Will gold shine in 2019?

Photo of David Lennox, Fat Prophets By David Lennox, Fat Prophets

min read

Solid gains in precious metal likely – but keep a close eye on the US dollar.

The gold price disappointed in 2018. The precious metal turned in a negative performance for the year, registering a 1.0 per cent fall on 2017 to US$1,280 an ounce by the end of 2018.

So, what should we expect in 2019?

The US dollar was a key factor in the gold price last year and should continue to be so this year (Editor’s note: Gold historically has an inverse relationship with the US dollar; it rises when the Greenback falls and vice versa, although the relationship is not always clear-cut.)

There was a negative correlation between the gold price and the US dollar (represented by the US Dollar Index) in 2018, as shown in the following chart:
 

Source: Bloomberg Markets

Although there was an easing of the relationship toward the latter part of 2018, this year the negative correlation should continue to be a key influence. In simple terms, the relationship comes about as gold is priced in US dollars and the price must adjust in the opposite direction to the move in the dollar to ensure physical gold equilibrium.

This year, the dollar may be buffeted by three major headwinds, which we believe should cause it to fall over the year to finish 2019 in the range of 90 to 93. With the US Dollar Index at the time of writing trading around 96.3, the impact on the gold price to hit the index’s year-end forecast should be positive.  

The first headwind for the dollar in 2019 will be US national debt, which has been quietly bubbling higher in the background. The Trump Administration has set the base for US debt to rise with recent taxation cuts to reduce federal revenues and an election pledge to renew America’s ageing infrastructure and increase federal spending. The following chart shows forecast US debt:

Source: Statista

As the US economy starts to slow, debt-to-GDP is forecast to reach 109 per cent in 2020, from the current 105 per cent. US GDP growth is forecast to slow to 1.7 per cent annually by 2020, from the current 3.0 per cent. 

A resolution of the trade war between China and the US should be another headwind to push the US dollar lower in 2019. We believe market expectations of the US swiftly repairing its negative terms of trade with China through imposing new and deeper tariffs on Chinese imports, will not be carried through, and President Trump will look to avoid damage to the US economy with one eye on securing a second term. The US running a bigger and longer-than-expected terms of trade deficit will be a second headwind to buffet the dollar in 2019.

The Federal Reserve will be a key participant in causing the dollar to weaken in 2019. The transition from a hawkish to a dovish view on US cash rates will bring a third headwind to bear on the dollar. Fed projections from the December 2018 meeting flagged the potential for two increases in 2019 and one in 2020. This is a dovish shift from the earlier forecast of three rises in 2019 and one in 2020.

A slowing US economy may, however, require the Fed to take an even more dovish approach compared to its December projections. A slower cycle of raising US cash rates would price out any “high yield” premium in the dollar.

Supply and demand
Gold demand and supply in 2019 will be a headwind for the gold price, with a higher surplus supply for the year. However, we expect demand will modestly recover in 2019, to reverse the spate of weaker figures seen since 2012, with annual gold demand shown in the following graphic:

Source: World Gold Council/Fat Prophets

Gold demand will continue to increase by 4 per cent, to 4,366 tonnes, in 2019. The key drivers will be the continued recovery in jewellery demand and investors returning to gold-related exchange-traded funds, with bar and coin demand remaining passive. Expectations are for central governments to also remain active in buying gold.

Supply will increase in 2019, continuing a trend established over the past few years, with annual gold supply shown in the following graphic:

Source: World Gold Council/Fat Prophets

The supply of gold, on 2018 forecast figures, will increase by 2.5 per cent in 2019, to 4,641 tonnes. Supply will be driven by non-US dollar gold producers continuing to benefit from better local currency margins, due to higher domestic currency gold prices compared to their counterparts in the US.

The supply and demand forecasts for 2019 will see the overall gold market remain in surplus supply, to the tune of 275 tonnes. Forecasts for 2018 have the surplus for last year around 323 tonnes, with 2017 the most recent actual of 251 tonnes. A declining surplus of gold in 2019 will moderate the headwind caused by the physical market.

In view of the negative correlation between the gold price and US dollar, and our view that a key gold price driver in the dollar may weaken in 2019, our expectation is for the gold price to end 2019 in the range of US$1,375 to US$1,400 an ounce. Gold at the time of writing was trading around US$1,285 an ounce.       

Apart from the potential positive capital return that our 2019 forecast for the gold price would suggest, other benefits can be found in holding gold in a portfolio. The “store of value” in gold when all else is failing is a defensive or “safe haven” trait to counter value losses in other asset classes during heightened volatility and uncertainty.

Gold can certainly have a place in an investor’s portfolio, especially in these demanding and uncertain times.

About the author

David Lennox is an analyst at Fat Prophets, a leading investment newsletter publisher.

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