PRECIOUS METALS Review and outlook for 2020 - #15 @CommoOFI - OFI Asset Management
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EXPERT VIEW
PRECIOUS METALS
Review and outlook
for 2020
# 15 @CommoOFI
ASSET MANAGEMENT
Gold and precious metal prices rose significantly in 2019. Central banks reversed their monetary policies towards the end of 2018 and made them much more accommodative again, providing fresh impetus for precious metals. Gold ended the year up by more than 15%, silver gained over 11% and growth in platinum prices exceeded 21%. Palladium, meanwhile, had another extraordinary year and jumped by more than 60%! After a year like that, one may well wonder whether precious metals still offer upside potential in 2020.
Summary of contents
REVIEW AND OUTLOOK FOR 2020
Gold and Silver ................................................................................................................ 4
Palladium ........................................................................................................................... 6
Platinum ............................................................................................................................. 7
Conclusion ......................................................................................................................... 8
EXPERT VIEW • Precious metals: review and outlook for 2020 | 3Gold and Silver
Yet again, precious metals were largely dependent on the monetary policy decisions taken by the main
central banks.
Let us not forget that there is a very close correlation between real interest rates and gold prices. Gold
offers no intrinsic yield, unlike stocks (dividends) and bonds (coupons), so it only becomes popular among
investors when bond yields fall.
Comparative change in the price of gold and US real interest rates (inverted)
1900 -2.25
-2.00
1800 Gold spot price (L scale) -1.75
1700 5Y US real interest rates (R scale) -1.50
-1.25
1600
-1.00
1500 -0.75
-0.50
1400 -0.25
0.00
1300
0.25
1200 0.50
0.75
1100
1.00
1000 1.25
12/2011 12/2012 12/2013 12/2014 12/2015 12/2016 12/2017 12/2018 12/2019
Source: Bloomberg, OFI AM at 3 January 2020
So with the Fed (the US central bank) adopting a new line and becoming far more accommodative
again in late 2018, and the economic situation deteriorating, 2019 got off to a good start for gold and
silver. But after deciding to lower interest rates in March, the Fed then adjusted its message to suggest that
the cut was a one-off, prompting many investors to take their profits.
Concerns emerged in the second quarter that the economic situation would be exacerbated by tensions
between China and the US following a series of complicated trade talks. This provided a little more impetus
for gold and silver prices.
The Fed then took a much more accommodative stance again in the third quarter, enabling prices to
continue climbing. But the US and China reached a truce in their trade war, albeit a minor one, triggering
a rise in real interest rates which took a toll on precious metals. Certain economic indicators improved,
which also penalised gold and silver prices.
Towards the very end of the year, precious metals got a little boost due to concerns about growth
potential in 2020 and expectations that the growth gap between the US and Europe would narrow and
negatively affect the dollar.The line adopted by the Fed today makes any decision to resume monetary tightening highly unlikely.
Debt levels, especially govies but also corporate debt, would make any lasting and/or sizeable increase in
interest rates unbearable for public finances. Bear in mind that US public debt currently stands at 105% of
GDP and will approach the 140% mark in 2027 according to the Congress Budget Office. This is why we think
there is little risk of a large-scale correction in gold prices, making investment risk asymmetrical.
There are also some major support factors to consider. First of all, we have gold-mining output. Although
gold production reached a new high in 2019, no major gold deposit discoveries have been made for the
past 20 years, and the biggest mining groups are beginning to doubt whether they can keep production
levels this high for very long. It seems to have become widely accepted that we have now reached peak
gold, i.e. the maximum output level for this “barbarous relic” (to quote Keynes) that will never be reached
again.
Citi recently estimated that the 26 biggest gold-mining companies (together accounting for 38% of
global output) might see their production plummet by 47%… by 2027! More generally, we reckon gold
production could drop by a quarter by then.
The other major support factor is that central banks are buying up gold again. For years after the Bretton
Woods system collapsed in 1971 – severing the link between gold and money supply – central banks in
developed countries would sell some of their gold stockpiles whenever their governments ran into
financial difficulty. The sharp rise in gold prices between 2000 and 2011 put an end to such practices, and
the last key central banks to have sold gold (the Bank of England and Banque de France in the early 2000s)
were heavily criticised for doing so.
