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Gold may hit fresh highs for this year over the coming weeks

Following the ECB press conference and the weaker-than-expected US employment data, gold prices have been propelled through the $1700/oz mark to test levels last seen in February.
Following the ECB press conference and the weaker-than-expected US employment data, gold prices have been propelled through the $1700/oz mark to test levels last seen in February.

It is expect that the Fed to ease further at this week’s FOMC meeting, providing gold the catalyst it requires to test fresh highs for this year over the coming weeks. The growth in investment demand over the past sessions has been sufficient to offset the persistent weakness in the physical market. Physically backed ETPs have set yet another record while speculative positioning has risen to a six-month high.

Economists note while the recent data have been mixed, they think the FOMC will take a glass half-empty view. They note that Fed Chairman Ben Bernanke made clear in his speech at Jackson Hole that he is growing impatient with the pace of the labour market recovery, and this was also the message of the August FOMC minutes.

They also believe that the lack of labour market firming in Q3 12 will lead the Fed to launch QE3 this week and an open-ended program of purchases of Treasuries and agency MBS is likely, with the Fed announcing a flow rate of asset purchases on a monthly or quarterly basis but not putting an overall ceiling on the programme.

If the FOMC does announce an overall purchase amount, our economists would expect it to be in the $500bn range, evenly split between Treasuries and agency MBS. In addition, the FOMC will extend its low-rate guidance into late 2015 from late 2014.

In turn, this would create the gold positive backdrop prices have responded to this year, but how much further can prices run? Gold gained around a third during the first round of quantitative easing, and just over 10% during the second round. Given that our economists expect the third round to be of a similar magnitude to QE2 and that prices have already gained 5% since the Jackson Hole speech, additional gains could extend to $1800/oz before encountering profit-taking.

The August US employment report was weaker than expected. Payrolls increased 96k, below our economists’ and consensus forecasts. This pace of job growth is not fast enough to push the unemployment rate down over time.

The final US Markit PMI printed 51.5, which was below the consensus and flash estimates of 51.9. The ISM manufacturing index fell slightly, to 49.6 in August after a print of 49.8 in July, which was above our economists’ forecast but below the consensus. The US non-manufacturing ISM surprised to the upside in August, rising to 53.7 after a July print of 52.6.

In Europe, following the announcement of no change in official interest rates, our economist note that the ECB press conference, in their view, emphasises the determination of the Governing Council to use potentially large bond market purchases to have a substantial effect on compressing yield spreads.

As ECB President Draghi observed, the ball is now firmly in the court of the governments. Our economists would expect Spain to have successfully applied for a precautionary programme from the Eurogroup (which is likely to entail primary market interventions by the EFSF/ESM) by the next EU summit (18-19 October), which, in turn, should open the way for the ECB’s new “Outright Monetary Transactions” (OMT) purchase programme to begin.

In China, the headline NBS August PMI fell to a nine-month low of 49.2, from 50.1 in July, similar to the flash HSBC PMI, which also dropped to a nine-month low of 47.9. China will release August economic data, starting from this weekend, the outturns of which will be important to gauge the near-term direction of the economy.

Overall, our economists expect weaker or stable prints in production, investment and consumption, and continued soft trade growth and now expect “growth stabilisation” and see downside risk to their 7.9% full-year growth forecast for 2012 and 8.4% for 2013.

ETP flows have remained positive at the start of September, up 7 tonnes thus far, following the strongest month so far this year with inflows of 65 tonnes in August (provisional estimate $3.5bn). Total metal held in trust has set yet another record high at 2497 tonnes, surpassing the March peak by over 50 tonnes. It bodes well that the recent rally in prices has been accompanied by an increase in longer term “sticky” demand, as well as speculative interest.

The latest weekly CFTC data unsurprisingly revealed continued growth in speculative positions and notably the increase in non-commercial positions was again driven by fresh longs. Net fund length has reached a six-month high but the reported data for week ended 4 September do not cover the run up before the release of the US non-farm payrolls data. Gross long positions are also at a six-month high but gross shorts are only at their lowest since May. Short positions are at a similar level to when QE1 was implemented while gross longs were at almost half, in contrast, gross longs (around 40% higher) and gross shorts (almost double) were higher when QE2 was implemented. Relatively open interest has room to grow.

Following an improvement in gold coin sales as reported by the US Mint, sales have kicked off September on a positive note at 10.5koz thus far.

Even as rainfall continues to pick up, with cumulative rainfall during 1 June-29 August now 12% below normal, demand in India remains fragile in the midst of the seasonally strong period for consumption, as prices hit fresh highs after a brief respite with local dealers hoping for a price correction. Instead, scrap flows have picked up in Singapore, Thailand and Indonesia and is higher than normal in India.

Gold bar premiums in Singapore have fallen to 25 cents/oz while the discount offered on scrap ranged between $1.20-2.30/oz in Singapore and widened to $1/oz in Tokyo. Interestingly, buying activity has picked up in China with volumes rising on the Shanghai Gold Exchange even as the price has risen.

The illegal strike at Gold Fields at KDC East operations by 12,000 employees was resolved last Wednesday 5 September with miners returning to work on the night shift of the same day. The strike lasted a week, having commenced on 29 August. Although lost production has not been quantified, the company produced 825koz of gold in H1 12 in South Africa and has gold production guidance of 3.5-3.7Moz for the full year for the company. However, concerns remain that union rivalry in South Africa could spread to the wider mining sector.

The GFMS Gold Survey Update 1 released last week provided H1 12 estimates and projections for H2 12. The survey highlighted that a pick up in official sector buying had, in part, offset the weakness across investment and jewellery appetite while in H2 12 they expect an investor-led rally to send prices to $1800/oz before year-end to trade above $2000/oz in H1 13 before commencing a secular decline.

In terms of supply and demand dynamics, GFMS expect overall supply to grow by 0.9% y/y and 11% h/h and jewellery demand to improve by 5.4% y/y and 2.1% h/h in H2 12 with the bulk of the recovery on the demand side stemming from investor interest.