Gold May Not Sustain Q1 Gains

The first quarter of 2016 was a bright one for gold, with prices surging by just under 20 per cent and even briefly crossing a new 13-month high at $1282.51, before declining below $1,250 per oz levels in early April. The quarterly rise was one of the largest in over a decade, and driven mostly by the type of turbulence and unexpected shocks that have characterised the global economy in recent times.

Economic uncertainties were quite marked in Q1 2016 with currency fluctuations and upheavals in equity markets leading to a reduction in risk appetite among investors. Gold, well known for its safe haven property, was the gainer.

Demand for the yellow metal has also been boosted by the lack of clarity on the next US Fed rate hike. Expectations were high that the Feds would announce a further move towards rate rationalisation, but the hike has been delayed by weaker than expected economic data. Yet there are clear indications that the US authorities will persist with a tightening of monetary policy during this year. When concrete measures are actually taken, it will definitely act as a dampener on gold prices.

Analysts at GFMS, in their recently released report Gold Survey 2016 pointed out that the strong start to 2016 comes in the wake of three consecutive years of annual price declines. However, they added that the price of the yellow metal is likely to retreat again once the current market turbulence eases.

The report suggests that while it is likely that the prices will drop below the threshold of $1,200 per oz in the coming months, the metal is also likely to find support at those levels due to improved market fundamentals.
Thus, while physical demand in key Asian markets remains weak, there is a strong likelihood that it will improve later in 2016, with pent up demand for investment grade jewellery being one of the key drivers. On the other hand, the GFMS report posits that global mine production will be down in 2016, the first fall since 2008, leading to reduction in supply.

This means that the physical surplus is expected to narrow during the year, providing support to prices and laying a stronger foundation for the longer term. At the same time, the analysts caution that gold prices remain highly reliant on sentiment-driven factors, at least in the short run.

India has already experienced this first hand during the months of February and March. Bullion imports have dipped sharply, falling by 34 per cent in February and by a massive 80 per cent in March. Imports in the last month of FY16 were just 18 tonnes as compared to 125 tonnes in the same month last year, and in value terms were a mere $973 million as compared to $4.98 billion last year.

Ironically, the decline was driven by two widely differing factors in each of the months. In February, purchases were deferred on expectation that the Budget would see a reduction in import duties that currently stand at 10 per cent. In contrast, the March slump was a result of virtually no purchases taking place due to the prolonged strike by jewellers against the 1 per cent excise duty announced in the Budget.

As a result of these declines, India's gold imports in FY16 have dropped by about 15 per cent from last year to 926 tonnes. Yet India still remains the largest consumer of gold worldwide, given that China, its closest competitor has seen an even greater contraction in demand.

The positive side for the economy is that the fall in gold imports, coupled with the major dip in oil prices has helped narrow the trade deficit to five-year low of $5.07 billion, with a consequent reduction in the CAD.
But, things could quickly turn the other way. Oil prices could begin to firm up with OPEC negotiating for a production freeze or cap. Any dip in gold prices to near $1,200 levels or below likely to trigger a spurt in gold buying, especially if it takes place in the run up to India’s second biggest gold buying occasion, Akshaya Tritiya, now just a few weeks away. With short term factors playing such an important role in a sentiment driven market, volatility will continue to be a dominant feature of gold prices.