Is it time to return to gold and the gold sector?

News - 8/21/2018

Since 30 June 2018, the FTSE Gold Mines index of gold companies has lost close to 15% in EUR (17% in USD), while at the same time the price of gold has fallen by 3% in EUR, and by 5% in USD (figures at 20 August)1.

- Since the start of the year, the respective losses work out at -18% in EUR/-22% in USD for the index and -4% in EUR/-9% in USD for the price of gold.

- Most of the sector’s decline is thus recent, and is linked to the price of the ounce of gold, which hit a low at USD1,160/oz during the session of 16 August 2018, before closing at USD1,175/oz, levels that have not been seen since the start of 2017. 

The context 

- Since 16 December 2015, the US Federal Reserve has raised its key rates seven times, each by a 25bp notch (once in 2015, once in 2016, three times in 2017, twice up until now in 2018, with two more hikes expected by the end of the year), but with the Fed maintaining a cautious tone with respect to the pace of its increases. This environment could have penalised gold prices, which typically react negatively to increases in interest rates.  

- However, since the first rate hike, the ounce of gold is up 11% in USD (7% in EUR), while moving within a price range of between USD1,150 and USD1,350/oz. This good resilience is mainly explained by the timid but gradual return of inflation, which enables real rates to remain at levels that do not penalise gold. This is currently the case, with a US Govt 2-year Yield at 2.6%, and core inflation (US CPI less Food & Energy) at 2.4% - i.e. inflation from which certain fluctuating elements have been removed - (US CPI less Food & Energy) is at 2.4% (as at 31 July 2018).

What are the reasons? 

- The recent drop in the gold price can be explained mainly by a return of interest in the USD, along with some loss of confidence in other currencies: the GBP has suffered from an increase in the risk linked to Brexit, the EUR has been hampered by the political context, notably with respect to Italy, and emerging currencies by the trade war on tariffs triggered by the US, and lastly and more recently, with the collapse of the TRY (Turkish lira). These movements favoured the safe haven status of the USD, notably at the expense of the ounce of gold, which did not play its usual protective role.

- This somewhat unfavourable environment was accentuated by sell-offs on physical and financial markets. Investors, who had returned to gold ETFs2 in 2016 and 2017, have reduced their positions over the past 2-3 months. The stock of gold held, at 70.25m oz (at 17 August 2018, source UBS), is thus down by close to 2% (1.37m oz) since the start of the year, while flows were still up at end-May. Comex (New York Commodities Exchange) traders largely contributed to exacerbating the downward trend. While their net short/long position is practically always positive - see chart below - this position became net short on 14 August, for the first time since April 2001. It is highly likely that the next move of these traders will be to hedge their short positions, which should thus contribute to a rebound in the gold price. 

Conclusions 

- The asset class linked to gold is generally not the most attractive (no returns on metals, company dividends quite small) and is thus often limited to specialists or investors who have experienced serious financial crises and who understand the interest of keeping a certain level of security in their portfolios.

- However, in view of the recent decline, the gold sector seems to have a limited downside risk for a certain rebound potential. 

In the context of the market turbulence over the summer, the sector probably deserves renewed interest. 

1. Past performance is not a reliable indicator of future results. Source : Edmond de Rothschild Asset Management (France).

2. An ETF, or exchange-traded fund, is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund.

DISCLAIMER 
20/08/2018
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EDMOND DE ROTHSCHILD ASSET MANAGEMENT (France)
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