Dubai: Looking back at 2013, gold continued its downward trend touching as low as $1,180 per troy ounce, from highs of more than $1,900 from mid-2011. This was a reflection of the massive unwinding of holdings by gold sector ETFs (Exchange Traded Funds) and trader positioning in COMEX (the Commodities Exchange). More than 800 tonnes of gold flowed out of the ETFs over the course of the year due to liquidations as investors became wary of exposure to gold. Simultaneously speculative positioning by traders in COMEX resulted in a decline in net-long positions by the equivalent of some 600+ tonnes of gold.

What could have brought about the sudden change of heart amongst gold investors? For one, a relentless bull market in US equities, convinced many gold ETF holders to change strategy. Contrary to expectations, inflation remained subdued in the US while Europe held it together. “Fed tapering” appeared in FOMC minutes somewhat sooner than anticipated. All these factors conspired in deflating gold even further.

So far in 2014, gold’s fortune seems to have turned a corner, and by the time of writing this article is up just under 10 per cent for the year. It remains to be been seen whether this is a momentary “dead cat bounce” or a longer lasting base. Any number of factors could play out, and it might be best to paint a few scenarios of the main potential drivers ahead. A stronger dollar together with buoyant equity markets have stolen gold’s shine as an attractive investment opportunity the past couple of years. As long as the dollar gets stronger and equity markets maintain the uptrend, gold might not see much more upside and possibly be capped around $1,350 - $1,400. The Fed looks set to continue tapering its asset purchase program and if US GDP growth approaches 2.8 per cent as some economists expect, the US should be the top performer in the G10.

Unless conditions in the US deteriorate significantly, the Fed appears on track to wind up the program by this year. Technically the US dollar index also looks set to resume its uptrend after successfully testing and holding support around the 79.50 level. This should drive dollar strength as markets begin to price in an eventual interest rate rise and dent gold’s appeal as a hedge against inflation. While not necessarily leading to a sell off, this would temper any further appreciation in gold for a while.

A distinct negative for gold and commodities generally, would be a hard landing in the Chinese economy. Manufacturing data out of China in January and February already point towards a slowdown in activity, although nothing really drastic. However, anything that impacts on Chinese income would see demand for gold affected.

Gold will be supported if ETF sales drop further. Concerns about political or global financial crises flaring up again would in fact spur renewed buying. While the ECB’s balance sheet is currently contracting (gold negative), the Eurozone is still in the ICU ward. Threats of looming deflation and elevated debt to GDP ratios in southern Europe with possibility of defaults tell us the debt crisis is not yet over. So Quantitative Easing for Europe (as has been hinted by ECB officials already) is not an impossibility.

On the balance of it, the medium to long-term outlook for gold remains constructive and the key themes behind gold as an investment class are not likely to disappear anytime soon

 

-- Domluke Da Silva is a CFA charter holder and a Member of CFA Society Emirates