, during which time the price of gold has fallen 35% from its peak in September 2011. Therefore, continued nominal negative rate moves (similar to those seen in Europe and Japan) spurring continued investment demand for gold may not be as clear-cut as expected. Technical difficulties While safe-haven demand and uncertainty are key catalysts, investment sentiment and other technical and momentum drivers have been at the core of this rally, as evidenced by a change in sentiment, investor short covering in gold futures, and a drop in price premiums in key gold markets such as China and India (which are indicative of fundamental-driven rallies in gold).

Sentiment at the start of 2016 shifted dramatically from net short to net long by money managers. This has helped drive gold’s strong returns and adds further credence to the view that gold prices may be reaching a floor. This technical driver is volatile, and further short covering and safe-haven demand by investors may decline, thereby serving less as a sustainable driver for gold. Follow the yellow brick road Gold’s fundamental balances remain favorable and continue to support its long-term outlook. Unlike in other commodity markets dealing with depressed pricing due to overcapacity glut, gold supply is contracting, while demand is steadily growing.

With an outlook for consumer-led growth in Developed Markets and rising incomes in Emerging Markets, gold demand should remain on an uptrend. Mining supply fell (9%) for the first time since 2008 last year and is expected to continue to contract as lower gold prices in recent years continue to force high-cost producers out of the market. Recycling, which accounts for roughly one-quarter of global gold supply, fell to an eight-year low.

(A Merrill Lynch Wealth Management Advisor who can be reached at 410-213-8520.)