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Gold is perceived as a safe-haven asset. Yet, despite the sharp declines in emerging market currencies, and the rally in other traditional safe-haven assets such as the Japanese yen, the gold price has dropped steadily, losing around 12% over the past four months.
According to the World Gold Council, total gold demand in the first half of the year hit its lowest since 2009.
In its weekly economic and market overview, OAM noted that the decline in the gold price is attributed to the strength of the US economy, rising US interest rates and a burgeoning US dollar.
"The sharp decline in the gold price over the past 6 months has coincided with the Federal Reserve hiking the fed funds rate at every alternate policy meeting."
South Africa economic review
• Consumer price inflation (CPI) accelerated in July from 4.6% year-on-year to 5.1% due mainly to the rising fuel price. Transport price inflation jumped from 7.3% to 10.0% on the year. Core CPI, which excludes food and energy prices due to their volatility, increased only moderately from 4.2% to 4.3%.
On a month-on-month basis, headline CPI increased by 0.8% with the housing and utilities segment contributing 0.5 percentage points. Utilities are surveyed in July, so a large increase was to be expected.
In the current environment of weak domestic demand, the biggest risks to inflation are the weakening rand and rising international oil price. However, both risks are likely past their peak, with renewed rand stability and slightly lower oil prices expected into the end of the year.
• The Reserve Bank Composite Leading Business Cycle Indicator, a key barometer of business and economic conditions 6 to 9 months ahead, increased in June by 1.1% month-on-month from 105.9 to 107.1 its highest since February.
In February, “Ramaphoria” boosted the leading indicator to 107.4 its highest since 2011. Among the ten components making up the leading indicator, the largest positive contributors resulted from an increase in the number of residential building plans passed and an acceleration in the 12-month percentage change in job advertisements.
The largest negative contributions came from a deceleration in the composite leading business cycle indicator for South Africa’s major trading partners and a deceleration in the growth rate in real M1 money supply.
Overall, the leading indicator is encouraging, indicating a recovery in economic growth in the fourth quarter (Q4) and Q1 2019.
The week ahead
• Fuel price adjustment: due this week. The Central Energy Agency is expected to announce a rise in petrol and diesel prices due to the recent sharp depreciation in the rand. Any price increase would undermine household disposable income, raise business costs, and place upward pressure on producer price inflation and consumer price inflation.
• Producer price inflation: Due on Thursday 30th August. Producer price inflation (PPI) is expected to have picked-up in July on a month-on-month basis from 0.4% to around 0.8% due to rising administrative cost pressure and the effect of a weakening rand on imported oil prices.
However, due to the beneficial base effect of year-ago comparative levels, PPI is likely to have only increased marginally on a year-on-year basis from 5.8% to 5.9%.
• Private sector credit extension: Due on Thursday 30th August. Having increased by more than expected in June to a year-on-year growth rate of 5.7%, private sector credit extension (PSCE) growth is likely to have exceeded 6% in July. A mild improvement in both corporate and household credit extension is expected.
• Absa manufacturing purchasing managers’ index: Due on Friday 31st August. Having regained the expansionary 50-level in July with a strong increase from 47.9 to 51.5, the Absa manufacturing purchasing managers’ index (PMI) may have given back some of its recent gains in August due to a slight weakening in external demand.
The forward-looking components of the PMI data will be closely watched for clues on the manufacturing outlook in the second half of the year.
• Trade balance: Due on Friday 31st August. The trade balance is likely to have posted a further surplus in July with lacklustre domestic demand containing import volumes and the weaker rand boosting export competitiveness. However, the trade surplus is unlikely to have matched the substantial R12bn surplus recorded in June.
Technical analysis
• The rand has retraced 50% of its 2016 to 2017 appreciation against the US dollar, indicating that the spike in the rand/dollar rate to R15.07/$ in mid-August may mark the peak in the currency’s recent decline.
• The rally in the US dollar index has reached its medium-term goal suggesting a correction from current levels. The dollar remains below a major 30-year resistance line suggesting the bull run in the dollar may be over.
• The British pound has broken back below key resistance at £1.35/$ suggesting a trading range of £1.30/$ to £1.35/$. The £1.28/$ level is expected to provide strong resistance.
• 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 is struggling to break decisively above key resistance at 3.0%. However, a break above this level is expected and would open the next target of 3.6%.
• The benchmark R186 2025 SA Gilt yield has retraced earlier weakness and fallen back below the key 9.0% level. A trading range of 8.4% to 9.0% is expected over the foreseeable future.
• Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.
• The Brent oil price has struggled to break above key resistance at $75 per barrel, indicating a likely trading range of $65 to $75 per barrel. The outlook for base metals prices is less certain after the copper price retreated sharply from the key $7 000 per ton level. A decisive break below $6 000 per ton would herald a bear market in copper and base metals’ prices.
• Gold has developed an inverse “head and shoulders” pattern, which indicates a price recovery and a test of the $1 400 target level.
• Despite the consolidation since the start of the year the break in the JSE All Share index above key resistance levels at 56 000 and 60 000 in December signals the early stages of a new bull market.
Bottom line
• Gold is perceived as a safe-haven asset. Yet, despite the sharp declines in emerging market currencies, and the rally in other traditional safe-haven assets such as the Japanese yen, the gold price has dropped steadily, losing around 12% over the past four months.
• Investors have withdrawn a massive $3.9bn worth of gold from exchange traded funds since the beginning of June, while non-commercial short gold futures contracts surged over the past two months from 73 905 to 195 604 the highest in over 20 years.
According to the World Gold Council, total gold demand in the first half of the year hit its lowest since 2009.
• The decline in the gold price is attributed to the strength of the US economy, rising US interest rates and a burgeoning US dollar. John Reade, chief market strategist at the World Gold Council said: “Because there’s nothing threatening the US dollar or US economy, people don’t see the need at this stage to buy gold.”
• There is a strong negative correlation between the strength of the US economy and the dollar gold price. Since 1970, the US has experienced 14 recessions, defined as two consecutive quarters of negative GDP growth. In 10 of the 14 recessions, the gold price has rallied chalking-up an average return of 28%.
The gold price tends to rise when the dollar weakens but falls when the dollar strengthens as has been the case over the past six months with the dollar index rallying from 88.59 on 1st February to 96.67 on 15th August. Gold thrives when US interest rates are in a declining trend.
Lower interest rates reduce the opportunity cost of holding non-interest-bearing assets, such as gold. The sharp decline in the gold price over the past 6 months has coincided with the Federal Reserve hiking the fed funds rate at every alternate policy meeting.
• The changing outlook for the US economy indicates a rally in the gold price over the next two years. US GDP growth is expected to slow in 2019 as the boost from the fiscal stimulus fades and the effect of rising interest rates becomes a drag on the economy. Economists are increasingly highlighting the risk of a US recession in 2020 especially if current trade tensions deteriorate further.
A downturn in US economic growth in 2019-2020 will force the Federal Reserve to shift from monetary tightening to monetary easing, undermining the US dollar. Federal Reserve chairperson Jerome Powell made uncharacteristically “dovish” comments at the Jackson Hole Economic Policy Symposium, hinting that interest rates are close to their peak. His comments could signal a peak in the US dollar and a bottom in the gold price.
Fed funds futures are signalling two more rate hikes in 2018 but the outlook for 2019 is less certain, with only a 50% chance of a rate hike by September 2019.
• 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 declines in the US economy and the dollar, the world’s reserve currency.
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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