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Gold Correction In Sight?

Updated: Mar 30

| March 03, 18:10 GMT | By Sania Akhtar



Throughout the 2020 year the world was subject to the Covid-19 pandemic and thus the uncertainty within the global financial economies had risen. Investors made the smart choice in investing into the biggest safe haven commodity in the world which is gold (XAU). In this period, we saw the price of Gold consistently rise from $1450 all the way to just above $2000 which was a staggering 42.92% gain in the valuation.

This strong growth in global investment demand for gold was to offset weakness elsewhere as COVID-19 remained in the driving seat.


Whilst with other commodities such as Coffee, Sugar and Cocoa there are economic indicators that will allow us to gauge the upcoming performance. With Gold the only indictors that apply would be strictly Supply, Demand and Investor Sentiment. This is because Gold is used mostly to hedge against any uncertainty within the other asset classes out there, especially in the currencies.


Another factor we must consider is inflation and this is the driving and most prominent factor that affects the valuation. Gold is seen as a desirable element in an investment portfolio. Gold will hold its value even during inflation. If inflation is very high, then money can soon lose all its value. Therefore, in periods of high inflation, people will seek to switch out of cash and into physical assets which retain their value. The most important inflation-proof investment is seen as gold. Thus, evaluating strongly correlated economies (such as USD and AUD) to gold will also provide us with a good insight on the forecast of the commodity.





Supply


The price of gold is dictated by the market forces of demand and supply. Though supply is not the driving force rather the demand for gold across the world. The reason being is that the main part of the gold supply is accounted for by mine production, usually 75% a year. Almost all the gold ever mined is still around and more gold is being mined each day. Which does not seem likely to drop anytime soon as there will always be a supply of gold. This commodity is not consumed and though the supply Is finite the circulation of gold within the world will remain constant.



This is indicating the slow gradual and consistent supply flow of gold within the world consistently averaging an increase from 2016.


Demand


This comes in various forms and thus we will look at each relevant micro factor that affect the demand of XAU.

The top economy that consumes gold on a YoY basis is India. Markets like India have a strong demand for using gold in jewellery, demanding a staggering 136.6 Tonne per year as of 2019. If Economic growth in India increases, then disposable income and therefore demand for gold. As gold is a luxury good, then a rise in income in India could lead to a bigger % demand for gold.


China is a close second when it comes to global gold jewelry consumption. Jewelry-related gold demand for China fell 9.7% year-over-year 2019-2020. A decline in consumer spending has led to a pullback in gold jewelry consumption in China. This was once again due to the corona virus pandemic.




Indicating the sharp decline in demand for gold due to the pandemic.


However, China had one of the best recovery rates in the world alongside Australia and New Zealand, thus we can expect consumption to pick and increase the demand for gold once again. From the chart we can see that the average figure is around 800 and 2019 -2020 only saw a 50% drop from 1000 to 572, we can assume that the demand factor for gold revolves more around the market sentiment rather than just the jewelry consumption alone.

Economic and Fiscal Sentiment


The value of gold is indirectly correlated to the value of the US dollar. This means If the dollar is predicted to fall because of inflation or debt fears, investors may seek for other safe haven currencies such as CHF and JPY. However, in times of economic stagnation or more relatively the pandemic, currencies are not as attractive to investors, especially given the impact the virus had on JPY. Therefore, as an alternative to investing in a currency, investors may buy gold. Hence the inverse correlation.


Furthermore, during the pandemic most, if not all governments implemented Quantitative Easing as a form of expansionary fiscal policy, as it happens, quantitative easing has not caused worrying inflation, the increase in bank reserves have largely been saved. But, if large economies like the US engage in excess quantitative easing then investors are more likely to favour gold as it gives greater security in times of uncertain monetary policy.


Moreover, from our macro understanding we can evaluate the stability USD. The Federal Reserve has accrued 6 trillion USD over the past two years as debt, reflecting the economy's longer-term problems. In addition, the potential US GDP scenarios are based on the factors highlighted in the related section. With interest rates expected to remain at 0.25 percent and inflation rising slowly, if the labour market continues to underperform, we could see some issues as spending for the economy would not be at the desired levels.

Recently, Jerome Powell took another dovish position on the USD, so we can determine from these variables that Gold grow after a likely corrective process.


Technical Breakdown Forecast

From a technical standpoint we can draw out our forecast on what the future of Gold holds, before implementing the macroeconomic factors discussed above.

When XAUUSD peaked at the 1800 level in 2011 we saw a 33% correction down to the 1200 region which has been identified as our fair value level. With the recent move that peaked just above 2000 we can see gold has started a short-term correction and is currently trading at 1732. Factoring the 33% correction and the rising in the treasury yields we can expect a further correction to just above our fair value point before the move up carries on.

Given the state of the US economy though the economy has somewhat stabilised, the dovish stance that was adopted by Jerome Powell indicates that the value of the Dollar may see further downside risk. Factoring that which increased consumer consumption of China due to the pandemic recovery, as well as reports that US yields upwards movement will be short lived, we can see gold potentially breaking the 2000 level and work its way upwards to the 3000 long term value. With much uncertainty surround the JPY still we may see investors choose gold as the best asset to invest in.


The fair value point including the 33% correction might seem far fetched at 1400, I personally believe the correction will last to a much healthier region at 1600 which is the next longer-term support before making the move up, which is just another scenario we can look to react to.