Six Reasons Why Gold Prices are Rising, But Gains Could Now be Over

The negative rate environment is having unintended consequences, one of which is the ressurection of gold as a safe-haven.

Gold is on the rise, prices have rallied sharply from lows in the 1040s in December 2015 to current prices in the 1230s - a rise of nearly 20%.

The rally appears to have paused having reached a one year high at 1284 prompting us to question whether the 'gold bug' is dying.

We ask the question as to whether gold can extend further, and the answer is a complex one based on a variety of drivers.

Analysts at HSBC have helped us out by providing six pointers into what might be driving the increased demand for gold:

1. Investors seek the safe-harbour of gold when risk aversion is running high.

The general uncertainty which goes with negative rates, the fear of the spiral of deflation, in itself is cause to expect an increase in demand for the metal. HSBC further add that the fact that certain central banks (the ECB aside) have not indicated a bottom-limit to negative rates, feeds speculation of even deeper cuts, leading to greater flows into gold:

“In particular, there is no sense yet that negative rates could not be cut even further. For example, Haruhiko Kuroda, the governor of the Bank of Japan, said that there is no limit to measures to ease monetary policy. The Riksbank surprised the market on 11 February with a 15bp cut, taking rates into more negative territory. Such rhetoric and action continue to feed the demand for gold.”

2. “Risk aversion” is now in the “market psyche”, according to HSBC, and as a backdrop it continues to drip-feed demand for gold. In addition, the bank says the flattening US yield curve presages the possibility of an economic slow-down, as it has not been so flat since 2008, during the early stages of the financial crisis, when gold was at the start of its bull-market.

“The difference between the 2 and 10-year Treasury yields is now less than 100 basis points. The spread has not been this narrow since January 2008. A flattening yield curve often presages an economic slowdown, which may trigger policy responses that generally support gold.”

3. Negative interest rates remove the ‘opportunity cost’ of owning gold, which is the cost of owning an investment compared to owning risk-free government bonds.

4. One of the goals of negative interest rates is to penalise savers and encourage them to withdraw their money and spend it in the real economy. This effectively means moving to cash. In such a climate gold becomes a very appealing alternative.

5. In previous periods of risk aversion gold did not perform as well as it is now. HSBC speculates this is because the dollar rose during those risk-off periods because investors preferred U.S bonds, however, this time around bonds have been passed over because of their unappealing yield potential, and gold has once again regained its previous preeminent position in the pantheon of safe-havens. As HSBC conclude: “This has important ramifications for gold going forward.”

6. Gold is an “intervention free” currency. This means that there is no risk to investors of a central bank intervening to devalue it, which there might be, for example, if the investors kept their assets in CHF or JPY. HSBC point out that there is now a heightened risk of central banks trying ever harder stimulus methods, including direct intervention to devalue their currencies as the impact of negative rates proves inadequate (in the case of EUR, JPY and CHF).

Standard Chartered: Longer-Term Gains to be Capped

Can the gains in gold prices continue?

Analysts at Standard Chartered say the near-term could see further gains, but further out they are sceptical on gold's prospects.

The problem for gold bulls is inflation expectations continue to fall.

"In our opinion, real interest rates are not expected to decline significantly from current levels, given our expectations for one Fed rate hike this year. Hence, we would not expect gold to move higher significantly from current levels, although it is likely to outperform industrial metals," say Standard Chartered in their latest Global Market Outlook note to clients.