Analysts see buoyant gold in 2016

Gold prices rallied in mid-March on the back of the U.S.Federal Reserve’s decision to lower interest rate expectations for 2016, with many economists and analysts forecasting the yellow metal would register a year-over-year increase.

On March 16, the Fed estimated two quarter-point hikes this year — compared to the four expected in December — to offset the weaker global economy. This helped lift the spot gold price 2.4% to US$1,262 per oz., and drove down the U.S. dollar to its lowest level since October.

A day later, while spot gold lost momentum to finish at US$1,256.90 per oz., the U.S. Dollar Index, which measures the strength of the greenback against a basket of foreign currencies, sank further to close at 94.75. Year-to-date, the yellow metal is up 18%. The only other years since 2000 where gold registered similar gains during this point were 2014 and 2008, when it climbed 14% and 19%, Raymond James analyst Phil Russo writes. Gold, however, exited 2014 down 2%, while gaining 6% in 2008, the year the financial crisis began.

Meanwhile, the Philadelphia Gold & Silver Index, comprising 30 gold and silver mining companies, is off to its best start, up 58% year-to-date, Russo writes. The index’s second-best year was 2008, up 19% at this time.

The recovery in gold and gold equities this year to date is partly  due to the “depth and breadth” of the preceding five-year bear market. This will set 2016 apart from the other years, Russo says. “The unprecedented run in 2016 follows an unprecedented bear market for the sector, and suggests the unrivalled performance can continue.”

Ore moves along conveyors to the leach pad in February at True Gold Mining’s Karma gold mine in Burkina Faso.  Credit: True Gold Mining

What’s good for gold?

“For gold prices to rise in U.S. dollars, it would be extremely helpful if the U.S. dollar rolled over,” Martin Murenbeeld, Dundee Economics’ chief economist, said in an early March presentation. The U.S. dollar, currently overvalued in his view, is at a turning point, he adds.

The greenback has retreated 4% year-to-date, making gold, priced in U.S. dollars, more attractive for foreign investors.

A sluggish global economy, however, negatively affects the gold price. Whenever the global annual growth rate is below 4%, commodity prices tend to go negative year-over-year, due to weak inflation, Murenbeeld says.

There’s a positive correlation between the gold price and reflationary measures, such as quantitative easing, and low or negative interest rates.

“What gold needs is a hell of a policy stimulation to get the heck out of a recession,” he said.

Murenbeeld expects gold will average US$1,190 per oz. this year, before ending 2016 at US$1,234 per oz. In 2017, he forecasts the metal will average US$1,304 per oz.

Gold bars produced in December 2015 at Lake Shore Gold’s gold operations in northern Ontario.  Credit: Lake Shore Gold

No longer an ‘obscenity’

Negative interest rates demonstrate economists have run out of ways to stimulate the economy with traditional policies, Don Coxe, chairman of Coxe Advisors LLC, said at the recent Prospectors & Developers Association of Canada convention. The policy spurs spending and economic growth by discouraging cash hoarding and incentivizing banks to provide more loans.

The European central bank, representing 19 countries that share the euro, was the first major bank to adopt negative interest rates in June 2014, with Japan being the latest central bank to drive its interest rate below zero.

“This is the single biggest new argument on why gold is going to be revalued, because it changes the basic approach to the capital-asset pricing model, which hasn’t been challenged before,” Coxe argued.

The model assumes investors are compensated for their time value of money and the risk they take on. Investors who get negative yields on certain government bonds violates that model and makes other assets, such as gold, more favourable.

“Are you telling me gold is riskier than a negative-yielding government bond?” Coxe asked, adding that investors assume a risk they should not have to own bonds. Negative interest rates have reinstated gold’s safe-haven status, making it less of an “obscenity” to own, he added.