What next for gold after Brexit?

Gold prices surprised investors with a sharp rally on Friday (up 4.7 per cent at close), hitting a high of $1,358.5/ounce. Prices finally ended at $1,315/ounce, up 1.3 per cent for the week.

Demand for the yellow metal in the spot market in London has been surging through the week, say reports.

The Royal Mint was reported saying that the number of visitors on its bullion trading platform had surged by over 500 per cent since Thursday, while new account openings had trebled.

Holdings of SPDR Gold Trust, the largest gold-backed exchange traded fund, ended at 934.3 tonnes on Friday, higher by 18.4 tonnes over Thursday.

The fund’s holdings have gone up by over 65 tonnes in the last one month. The mad rush to buy gold can be explained by investors’ aversion to risky assets, including equities and commodities such as oil. In times of global uncertainties, gold is viewed as a safe asset just like the US dollar.

When the UK exited the European Exchange Rate Mechanism on September 16, 1992, sterling fell sharply against the dollar. It dropped about 15 cents in a week (or 8 per cent) and gold prices rallied on safe haven demand. The yellow metal rallied to $352.50/ounce by the first week of October from $347.50 on September 15. But then, by November, gold prices crashed to $332/ounce.

This time, it may be different, as the Brexit has larger repercussions, say experts. A World Gold Council report says, “It is difficult to find an event to compare this (Brexit) to. While trading blocs have broken down before, none have been as sizeable and important to the global economy as Europe. The UK domestic, European and world implications are profound. Nor will it be a quick process.

Once Article 50 of the Treaty on the European Union has been invoked, a two-year negotiation process will begin. In the meantime, the UK’s decision could trigger referendums in other European countries…”

We examine below, the three factors that will determine the way forward for gold.

Risk aversion

There is fear of a global recession led by the UK and an aversion to invest in equities now. Treasuries are do not appeal to investors as most central bankers are mulling stimulus measures to support their economies.

The global recession risk is above 50 per cent now, says, T. Rowe Price Group Inc.

So, investors are seeking safe havens that could protect their portfolio from volatility. This is a positive for gold.

Dollar movements

The US dollar has had a strong rally for the last few weeks. On Friday, the dollar index rallied about 2 per cent and closed at 95.448.

But the outlook on dollar from here is clouded by weak prospects of a rate hike from the Federal Reserve.

Markets are now expecting that the Fed may not hike rates before 2018.

In fact, the CME Group’s fed watch tool is now predicting a 4.8 per cent probability of a rate cut in July. Bank of England is also expected to cut rates soon to provide markets with liquidity.

The weak dollar thus may give a leg-up to gold.

But given that pound may weaken further from current levels, it may add muscle to the US dollar, throwing some hurdles on the way up for gold.

Good demand

Investment demand for the metal across developed and emerging markets is strong and this is well captured in the swelling holdings of large gold-backed ETFs like SPDR Gold Trust. The negative interest rate scenario in many countries is stoking demand for the yellow metal. With central bankers too eyeing the metal to diversify their exposure from paper currencies, the fundamentals for gold look good at present.

Poised for a strong run-up

Gold looks poised to make strong gains from here. Though it reversed sharply from the intra-day high of $1,358 on Friday, the close above $1,310 shows that the probabilities of the metal continuing its rally and hitting $1,350-1,360 levels is still high. The medium-term support is around $1,255. MCX gold (up 2.6 per cent for the week at ₹31,401) and MCX silver futures contract (up 2.5 per cent at ₹42,392) are also looking positive in the short to medium term. The MCX Gold contract has an immediate resistance around ₹31,900-32,000 levels. If this is crossed, the contract may move to the target of ₹32,500. If not, it may see a correction to ₹30,000.

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