Bullish trend to continue in gold, Rs 33,300 levels look likely on global volatility

Gold prices have seen a good start to 2018, with gains extending from 2017, as dollar weakness continued unabated. The rally in gold prices over the last couple of months has been peculiar, given that bond yields are near three-year highs and global economic growth is broad-based.

The Fed, after raising rates thrice in 2017, and once in 2018, is pretty much on course for two more rate hikes this year. It is therefore, a tad surprising that the dollar has failed to gather strength over the last several months.

We believe that prospects of other Central banks like the European Central Bank (ECB) and the Bank of Japan (BOJ) scaling back stimulus have played a major role in undermining the dollar. The Fed policy outlook is relatively clear, while the scope of surprise from the ECB and BOJ is higher. This would continue to have a bearing on the dollar this year.

Secondly, the dollar would also take a hit if the rhetoric over trade war between US and China intensifies. The comments from the US Treasury Secretary this year have provided hints about the potential impact on the dollar.

Thirdly, the tax cuts in the US, coupled with prospects of higher infrastructure spend, will increase the fiscal deficit and thereby lead to more borrowing from the treasury market. Additional bond supply at a time when the Fed is scaling back its balance sheet could push bond yields further up. Add to this the chances of higher inflation this year and we have a perfect storm brewing for gold prices.

The recent trade war tiff, where the US imposed trade sanctions on many other global nations, is also supportive of prices in the medium term. If a trade war becomes a reality, it could push inflation up and growth down and that should ease the aggressiveness of the Fed. That’s why it has become the focus of the gold market.

On the demand front, consumer demand in India remains lower compared to historical averages in the last two years, owing to a host of regulatory and tax related changes. There are a couple of factors that we think have led gold demand lower in India, one structural and other transitional. The demonetisation exercise and its subsequent impact derailed gold cash purchases.

Remember, gold buying in India has been historically driven by cash. From a structural perspective, the clampdown on cash has led savings being diverted to financial assets rather than to physical assets like gold and real estate. Equity mutual funds in India have seen record inflows as surging equity markets made them attractive for retail investors. This, we believe, is unlikely to change dramatically and therefore, annual gold demand in India could establish a lower base of around 650-750 tonnes a year going ahead, compared to 800-900 tonnes that we saw previously.

As far as transitional factors go, the implementation of GST and its transition impacted the gold industry in general and led to reduced buying as people were still getting used to the new tax regime. This factor has started to fade away and data validates that. Jewellery demand in India jumped 4 percent YoY in Q4 to 189.6 tonnes. Compared to Q32017, the jump was even bigger at 50 percent, suggesting that GST headwinds are starting to fade and will not materially impact gold demand in 2018.

Consumer demand in China picked up as bar and coin demand was up sizeably compared to five-year averages. Jewellery demand, on the other hand, picked up for the first time in 4 years, totalling 646.9 tonnes, up 3 percent YoY. We believe that the continuing focus of the Chinese government to cool off the real estate market has probably led the shift of investment towards gold at a time when economic growth prospects also look relatively better.

We have been maintaining a positive stance on gold, and a jump in volatility from record lows in 2017 would create a beneficial environment for gold prices. Secondly, we suggested that equities markets remain over stretched and could be overdue for some correction, and thereby any downside in equities would create a positive environment for gold. We saw the first glimpses of this trade in February-March and it will be interesting to watch how volatility unfolds from here.

From the fundamental perspective, global gold demand was subdued last year, with full year demand coming in 7 percent lower compared to 2016. Investment demand, which is among the primary drivers of gold prices, was down 23 percent YoY. Among top consumers of gold, both Indian and Chinese consumer demand was slightly higher YoY, but was below historical levels.

On balance, while physical fundamentals are yet to catch up, sentiment drivers could still drive gold prices higher this year. We retain our bullish forecast for gold and expect a target of USD 1,410-1,430 for 2018, as our base case. In a slightly more bullish scenario, if global equity markets indeed see a downturn and if volatility spikes, gold could move towards USD 1,470 levels as well. We expect USD 1,235-1,270 levels to act as a strong base for this year, with upwards targets towards USD 1,440-1,470. On the domestic front, Rs 28,800-29,300 zones should act as a strong base for the year and an upside move towards Rs 32,500-33,300 look likely.

News: Money control.com