Russel Chesler is an investment director with Market Vectors Australia. He wrote this article for Morningstar Australia.
The gold price has been volatile in 2014. After rising steeply in the first quarter of 2014, it fell to 18-week lows during the last week of May. However, the price is still well above the US$1,200 level at which it began the year.
There are several factors that could help King Midas maintain his golden touch for the remainder of 2014. Certainly, if you hold gold shares or gold exchange-traded funds (ETFs,) you're likely to be in for a better ride this year than in 2013.
The key dynamics supporting further gains in the gold price in 2014 come from three dominant factors.
1) Geopolitical risk
Geopolitical risks in emerging markets have probably been the main driver of gold prices this year. People are worried about financial stability in Thailand, Venezuela, Ukraine, and Turkey. Investors' fears of political unrest and concerns about a contraction in these economies have seen capital flow out.
With no resolution in sight for many of these countries, we think these geopolitical risks will continue to underpin the gold price throughout the year.
Elsewhere, people are still concerned about economic growth in China and its banking system. China is a major global preoccupation. Given surging debt in that country, concerns run deep about a possible correction in the world's most populous economy. After clocking double-digit growth rates on average over the last three decades, China's economy has slowed as the government repositions activity to rely more on domestic demand. Despite those efforts, China's first-quarter annualised growth rate of 7.4% was the lowest level in 18 months.
Any further unexpected signs of a slowdown in China are likely to knock confidence in global markets, which would give a boost to the gold price.
Another positive sign for gold is a recovery in demand in India. In the second half of 2013, gold demand dropped off significantly because of exchange controls and import restrictions that were placed on the Indian gold market.
There are still talks this year about India reversing or relaxing many of those controls. If so, that would be another big catalyst that could shift gold prices higher later in the year.
As for gold demand in China, in an April 2014 report, the World Gold Council predicts it will remain flat in 2014. While some analysts have put a negative spin on this, we see it as positive for gold.
Last year saw unprecedented demand as the Chinese stepped in to take advantage of the collapse in gold prices. Demand that approaches similar levels this year would still be very supportive of gold. The Gold Council estimates that Chinese demand will rise about 25% in the next four years, which will be another significant factor supporting its price.
2) Merger and Acquisition (M&A) activity
In terms of M&A activity, some interesting activity occurred during April that caused us to take a more positive outlook on gold stocks. An example was the takeover battle for Canada's Osisko Mining.
While Goldcorp was not successful in its hostile takeover bid, Agnico and Yamana entered a friendly agreement to acquire 100 per cent of Osisko's shares. So, there is M&A activity well and truly happening in Canada.
Such activity is on the radar for gold miners around the globe, including those in Australia, especially at the current low price levels for some gold miners. Assets are the cheapest they have been in years and bigger gold miners will be considering their options.
In other markets, gold bullion ETFs have seen inflows this year. This comes after some relentless outflows during 2013 that helped drive the price of gold down. These inflows show us that investment demand is returning to gold.
3) Lingering concerns about developed economies, where running huge deficits has become a defining characteristic
Turning to the US economy, risks remain. Gold also did not react to the US GDP numbers that showed annualised growth of just 0.1% in the first quarter. We believe this is evidence that US Federal Reserve policies have not worked.
The current US recovery is now longer than the average for post-World War II recoveries globally, yet growth has been half the average and unemployment has never been higher at this stage of past recoveries.
Monetary stimulus and low interest rates have benefitted big banks, indebted governments and those who hold equities at the expense of savers and small businesses in need of capital.
The withdrawal of US Fed stimulus puts those who have benefitted at risk, potentially creating further pressure on a weak US economy along with financial risks that could benefit gold.
In summary, there is a range of factors that could support further increases in the gold price in 2014. While not everything King Midas touches will turn to gold, he still could have his magic touch.
