Gold has had a pretty good year so far. We have no pretense on where the value of gold per ounce at will be either by year end or next year. While analyst like to compress valuation to a single number i.e buy price targets, Investment is not an exact science.
We have made a number of predictions so far. Some can be considered early such as our Sydney property forecast of a slowdown which is yet to materialize. Some of our equity exposure in LNG has not panned well as we would like. However in the FX space, we have made a good call on our bullish AUD prediction on the back recovery in commodity prices like iron ore.
Gold Price Chart
We know based on historical relationships that the primary predictive value driver of gold is the US exchange rate and market sentiment on volatility. The gold price has historically negative correlation with the US dollar. A rise in US interest rates which pushes up demand for dollar has been bearish for gold and vice versa as US rates fall. As well as during periods where markets are volatile, gold becomes a safe heaven.
The current uncertain market environment is positive for our gold forecast. The result of UK leaving in the Eurozone made a large impact on the Sterling Pound, causing its largest one day loss since floating. Gold jumped where it reached highs of the year as global equity markets absorbed the result. It is the best example that it can be useful in periods where there are large increases in volatility.
The solid performance of gold and silver year to date can be also seen due to slower than expected rate of rate increases in the US interest rate by the Fed. We don’t think the performance will be repeated going forward and momentum will be slowed into the second half of the year.
While the Fed might not raise rates faster than many expect for the rest of the year. It is inevitable that the Fed funds rate has made a cyclical bottom and the trend is going up.
Higher rates will be bearish for precious metals.
Our prediction of gold price is that it will be lower than where it is today with an important caveat that there are no material slowdown in US economic growth or continue political risk from Europe.
One hedge in our gold forecast is that Gold price AUD terms could actually increase. Although we see the Australian dollar to appreciate against the US dollar in the medium term, it would erode portion of the gold return as the commodity is usually quote and priced in US dollars. Hence even you think the gold price trends up over time, it must rise faster than AUDUSD appreciation.
Silver Price Forecast
Silver like to be referred to as gold’s poor cousin or poor mans gold had its one of its best runs recently. The current silver price trend is following the weakness in US dollar. This can be seen primarily driven by the collapse in the US treasury yields. We think the price of silver will track gold but with more volatility. Like gold, it is still significantly off the peak reached in 2010/2011.
Gold to Silver Ratio
We know that gold and silver are two of the oldest currencies in the world. In exchange rates, the value of each currency is relative to another. Just like EUR/USD is value of EUR to USD or JPY/USD shows the value of yen to dollars.
Chart above shows the value of silver relative to gold. It is commonly known as the Gold to Silver ratio. It essentially shows how much 1 ounce of gold can buy 1 ounce of silver.
For example if the ratio is 80 it means that gold is worth 80 times more than silver. This relationship changes overtime as market prices of the precious metal moves over time.
When the ratio is out of synch with its historical trend. Spread trades can be used to target a mean reversion level and can be attractive as returns are uncorrelated with the market. However the relationship changes overtime can be slow so this will take time to play out.