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Gold Outlook for 2017 – Part I: Fundamentals at Year-end 2016
Last year around this time (December 14, 2015), gold slipped under $1,050 per ounce – its lowest level since 2009. The main reason for gold’s decline was the Federal Reserve’s decision to raise short-term interest rates by 0.25%, the first such rate increase in nine years. At the time, the Fed indicated that they would raise rates up to four times in 2016, but that didn’t happen. The longer the Fed delayed its decision, the more gold rallied, reaching its 2016 high of $1,366 on July 6, shortly after the June 23 “Brexit” vote.
Since then, gold has declined by over $200 (-15%) to $1,160 as of last Friday. Most of the decline came after the surprise victory of Donald Trump and the Republican Congress in the November 8 election. A secondary cause is the assumption that the Federal Reserve will once again decide to raise interest rates in their Federal Open Market Committee (FOMC) meeting this week. (The announcement will come on Wednesday, December 14). With most economic statistics rising strongly in the last month, the Fed will have plenty of reasons to raise rates. Like last December, the Fed and the major gold traders will likely assume that several more interest rate increases will follow in 2017, thereby putting a damper on gold.
Right now, the reigning assumptions are that the U.S. economy will grow strongly under new policies instituted by President-elect Trump and his supposedly compliant Republican Congress. But there can be several credible scenarios whereby the Congress and President bicker and falter over necessary details, or the economy doesn’t respond as positively as expected to their policies. Most likely, there will also be major disruptions in foreign hot spots like North Korea, Iran, Russia, Iraq, Syria – and especially China.
Gold can be a “crisis hedge” when foreign conflicts heat up. It can also be an “inflation hedge,” if we see prices start creeping up in tandem with economic growth. Gold is also a hedge against volatility in other markets. Right now, gold is down and stocks are rising but the reverse situation can return at any moment.
The new Trump policies – including a proposed trillion-dollar infrastructure bill – might also balloon the budget deficit past $1 trillion per year in each of his first two years. As the following chart shows, there has been a long-term correlation between the total public debt and the price of gold. When gold rises faster than debt, that’s a time to sell gold, but there has been a huge growth in public debt under President Obama – over $7.5 trillion in eight years – but there has been very little net rise in gold under Obama:
In recent years, gold ETF traders have been the “tail that wags the dog” in the gold market. Even though China and India are responsible for far more physical gold buying than the U.S. and Europe, the leveraged futures and ETF markets in America tend to push gold higher or lower based on the reigning trend of the mob. Earlier this year, gold ETF buying overwhelmed slow physical demand, but now the reverse is true: Although gold’s price fell almost 8% in November, the U.S. Mint reported that their sales of gold bullion coins rose for the fourth month in a row, reaching their greatest sales monthly sales total since July, 2015.
Anti-Gold Attacks in India and China Also Dampen Gold’s Price
India and China are the two leading nations for gold demand, accounting for 50% of annual demand for the physical metal. This year, the Chinese government has been actively limiting the number of firms allowed to import gold, while India’s government has staged an all-out attack on their cash economy and gold. The Modi government recently banned 500-rupee and 1,000-rupee banknotes (worth only about $7.30 and $14.50, respectively) in an attempt to attack private cash purchases of gold, primarily in India’s rural regions, where gold comprises a major feature in Indian wedding ceremonies and a bride’s dowry.
India’s war against cash and gold has taken a terrible turn in India. The Indian government has licensed agents to raid homes, confiscating “excessive” jewelry. The government said nothing would be taken “if the holding is limited to 500 grams per married woman, 250 grams per unmarried woman and 100 grams per male,” but bear in mind that there are about 31 grams per Troy ounce, so this allowed limit is only three ounces per male or about a pound for married females. As you could imagine, this threat engenders fear and creative means of hiding one’s wealth from these marauding agents. Some of the richer Indians heard about this law in advance and acted to protect their assets, but poor families were hit hard, since gold is considered the best form of inflation-resistant savings – “real” wealth instead of paper promises.
This development seems so outrageous that it’s hard to believe the Modi government can survive unless it quickly repeals this widespread attack on gold and large-denomination paper money. India is scheduled to hold several regional elections as well as a Presidential election in 2017, so there could be a backlash against this recent gold and cash seizure among the majority of poor and middle-class Indian families.
Some Major Financial Firms See $1,350 to $1,550 Gold in 2017
Around this time of year, some of the major investment banks and bullion dealers make their annual gold predictions. Earlier this year, we examined the generally downbeat predictions of the London Bullion Market Association (LBMA), which proved a great embarrassment to them as gold prices kept rising. We won’t see the LBMA predictions until early January, but here are some bullish views recently published.
James Butterfill, head of research and investment strategy at ETF Securities, is bullish on gold, despite the post-election slump, saying “we maintain our gold target of $1,440 for mid-June. Aside from the risk from a Trump presidency, 70% of Europe by GDP has elections in 2017 just when populists are rising rapidly in the polls. Political risks remain high.” Despite a likely rate increase in December, he says a dip as “a great buying opportunity” since any rate increase reflects “long-term risks of [rising] inflation.”
Gold’s recent correction, he says, results from the assumption that “Trump would be able to enact all his reforms.” He counters: “Once Trump is in the White House it will become evident that he will struggle to enact many of his proposed reforms. Of particular note will be the difficulty in approving a higher debt ceiling to budget for his tax cuts and infrastructure spending…Furthermore, the Fed is likely to allow inflation to run above interest rates, dragging their heels in raising rates” causing a “volatile U.S. dollar.”
Britain’s HSBC bank is projecting gold at $1,550 per ounce by the end of 2017. They reason that Trump could trigger trade wars that will destabilize global markets, boosting gold prices. “With Mr. Trump openly questioning decades-old military and political alliances and the European ideal under attack first by Brexit followed by a rise in anti-European sentiment in important European nations, it appears likely that investors will move increasingly into gold.” The recent post-election slump in gold won’t last, HSBC says. “We believe the gold decline will be temporary and that as global risks increase and uncertainty increases globally gold will be utilized increasingly as a safe haven and flight to quality asset.”
The Swiss bank UBS looks for gold to average $1,350 for 2017. UBS strategist Joni Teves said that gold will remain under pressure leading up to the December 14 meeting of the Fed but added. “Given that the market has already moved and positions have been adjusted, we think any further downside from here is likely to be relatively more contained.” UBS “would buy into further weakness, gradually building a long-term gold position. Their rationale is based on analysis of “real” interest rates – the yield on government bonds (usually 10-year notes) minus inflation. “A scenario where nominal yields run up yet inflation expectations also pick up such that real rates remain relatively flat or even compress would remain supportive for gold, especially against the backdrop of lingering macro uncertainty,” UBS said.
Credit Suisse downgraded their 2017 gold price target from $1,438 to $1,338 for 2017, but they see a strong rise from $1,160 now to $1,275 for the first quarter and $1,400 in the fourth quarter. Their premise for this optimism is rising inflation, possible interest rate gridlock, and improving demand for gold.