What’s your outlook for commodities?
We think that economic growth should remain strong this year for the major regions such as the US, the emerging markets and the more robust European core countries such as Germany (we estimate global GDP growth for 2011 to be 3.9%). This has been well supported by the recent better-than-expected economic indicators in the US and Europe, which have strengthened investors’ confidence. Together with the accommodative monetary policies from the developed markets and the continued strong economic growth across emerging markets, this argues for a constructive view for commodities in 2011.
Within the precious metals space, we think that silver and palladium could potentially outperform gold given their higher market beta relative to gold. It appears to us that there seems to be limited upside potential for the gold price this year, given the more positive outlook for the global economy and as investors start to shift towards more risky assets. On the other hand, gold is still a good shock absorber as the global recovery is still fragile.
What are some of the other precious metals you think could fare well this year?
Silver has appreciated considerably in recent months as expectations of a global recovery turned positive following better economic data flow. With more robust economic growth, not only do riskier assets outperform, but the industrial component of demand preferentially benefits silver. Silver-based products are incorporated in a broad range of product lines like clothing, refrigerators, mobile phones, computers, washing machines, vacuum cleaners and keyboards. In addition, China has moved from a net exporter of silver to net importer. This is likely due to the rising industrial consumption and the emergence of retail investment demand since mid-2009. The price of silver appreciated by more than 80% in 2010. The metal should continue to fare well this year as the global economic recovery progresses broadly. However, a downside risk for silver is its high sensitivity to swings in the economic cycle, as industrial demand takes up a significant portion of silver’s overall usage.
We also carry a positive view for palladium. Demand for petrol-based vehicles is likely to continue to recover in 2011 in correlation with economic growth. This is especially so in the emerging markets where vehicles sales are likely to stay robust given the strong economic growth and rising domestic consumption, which will in turn support the palladium market. The largest use of palladium today is in catalytic converters, a necessary component of vehicles. Catalytic converters convert up to 90% of harmful gases from auto exhaust into less harmful substances -- for example, carbon monoxide into carbon dioxide. Palladium is also used in jewelry, dentistry, watch making, aircraft spark plugs, surgical instruments and electronics. The price of palladium appreciated by more than 90% in 2010, with most of the price appreciation happening in the second half of the year. However, higher price volatility could be expected from palladium relative to gold, given its higher market beta. Similar to silver, the downside risk for palladium is also its high sensitivity to swings in the economic cycle.
How do you expect gold to perform this year?
The price of gold seems to have met some resistance around $1,400/oz. Gold will likely have a difficult time breaking the psychological resistance around this level without another significant crisis event. On the other hand, in an environment of heightened macro-economic uncertainty, risks for a huge price setback seem low as well. Risk-averse investors should continue to hold gold as an instrument to diversify their portfolio positions. Gold is used as a hedge instrument in the current environment with a fragile state of the economic recovery, rising public debt and an accommodative monetary policy stance. Our three-month and 12-month price forecasts for gold are $1,400/oz and $1,420/oz respectively.
However, we are likely to adjust these forecasts if central banks in the developed world keep interest rates low for longer than currently expected, thereby favouring gold in a low real interest rate environment. Moreover, central banks may increase gold buying and/or risk aversion might strike back more strongly than expected, both of which would support gold prices and require forecast adjustments.
At what price would you consider gold to have entered "bubble" levels?
The current gold price rally is now entering its 11th year versus its historical average of four years, representing the most durable gold rally in history. Not surprisingly, a market discussion has turned to the dangers that a bubble is forming. At first glance, these concerns seem justified if one considers the gold price rally in terms of duration and magnitude. However, looking at history, this is not the most powerful gold price rally in percentage terms on record. To be on par with the 720% rally between 1976 to 1980, the gold price would need to hit $2,100/oz. (As of January 28, the gold price was $1,313). We estimate that gold prices would need to reach $1,455/oz to represent an all-time high in real terms on a producer price index-adjusted basis and surpass $2,000/oz to resemble a potential bubble.
