Risk appetite, safe haven demand and the prospects for QE3 are key factors for precious metals...
BNP PARIBAS analyst Anne-Laure Tremblay has been with the firm for over five years. She covers commodity derivatives forecasts for gold, silver, palladium and platinum and contributes to the Metals chapter of BNP Paribas's Global Outlook publication. Hard Assets Investor caught up with Tremblay in BNP Paribas' London office recently to discuss the latest developments in the gold market.
Hard Assets Investor: After falling off the radar for a short while, it looks like Eurozone fears are back as a driver of financial markets. Spanish yields spiked to a record high of 7.75 percent this week. What impact will this have on gold?
Anne-Laure Tremblay: Gold tends to be seen as a safe haven, which means that it tends to react less to bad news. Gold does not go up when there is extreme risk-aversion as the events of the past few months have shown. But it goes down by less than other commodities, for example, when there is an episode like we're seeing at the moment, where people are worried about countries in the Eurozone defaulting. Any aggravation of the risk-aversion linked to the Eurozone crisis would probably drive gold lower, but less so than any other commodity.
On the other hand, risk-aversion episodes would probably force central banks to intervene by increasing the amount of liquidity in the markets. This consequence of an episode of extreme risk aversion would be beneficial for Gold Prices.
If we get QE3 or the ECB decides to relaunch LTRO [long term refinancing operation], then there would be a positive effect in gold.
HAI: You recently said that you see the Fed announcing QE3 as soon as next month. Why do you think the central bank will act now, and what will it do for gold?
Anne-Laure Tremblay: The outlook for the US economy will warrant an intervention. The Federal Reserve has been very clear that it is currently closely monitoring the job market in particular. We expect the job market to be sufficiently weak for the Fed to intervene at the end of August.
The intervention of the Fed through a third round of quantitative easing (QE3) would be positive for gold. It is worth looking at what happened in the previous two rounds. Each time, gold was a strong beneficiary of additional liquidity. There are two reasons for this—a rise in inflation expectations and weakness in the US Dollar—both of which tend to be positive for gold.
HAI: How high do you think prices for gold can rally on the back of QE3?
Anne-Laure Tremblay: We forecast that gold will average $1800 in the fourth quarter of this year. We then see prices continuing to rise into 2013, as the effects of QE3 and additional monetary accommodation, whether in the US or other countries, continue to have a positive effect on gold. We then see gold peaking in the second half of 2013, if markets stop anticipating further monetary accommodation. This is in turn dependent on an improvement in the economic outlook.
We wouldn't be surprised if gold were to reach above $1900, possibly touching $2000 next year before it ends its rally for good.
HAI: Let's move on to silver. It's had a great run-up to nearly $50 Dollars last year. But since then, it's fallen and seems to be struggling. What do you see as the next big catalyst for silver?
Anne-Laure Tremblay: There tends to be two drivers for silver. The first one is gold and the second one is risk appetite. Silver will follow gold in terms of direction 90 or 95 percent of the time. But it tends to underperform or outperform gold depending on the level of risk appetite.
The last round of quantitative easing was concomitant with a rise in risk appetite. Thus, we saw silver outperforming gold. In the first round of quantitative easing, it wasn't as clear, but overall, we saw the gold-silver ratio go down, which meant that the silver outperformed gold.
In that context, and taking our assumptions for QE3 to be launched at the end of August, we expect silver to outperform gold in the last few months of 2012. Beyond that, in the beginning of 2013, we'll see the continuing effects of QE3 and we expect silver to perform well. When these effects wane, and markets start to price in the end of monetary accommodation around the world, then silver will be particularly vulnerable to a strong sell-off.
HAI: Ahead of that sell-off, do you think silver can potentially move back to its record high or toward that area?
Anne-Laure Tremblay: We don't have a forecast for silver to move back to $50/ounce or close to it. While silver benefited from QE2 and moved significantly higher, what we saw at the end of the rally was a bubble rather than any fundamentally based rise in the price. We don't expect another bubble to form in silver, as a lot of investors lost money last year on that investment. We do have a strong positive forecast for silver, but we don't expect it to go back to its 2011 high.
HAI: You mentioned the gold-silver ratio. Is that ratio useful as a forecasting tool?
Anne-Laure Tremblay: Yes it is. Silver is driven primarily by two things: gold, and risk appetite. In part, I derive my silver forecast from the gold-silver ratio. That gold-silver ratio is determined by the level of risk appetite that I assume for the next months.
HAI: Do you have a range that you like to look at in terms of what that ratio is?
Anne-Laure Tremblay: It's more in terms of direction of the ratio. For example, at the moment, it's around 58. If there's an extreme episode of risk aversion, it could go back to its highs. For it to go back above 80, which it briefly did at the end of 2008, we would have to have a widespread contagion of risk like we had with the Lehman Brothers bankruptcy. But barring that, we don't see it moving much above 65 or 70.
Conversely, the ratio went to almost 30 at the beginning of 2011. Well we don't see that coming back either because that was linked to a bubble. Even in the context of very high risk appetite, it's unlikely it would move much below 40.
HAI: What do you see as the most significant drivers of gold and silver in the short long term?
Anne-Laure Tremblay: In the short term, the main factor to watch is QE3 in the US. In that regard, the nonfarm payrolls at the beginning of August will be something that will be closely watched by the market to assess the probability of a further round of quantitative easing.
HAI: You touched on it a bit, but is it your view that the gold bull market is going to end next year after prices peak above $2,000?
Anne-Laure Tremblay: That's very much linked to monetary policy because we believe that monetary policy is the biggest driver of Gold Prices. Our assumption at the moment is that the markets will start to price in the end of accommodative measures by central banks sometime next year. It's very difficult to pinpoint when exactly that will happen, because it ultimately depends on how the economy is doing. But our current forecast is for that to happen sometime during the second half of 2013.
That doesn't mean there will be a tightening of monetary policy, it just means that markets will start to price in a future tightening of monetary policy in the US, which could happen in 2014 or even later. And once this happens, unless we have a spike in inflation, which at the moment is not in our forecast, we believe that the other factors won't be sufficiently strong to warrant a continued rally in the Gold Price.
HAI: Looking at beyond five years from now, say, when interest rates perhaps do begin to rise, will we see a more significant correction in gold and silver?
Anne-Laure Tremblay: In silver, definitely, because silver has less of a safe-haven component than gold has. But there are long-term actors in the gold market that will continue to be present in the gold market. Those include central banks, emerging markets— including India and China—which invest in gold for other reasons than short-term performance of the metal, as well as people in Europe who want to have some of their investments in physical gold.
These pockets of consumers will stay in the gold markets and will provide a floor for Gold Prices. But this floor is not necessarily $1,500. You have to remember that it was not so long ago that gold was under $1,000/ounce. The potential for a decline in the Gold Prices is quite significant, but we don't believe it will go back to $200 or $300/ounce like it was at the beginning of the gold rally.
HAI: How far can silver fall?
Anne-Laure Tremblay: Silver is much more vulnerable than gold to a decline. It's much more volatile and it's not being supported by any supply-side story. The production costs for silver are very low. Even if it were to fall to $10 an ounce, it's unlikely we would see a contraction of silver supply sufficient enough to warrant higher prices.
HAI: Would it be fair to say you think we're in the closing stages of the bull market in gold and silver?
Anne-Laure Tremblay: If you take a 12-year view, we are definitely in the last stages of the gold and silver market rallies. But that is dependent on our view of monetary policy. If that story changes, then our outlook for gold changes as well.
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