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Cape Town - Overberg Asset Management looks at the factors behind the gold market in this week's overview of the economic landscape.
While near impossible to model predicted gold price movements, the outlook for bullion is brightening. The improving outlook is based on supply-demand fundamentals, historic relationships between the gold price and the monetary base, cross border capital movements and expected dollar weakness. (See Bottom line)
South Africa economic review
• Retail sales unexpectedly increased in March by 0.8% year-on-year - an improvement on February’s 1.6% contraction and ahead of the consensus forecast of a contraction of 0.7%. The winning retail categories were food, furniture and pharmaceuticals which gained on the year by 14.8%, 8.2% and 7.2% respectively.
The biggest loser was the textile category which fell 5.6% on the year. In the first quarter retail sales fell 1.0% on the year shaving around 0.3% from first quarter GDP growth. Despite encouraging March figures, the outlook for retail spending remains weak, clouded by depressed consumer confidence, tight lending standards and poor employment growth. Until real disposable income starts to show growth there is unlikely to be any reprieve from the downtrend in retail sales. There is a strong correlation between real per capita disposable income and retail sales growth.
READ: Retail sales up, but quarter showing 'worst since financial crisis'
• Foreigners were net sellers of both South African bonds and equities in the past week to the tune of R3.05bn and R0.99bn respectively with net bond sales attributed to renewed political corruption allegations in Brazil. For the year-to-date net selling of equities was R43.49bn while inflows into the bond market remained positive at R38.02bn.
Domestic bonds are in strong demand despite recent credit rating downgrades due to rising global appetite for higher yielding emerging market assets. However, since the South African bond market is large and very liquid any change in broader sentiment would have significant repercussions. Although still negative, for the first time in 18 weeks, the net foreign sales of equities were less than bonds potentially signaling a turning point in foreign sentiment towards the domestic equity market.
The week ahead
• Reserve Bank composite business cycle leading indicator: Due Tuesday 23 May. The leading indicator, which measures expected business conditions 3 to 6 months ahead, increased in February for a 7th straight month to 98.0 its highest level since early 2014 although likely to show a decline in March due to President Jacob Zuma’s ill-fated cabinet reshuffle.
• Consumer price inflation: Due Wednesday 24 May. Helped by falling food prices consumer price inflation is expected to soften from 6.1% year-on-year in March to 5.6% in April according to consensus forecast. Core CPI excluding food and energy is expected to remain unchanged at 4.9%.
• Producer price inflation: Due Thursday 25 May. Producer price inflation (PPI) is expected to soften from 5.2% in March to 4.9% in April according to consensus forecast. The PPI deceleration is being assisted by a constructive base effect of higher year-ago levels, a strengthening rand and lower food prices.
• SA Reserve Bank (SARB) interest rate decision: Due Thursday 25 May. The SARB's Monetary Policy Committee (MPC) will conclude its three day meeting. According to consensus forecast the MPC will leave the repo rate unchanged at 7.0%. Although consumer price inflation will regain the SARB’s 3% to 6% target range and economic growth remains weak, there is a high degree of uncertainty over the rand’s direction due to potential credit rating downgrades. Renewed rand volatility would jeopardise the inflation trajectory.
Technical analysis
• The rand is trading in a range between R13.00 and R13.50 to the dollar. A break below R13.50 to the dollar is required to pave the way for further depreciation to the R14.50 to the dollar level.
• The US dollar index is testing a major 30-year resistance line, which, if broken, will pave the way for further strong gains in the currency.
• Following the announcement of the snap election the British pound has broken above key resistance at £1.25 to the dollar which has now become a key support level and should promote further near-term currency gains. Recent strong gains have diminished prospects for a £1.18 to £1.22 to the dollar target.
• The JPMorgan global bond index is testing the support line from the bull market stemming back to 1989, which if broken will project further sharp increases in bond yields.
• The US 10-year Treasury yield has broken back above the key support level of 2.0% endangering the multi-year bull trend in US bonds.
• The benchmark R186 2025 SA Gilt yield is trading in a tight trading range of 8.5% to 9.0%. A break above 9.0% is required for the yield to move decisively higher towards the 10.5% target level.
• Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdqaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.
• Despite failing to hold above the $55 level the Brent crude price is well supported at $50 a barrel. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $5 500 per tonne.
• Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1 400 target level.
• A break above 54 200 on the JSE All-share index would project an upward move to 60,000 marking a new high for the JSE.
Bottom line
• The greatest limitation for gold as an investment is its lack of income yield and the difficulty in predicting or modelling its anticipated price movement. Warren Buffett, well known for his disdain for gold as an investment famously said: “It is an entirely different game to buy a lump of something and hope that somebody else pays you more for that lump two years from now than it is to buy something that you expect to produce income for you over time.” Acknowledging the income generating limitations not to mention the insurance and storage costs associated with holding gold, there is a place for some gold in investment portfolios, as a hedge against geopolitical and economic risk.
• Gold demand is increasing in India and China, the world’s two largest bullion markets. Combined demand from these two nations already exceeds the total amount of gold mined worldwide. In India gold imports increased in April by 440% year-on-year to 98.3 tonnes compared with 22.2 tonnes the previous year. In China gold demand is expected to surpass 1 000 tonnes this year compared with 975 tonnes in 2016 boosted by curbs on property speculation and greater flexibility in gold trading. Bank of China International has sponsored G-banker, an online trading platform which enables buyers to buy, sell, deposit and withdraw gold via digital trading and a mobile app. Shanghai Gold Exchange volumes recently surged to 34 tonnes per day up sharply from the long-term daily average of around 27 tonnes.
• Outstanding gold contracts on the New York Commodities Exchange (Comex) have fallen for ten straight weeks, the longest stretch since October 2011. This negative positioning often acts as a “reverse indicator” signalling that we may be near to the bottom. Buying of gold contracts is more likely to rise from depleted rather than fully invested levels.
• How is the Fed interest rate hiking cycle likely to affect the gold price? Contrary to generally accepted wisdom rate hiking cycles are normally associated with a rising gold price. During four separate Fed rate hiking cycles since 1988 commodities, to which gold tends to be closely correlated, provided almost double the performance of equities.
• The gold price tends to rise when the US dollar weakens. The dollar was boosted between 2012-15 by massive capital flight from the eurozone and China in response to ECB quantitative easing and relaxation of capital controls in Beijing. Most of the estimated $1.6trn which left China and $1.4trn which left the Eurozone flowed into the US. As monetary tightening spreads from the US to other regions in response to the global economic recovery, the massive capital flows into the US between 2012-15 will reverse, resulting in dollar weakness and a concomitant rally in the gold price.
• Perhaps the most persuasive argument for including some gold in investment portfolios is the relationship between the gold price and the size of the US Monetary Base. The divergence between the value of stated US gold reserves and the size of the US Monetary Base is as wide as it has ever been, matched only in 1976 when a bull market in gold was just starting.
For the full report, including a look at international markets, click here.
* Overberg Asset Management (OAM) is an Authorised Financial Services Provider No. 783. Overberg specialises in the private management of local and global discretionary portfolios as well as pension products.
Disclaimer: Information and opinions presented in this report were obtained or derived from public sources that Overberg Asset Management believes are reliable but makes no representations as to their accuracy or completeness. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this Report and should not be relied upon. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Furthermore, Overberg Asset Management accepts no responsibility or liability for any loss arising from the use of or reliance placed upon the material presented in this report.
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