The collapse in gold’s value and negative sentiment towards the yellow metal arguably presents a case for a value play but a lack of any clear catalysts makes it attractive only to the brave.
Just last week the price of bullion collapsed below the $1,200 mark, its lowest level in three years, as the fears over the US Federal Reserve tapering back its massive stimulus programme continued to rock markets.
But ETF Securities head of research and strategy Nicholas Brooks believes market reaction to the Fed’s comments has been overdone.
“On our estimates, gold, silver and platinum, with implications for palladium, are now trading around 20 per cent, 10 per cent and 25 per cent below their respective average marginal costs of production. Prices will have to move above these levels to support long-term supply growth,” he says.
Following a bull run that endured for more than a decade, macro factors including lower demand from China, a stronger dollar and the potential reduction of QE are currently leaning heavily on the price of gold and other metals.
As the US economy has gradually improved the US dollar, following a prolonged period of weakness, has gathered strength taking with it the shine of gold, a traditional hedge against the greenback.
In April this year, it suffered its biggest sell-off in more than three decades, taking some $1trn off the value of reserves. A number of theories in regards to the fall were put forward, one was that investment banking giant, Goldman Sachs, recommended clients go short bullion, as it cut its long-term forecast for the precious metal.
But Brooks believes precious metals provide an attractive entry point for investors at their current levels.
He says: “All good bull markets need a correction. After a 12 year run, the gold price was well overdue a major correction and this is now taking place, albeit at a much higher velocity than its increase – as is usually the case. The silver price has been dragged down with gold, and platinum and palladium prices have been affected by China growth concerns as domestic liquidity has been squeezed.
”We believe the price corrections have been excessive and have returned precious metals prices to attractive long-term accumulation levels.”
Charles Stanley Direct head of investment research Ben Yearsley says: “It is a brave investor who goes for gold right now and arguably given its fall there is value to be had. But I just cannot see what can and will change to reverse its fortunes right now. A catalyst is not there, I do not know what will change the momentum.”
Brooks admits in the near term it is difficult to see any immediate catalysts, such as a reduction in US real yields or a weaker US dollar, to spur gold into resuming its bull market climb. He says further declines cannot be ruled out and it is likely to face headwinds as long as US interest rates continue to rise, inflation expectations continue to fall and the US dollar continues to strengthen.
“We believe these are cyclical factors that are temporary,” Brooks adds. ”We believe the reaction of bond markets to Fed comments has been overdone, and ultimately real interest rates will fall back from current levels. Interest rates need to remain structurally low to keep government debt interest costs in check, support the recovery of the real estate market and consumer balance sheets, and offset fiscal drag.”
The correlation of silver and gold price movements has been strong over the long term and this correlation has risen sharply over the past nine month. Brooks does not see any immediate reason for this relationship to change and expect that silver’s directional outlook will remain tightly tied to that of gold.
He says: “Platinum and palladium, however, are far more sensitive to industrial demand – particularly China demand. Therefore the recent sharp spike in short-term interest rates in China has been the main factor behind the their price declines.
”We expect China’s liquidity conditions will ease and growth fears will dissipate over the course of the year, removing this hindrance to platinum and palladium price performance.”