Commentary: Strong headwinds for gold in 2014

Challenging macroeconomic conditions are likely to drive gold prices lower in 2014, commodity specialists at Bank of America Merrill Lynch and Credit Suisse say, and both banks agree the precious metal could test the US$1,000 per oz. level before the year is out. Bank of America Merrill Lynch forecasts gold will average US$1,150 per oz. this year, while Credit Suisse says the average will be closer to US$1,080 per oz.

Rising U.S. 10-year treasury yields and subdued inflation sum up the essence of the economic headwinds facing gold this year, Bank of America Merrill Lynch says in its report published Jan. 9. Researchers at the bank contend that investors, who have been marginal buyers in recent years, are likely to continue reducing their exposure to gold at the same time, as demand for physical gold from buyers in China and India (import restrictions in the latter are in place to ease New Delhi’s current account deficit) will likely “not be strong enough to stop prices from falling further.”

The good news, they say, is that gold could bottom out this year as markets rebalance. In terms of supply, “miners are adjusting to the challenging operating environment and capex curtailments will almost certainly reduce the scope for supply increasing going forward,” Bank of America Merrill Lynch contends. At the same time, “continued apprehension over unexpected inflation, on views that the output gap may be much smaller, especially in the U.S., could bring gold buyers back into the market.” As a consequence, the investment bank’s commodity analysts argue, 2014 “may provide interesting entry points for gold investors.”

Credit Suisse points to most of the same macroeconomic arguments against higher prices (rising rates, absence of inflation) and add a few new ones (the end of the decline of the U.S. dollar and global growth momentum). But overall the bank’s analyst is less sanguine than his peers at Bank of America Merrill Lynch, stating that:  “in absolute and relative terms, gold still appears overvalued.”

London-based research analyst Tom Kendall argues that the exceptional demand in Asia last year for jewellery and small-investment products would not be repeated this year, and that “with the exception of a handful of smaller emerging market economies with weak currencies, investors buying gold today as insurance against a future macroeconomic event will be paying a high premium at a time when risks are still subsiding.”

According to Kendall’s 2014 gold model, the market will be oversupplied by 100 tonnes in 2014.

“Mining companies could take much more aggressive action to suspend sub-economic operations than anticipated,” Kendall writes. “However, with all-in cash costs having been cut substantially in 2013 and exploration budgets trimmed sharply, we think lower prices are still a prerequisite for a major restructuring of the gold industry, which in turn would come with a lag of at least three to four quarters.” Indeed, he doesn’t think cost support will come into play until at least the first half of 2015.

Kendall forecasts that it is unlikely India will repeal its import restrictions on gold or its limits on the use of credit to buy it, because the government “has staked considerable credibility on reducing the balance of payments deficit,” while the domestic economy struggles.

But what about central banks and their appetite for gold? Here, too, Kendall is pessimistic. “Those banks that declared sizable increases in their gold reserves between the global financial crisis and first-quarter 2014 (including Argentina, Brazil, South Korea, Mexico, the Philippines and Thailand) have reported no change in holdings since March last year, despite the [approximately] 25% drop in price,” he says. “The motivation for many of those to diversify their USD-dominated FX reserves remains, but the past five years has been extremely difficult for reserve managers (European crisis, Australian dollar depreciating, Japanese yen depreciating, gold slumping), and given their inherently cautious mandates, we do not expect an early or wholesale return of those previously large buyers.”

As for China, he says, “authorities are motivated to build a sizable gold reserve before [China’s renminbi currency] gets close to convertibility . . . [and] that point is probably still three years away.” In the meantime, Chinese state institutions will continue to accumulate most, if not all, of domestic production in China, which in 2013 worked out to 420 tonnes, he says.

The big question becomes: What happens if and when the Chinese stop buying?

“Given the size of the imports into Hong Kong last year [1,263 tonnes in the first 10 months], it does not require a huge leap of imagination to think that there may well have been some sovereign buying from non-domestic sources,” he says. “Gold bulls would be inclined to view that positively, but if — as some estimates have it — Chinese state buying exceeded 1,000 tonnes in 2013 and the price still ended the year sub-$1,200. We are more inclined to wonder what would happen if they stepped back from the market.”

Looking out past 2014, Bank of America Merrill Lynch forecasts average gold prices in 2015 and 2016 of US$1,256 per oz. and US$1,400 per oz., while Credit Suisse predicts average gold prices will fall to US$990 per oz. in 2015, before rising to US$1,000 per oz. in 2016.