Precious metal's worst could be behind us

The perfect storm of rising bond yields and stronger US dollar amid the approaching end of the US quantitative easing (QE) programme has beaten down the gold market this year. As bond yields rose, investors had one less reason to hold gold and preferred income-generating assets such as bonds. And as an alternative currency, the yellow metal has lost its shine to the strength of the greenback. Moreover, gold demand from the world’s top two consumers has been weak as China’s economy slowed in the second quarter, and India’s central bank stepped up the effort to curb gold imports to stabilise the sinking rupee.

Despite bearish market forces and bleak sentiment, there are a few reasons to believe that gold price might have found its bottom. 

First, the recent price action might suggest that QE tapering has mostly been ‘priced in’. Gold price has tumbled 20 per cent year to date and 30 per cent from its peak in August 2011 to roughly the same level as in October 2010 before QE2 was announced. In this sense, the recent price correction might suggest that markets have already been positioned for the end of the liquidity injection programme.

Second, market activity has shown uptick in sentiment. SPDR gold shares, the largest physically backed gold exchange traded fund (ETF), has faced massive redemption since the beginning of this year. The fund’s total gold holding has decreased 440 tons or a third of its holding at the beginning of the year. But recent movement is showing signs of stabilisation, with the latest data showing a modest increase in holding.

Third, improving economic outlook in China should help stabilise gold demand. With better-than-expected economic reports over the weekend, China is setting a better start for the third quarter. China, the world’s second-largest gold consumer, is becoming even more important to the gold market. In the first half of 2013, the country consumed 706.36 tons of gold, up 54 per cent from the previous year, the full-year demand could hit a record 1,000 tons and will overtake India as the world’s largest consumer, according to World Gold Council report.

Looking forward, however, the outlook for gold might not be as rosy as it has been in the past decade. The traditional drivers for gold demand remain weak. With a subdued inflation outlook owing to excess capacity in the developed world and end of the easy money regime, gold is unlikely to reclaim its peak anytime soon. With limited upside, the precious metal should take a role as risk diversifier, not a major part of investors’ portfolio. 

 

Komsorn Prakobphol is a senior investment strategist at Tisco Wealth. He can be reached via www.tiscowealth.com or [email protected].