GOLD AND SILVER   RUNNING INTO CRISIS?

Julius Baer - Lunes, 15 de Febrero

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Rising risk aversion and mounting global growth con-cerns remain in the driving seat of the gold market. Re-newed physical demand puts today’s recovery on a solid footing, in contrast to past sentiment-driven recoveries. 

A medium to longer-term bearish view on gold is not justified anymore. We turned neutral and recommend that investors use gold as insurance in their portfolios. 

Should the global economy run into crisis, we expect prices to rise another 12% to 15% from today’s levels, driven by a sizeable pick up in safe-haven demand. 

Silver has been recovering in gold’s slipstream although it does not share the same safe-haven characteristics. Hence, silver should not be used as portfolio insurance. 

 

The return of the safe-haven seekers 

Rising risk aversion and mounting global growth concerns remain in the driving seat of the gold market. Prices have recovered strongly since the start of the year and are now pushing towards USD 1,250 per ounce. As seen multiple times over the past couple of years, the upmove is sup-ported by normalising sentiment in the futures market. Sentiment was very bearish by the end of last year as indi-cated by record-high speculative short positions. Specula-tors were betting heavily on a further decline in gold pric-es, based on expectations of multiple interest rate hikes in the United States and a stronger dollar. These expecta-tions proved to be too optimistic in the meantime as the growth backdrop is deteriorating, interest rates are falling and the US dollar is weakening. Consequently, the specu-lators started closing their short positions.

 

However, there is more to gold’s recovery than normalis-ing sentiment in the futures market. Safe-haven seekers are back in the physical market. Holdings of physically backed products are up by more than 130 tonnes since the start of the year, recording twenty-two consecutive days of inflows. This is the longest streak of inflows in more than five-and-a-half years. Renewed physical demand for gold puts today’s recovery on a more solid footing, in con-trast to the primarily sentiment-driven recoveries seen multiple times over the past couple of years which eventu-ally reversed.

The end of the multi-year downtrend 

Against the backdrop of rising risk aversion and mounting global growth concerns, a medium to longer-term bearish view on gold is not justified anymore. Gold’s multi-year downtrend, which was driven by fading safe-haven de-mand amid expectations of sound global growth, higher interest rates and muted inflation, has most likely come to an end as two of the three factors have reversed. 

 

A bearish view on gold is not justified anymore. 

 

Consequently, we have turned neutral on gold earlier this week and recommend that investors use it as insurance in their portfolios. Should the global economy run into crisis – which is still not our base case scenario although the likelihood is increasing – we see more upside for prices from today’s levels.

 

As during the financial crisis, gold could come under pressure initially, pushed down by a stronger US dollar and forced selling. Subsequently, we would expect a sizeable pick-up in safe-haven demand from investors who are seeking protection from elevated equity-market volatility, lending lasting support to prices. Prices would likely rise another 12% to 15% from today’s levels if inflows into physically backed products reached 450 to 500 tonnes, which would be similar to 2009 and 2010. 

Should our base case scenario materialise and a crisis be averted, we believe gold prices should fall back towards USD 1,100 per ounce on a twelve-month horizon. Howev-er, as the fears of a crisis would fade only slowly, the de-cline would be gradual, allowing investors to sell the insur-ance without major losses. 

 

 

Silver is not a safe haven 

Moving in gold’s slipstream, silver has recovered from the multi-year lows reached last December. Prices are up to more than USD 15.5 per ounce, primarily driven by short-covering in the futures market but lacking support from the physical market. 

Holdings of physically backed silver products are down more than 200 tonnes this year, most likely reflecting in-vestors’ concerns over the global growth backdrop and thus industrial silver demand. Industrial demand accounts for more than half of total demand. China and the United States are the world’s biggest industrial silver consumers and thus a hard landing in China and/or a recession in the United States would cause major headwinds to the silver market. 

 

Silver’s close relationship with gold breaks down in times of risk aversion. 

For the past couple of years, silver has been taking its cues primarily from gold given that both metals were heavily dependent on investment demand. However, our analysis shows that the close relationship between the two metals breaks down in times of financial market risk aversion. Gold underpins its status as a safe haven while silver suf-fers due to its industrial applications. Looking back at the worst sell-offs of the S&P 500 index, we find that gold prices rose by 4% on average while silver prices lost 10% on average. 

Silver does not share gold’s safe-haven characteristics and thus should not be used to insure the portfolio in times of rising risk aversion and mounting global growth concerns.

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