'See a positive picture for the commodity complex in 2019'

Gold prices are set to rise next year as the Federal Reserve slows its pace of US interest-rate hikes, yet we do not expect the yellow metal to run away to the upside either since the economy will remain strong.  In a widely anticipated decision, the U.S. central bank hiked interest rates by 25 basis points on Wednesday. But what took markets by surprise was the Fed's commitment to retain the core of its plan to tighten monetary policy, despite rising uncertainty about global economic growth. Gold prices have tended to rise as real yields fall, and vice versa.

Demand for gold should be strong in the first quarter due to seasonal factors, tied to buying around celebrations in key gold-consuming nations, like India and China. Chinese New year demand seasonal demand in India could underpin prices.

Investors are currently demanding more gold at a given level of real yields than in the past. As in the case of oil, we think extrapolating too much from recent strength is not wise, and that back-end prices remain anchored – we believe gold’s ability to decouple from the level of yields is ultimately limited.  As investors flocked to the safety of government bonds, U.S. benchmark Treasury yields fell to more than eight-month lows on Wednesday. Certain factors, such as emerging market (EM) central banks increasing their gold holdings, could be a continued force.

The stock market may be more sideways next year, which may also support gold and silver demand. So far this quarter, gold performed very well, returning more than 5 percent as of December 18, compared to negative 11.9 percent for the S&P 500 Index.

So what is expected to limit the upside?

While economic growth may slow, it will still remain healthy overall. That will hold down any safe-haven buying. We do expect prices to rise on the back of a falling dollar, but just don’t expect investors to go crazy buying gold next year, as equity market hangover from high returns over the past years have dented the appeal for precious metals.

There has been a noticeable slowdown in traditional physical buying from India, due to various factors, from change in the younger generation who are more credit savvy and give less importance to savings. However, the pace of investment buying may very well pick up in 2020 and 2021. 

Chart-1

December has historically been a strong month for stocks. But fears of a slowdown in global growth, rising interest rates and the U.S.-China trade war have prompted many investors to pare down their stocks in favor of gold, often perceived as a safe haven in times of economic and financial instability. As seen in the chart above, it can be gauged from the change in stance in the speculative net long positions of funds which have turned positive for the first time since July 2018. Therefore, we favour gold prices performing well in 2019.

Technical Picture

The chart picture is quite positive and hinting at strength ahead in the coming months. In the past three years post the rate hikes, gold has rallied and this year too might not be an exception. 

We expect $1350( MCX: 34,000) to be an important cap on the upside, where strong resistance lie. The bullish view could get negated, if prices were to break the $1200 (MCX: 30,500) level on the downside, which is not our favoured view.

BASE METALS
 

The base metals sector is influenced more by the global growth outlook than any other commodity grouping, given that its supply-side response does not reset annually (as with agriculture) or have a short-cycle investment response (like energy). While metals broadly have tended to be tied to China’s economy in particular, we think a modest deceleration in China would be unlikely to derail the supportive metals outlook, given expectations for strong, synchronous global growth and specifically in India. In addition, years of underinvestment will limit supply growth in the next few years. In our view, the primary downside risk for base metals in the 2019 is a surprise downgrade in the global economic outlook, given that the US China talks have not yielded great results so far.

We see generally a positive picture for the commodity complex this year.  In the case of oil, our modestly positive view is driven primarily by the shape of the oil price curve – which is currently in backwardation – and the ability for forward prices to move up toward current spot prices. We are quite sanguine on natural gas and mildly positive on agriculture, though for the latter, we believe some deviation away from normal weather will be necessary to realize potential gains. Lastly, while we think gold is currently rich, we are cautiously positive on base metals given the solid global growth outlook and supply constraints and falling inventories.

Equity and Commodity Cycles

Let's first take a look at how commodities, bonds, stocks and currencies interact. As commodity prices rise, the cost of goods moves upward. This increasing price action is inflationary, and interest rates also rise to reflect the growing inflation. As a result, bond prices fall as interest rates rise since there is an inverse relationship between interest rates and bond prices. 

This chart compares equities to commodities. In 1970, 2000 and today, equities have become overpriced, while commodities are oversold and cheap by comparison. In 1973, 1990 and 2008, oil and commodities became overbought and investors sold commodities and bought stocks. If history repeats (and it often does), we are about to witness a massive switching from equities into commodities. The ongoing demand in Asia might be for items such as natural gas, copper, lithium, vanadium, zinc, and cobalt, and the stocks of the companies that mine and produce these commodities will be in great demand.

 

Both Nifty and Gold rose higher during this period, but from 2013, MCX gold prices have been in a broad range.

Nifty and MCX Gold 2008 till date

Nifty has risen and crude has been badly hit during the above period.


Nifty and MCX Copper from 2008 till date

In this case Copper fell in 2008 till 2010 while Nifty rose in the same period. And post 2013, Nifty has been rising while Copper prices were dull and muted.

Nifty and MCX Crudeoil from 2008 till date 

Nifty has risen and crude has been badly hit during the above period. 

CONCLUSION

The equities markets around the world have risen to new highs. There comes a time, however, when a sector becomes so overbought, that smart money begins to leave and search for a sector that has been overlooked. Post the 2008 financial crisis, equities have performed exceedingly well, while most commodities have not. Presently, they are halfway near 2008 lows and makes it attractive for 2019. Many producing countries are affected due to low prices and capacities have not risen much in the past decade, which is a recipe for supply tightness going forward. Every, ten years the cycle seems to be favouring commodities and signs are quite imminent for a prospective outlook going forward for commodities.

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(The author is the Director of Commtrendz Research and these are only guidance for price direction. He is not liable for any gain/loss arising out of it.  He can be reached at gnanasekar.t@commtrendz.com.)