Merrill Lynch Wealth Management’s Johannes Jooste asks if gold has had its day
Johannes Jooste, chief market strategist EMEA at Merrill Lynch Wealth Management, says the recent plunge in gold prices is linked to investor concerns over broader global economic strength and notable falls in other non-precious metal commodities.
The market has reflected a good deal on sharp falls in the prices of commodities, especially precious metals. Indeed, since the beginning of April gold prices have plunged 12.2% in US dollar terms. Commodities in general (as measured by the DJ UBS Commodity Total Return Index) have lost 3.6% over the same period. What can investors glean from such price action?
A number of different reasons have been extended for the recent fall in gold prices.
Liquidations of gold exchange traded products (ETPs) have been significant. However, while a large ETP market for gold does make quick sales easier than in former years, it is difficult to attribute gold’s recent volatility entirely to ETP flows alone. Speculation of central bank gold sales in Cyprus also pressured the gold price. Yet central bank sales of gold in peripheral Europe are unlikely to materialise either, according to BofA Merrill Lynch Commodity Research, as previous use of gold reserves has historically been collateral for loans rather than an asset for sale outright.
Weaker economic activity from large emerging economies, notably China and India, has reduced some marginal demand for gold and the broader commodity complex in recent times too. Indeed, weaker industrial production and fixed asset investment data for China have arguably dampened demand for raw materials.
We feel that both gold and the broader commodity complex may face more challenges as the nature of emerging markets’ expansion evolves. The strong relationship between copper prices and Chinese lead indicators has broken down. The transition away from investment-led to consumption-driven growth in many emerging markets is potentially one reason for the lagging performance of base metals demand (and prices) in the global risk asset rally year-to-date. Further, financial liberalisation in emerging markets should reduce demand for precious metals for investment purposes, in our view.
A strengthening US dollar also continues to challenge commodity prices. While the year-to-date rise of the greenback has been modest, the three month price change in gold has had a 91% negative correlation with the US dollar over the past year, according to Absolute Strategy Research. Given our expectation of continued, gradual rise in the US dollar, gold and commodity prices may face short-run headwinds.
Nevertheless, we feel that the longer-term thesis for gold in a multi-asset portfolio still persists. Gold’s historical role as an offset to inflation risks does still hold, in our view. It is true that the recent rise in US real interest rates has been driven less by rising nominal rates and more by falling inflation in the US. Higher global liquidity provision has arguably not supported commodity prices recently as the channels between stimulus, economic activity and prices remain strained.
Yet our expectation is that unprecedented global monetary expansion should eventually feed through into concerted economic acceleration and higher prices. Tail risks, especially in a fragmented and politically divided Europe, have fallen in magnitude but still remain. As such, the strategic case for gold as a portfolio diversifier or counterbalance could still be made. However, a neutral allocation to broader commodities may be prudent on a more tactical basis, at least until recent market volatility abates.