Sunday, January 3, 2016

Will 2016 be better for precious metals?

The surging dollar, prospect of higher interest rates in the US and the slump in commodity prices bore down on precious metals in 2015. While gold prices dropped 10 per cent, silver slid 12 per cent and platinum slumped by a sharp 26 per cent on worries of drop in demand for diesel cars in Europe (after the Volkswagen emission scandal).

Investment demand for all the three precious metals was poor as investors took shelter in bonds. SPDR Gold fund, the largest gold ETF in the world, saw its holdings drop to the lowest in many years. Hard-bitten bullion investors are now thinking twice about betting on precious metals.

So, will the tide turn in favour of these metals in 2016? Many believe that as the Fed continues with its scheduled rate hikes in the next 12 months, the selling in gold will accelerate. But there are two factors that can counteract this, to set the direction of gold this year.

Dollar trends 

Gold prices tend to be inversely correlated to the dollar. Currently, most players expect the dollar to strengthen this year on the back of Fed rate hikes. But if the Federal Reserve delays its second rate hike (expected in March) due to unfavourable economic conditions or effects less than four hikes that it indicated in the last meeting, the greenback can lose muscle. Even otherwise, during the past up-cycles in rates, it has been observed that the dollar skyrockets just before rates start to go up, but moves down after the first two/three rate hikes. Should the dollar weaken, that can provide a leg-up to gold prices.

Crude oil moves

The direction of crude oil prices feeds directly into global inflation expectations. And rising inflation expectations are bullish for bullion. Currently, crude oil prices are on a slippery slope. But if the global economy holds up and oil eventually stabilises around $50/barrel, that may help gold. Though there is a fear that if sanctions on Iran are lifted, the incremental addition to oil output will be high, one cannot be sure that oil prices will head further down.

At current price levels, there is not much new investment happening in oil exploration and drilling. Plus, it won’t take much for speculators to wind down sell positions to jump on to the buy side. As the base effect of lower crude prices will also wane this year, higher inflation could provide new legs for a gold rally.

But there are risks to these scenarios. In 2016, if the US economy posts good growth, safe haven buyers may again start to pile on to the US dollar in place of gold. This will be negative for gold. If forecasts of $20/barrel for oil or a weaker euro play out, then gold may continue its slide.

Better to bet on silver

Given the uncertainties for gold, within the precious metals pack silver looks a more promising investment for 2016, on account of its better fundamentals. The grey metal is seeing supply drop at a fast pace across the world — from Chile to the US and Canada. Last year, silver production in Canada dropped over 20 per cent. The US, which is among the top 10 producers, saw silver production drop 7 per cent in the first 10 months of 2015. Drop in output follows a steep fall in silver prices. With production costs for silver miners at about $17/ounce, market prices are already below $14/ounce. If more unviable silver mines shut down this year, the supply deficit will widen. This will be the fourth consecutive year of a global supply shortage in silver.

Technically

Gold prices may start the year on a weak note. As more visibility is available on the Fed’s next rate hike, prices can drop further from the current $1,061/ounce levels to even $1,000/ounce. But going by past experience, when the second rate hike happens by March or so, gold prices can reverse direction.

In 2015, gold prices hit a low of $1,046/ounce in December. All its attempts to rise to $1,200 levels since then have failed, with bullion not being able to cross even the $1,100-mark.

In 2016, gold may target $1,155 on the upside. This represents the 61.8 per cent retracement of the upmove from the 2008 low to the 2011 high. Further upside from here can take the yellow metal to $1,200.

In the near term, however, the metal can test support at $1,000. If it doesn’t hold at $1,000, it may go down to $970.

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