Meanwhile, economic globalisation created enormous trade surpluses in emerging countries which had
gradually become the world’s factories. Central banks in these countries then had to invest their reserves.
Having invested in the government bonds of their debtor countries given the scale of their debt, central
banks then sought out ways to diversify.
We have seen a shift from central banks placing orders to sell 500-600 tonnes per year to placing orders to
buy more than 600 tonnes per year! This has resulted in a variation of around 1,200 tonnes per year in a total
market of 4,500 tonnes.
And the momentum shows no signs of running out of steam. Gold buying reached a record of over
651 tonnes in 2018 and then continued in 2019, with 550 tonnes having already been purchased by the end of
the third quarter of 2019. Moreover, when contacted, none of these central banks say they have any intention
of scaling back their gold-buying and over half of them actually want to step up their gold allocations.
OUTLOOK
Gold prices are being supported by limited mining output and consistent demand from central banks,
and above all they should continue to benefit from very low real interest rates.
It is becoming increasingly difficult to find lucrative and safe investments that use up little capital.
So, in the coming months, we might possibly see an increase in demand for US bonds – which still
offer yields in the region of 2% and, moreover, a somewhat stable currency. If this does indeed
materialise, US real interest rates could continue to trend towards zero, just as they have in two other
major economic regions, Europe and Japan.
And because of the link between real interest rates and the price of this precious metal, we think such
circumstances could once again push gold up to its historical high of $1,900 per ounce or even slightly
above within the next 18 to 24 months.
Silver remains very closely correlated with gold, although it is more volatile, and could see slightly
stronger gains; we reckon it might move back up towards $23 per ounce.
EXPERT VIEW • Precious metals: review and outlook for 2020 | 5Palladium Palladium once again delivered an exceptional performance last year. Having gained 20% in 2016, 60% in 2017 and 15% in 2018, the metal ended 2019 up by more than 60% and at a new historical high. The reasons for this uninterrupted climb remain the same. Palladium is a small market (about 350 tonnes) that relies primarily on two countries for its production, Russia and South Africa (around 80%). Production is extremely limited given the lack of major deposit discoveries made in recent years. Demand should therefore outstrip supply in this market for the 9th year running this year. Palladium prices rose by a further 13%+ between 1st and 15th January 2020, reaching yet another historical high! The momentum therefore seems set to last. However, concerns about demand could call a halt to this spectacular growth. Palladium is used mainly to manufacture catalytic converters for petrol-engined vehicles (more than 75% of demand), so slowing car sales, especially in China, could be a cause for alarm. Recycling should develop and might partly relieve the pressure on the market. However, environmental standards are becoming increasingly strict in China, which has just introduced the China 6 standard, so car makers might have to fit their vehicles with more efficient catalytic converters. This would necessarily involve an increase in the use of platinum-group metals. It is also worth noting that the development of electric cars poses no threat for the short term as volumes are too small. It could even prompt an increase in the consumption of platinum-group metals if mainly hybrid vehicles are sold. Hybrid vehicles run at lower temperatures because of the frequent switching between engines, so more platinum-group metals need to be used to treat exhaust fumes properly (around 10% to 15%). In these circumstances, only the use of a substitute metal might penalise palladium for any length of time. Platinum is the only candidate to have been identified so far. But this is a smaller market (about 250 tonnes), so car makers are reluctant to make the switch for fear of finding themselves with an ultimately bigger problem to deal with, having already spent heavily (on research and development, certification, changes to the assembly line, etc.). One last factor supporting palladium prices is that financial demand remains very robust. A particularly favourable forward price structure has driven demand for futures contracts to historically high levels. As metal lending also offers juicy returns, the inventories held by funds backed by physical metal are tending to decrease. OUTLOOK The market could prove volatile. But unless there is a radical shift to all-electric vehicles (which is unlikely), we see no reason to expect a lasting correction in palladium prices. Palladium prices held up even when the global automotive market slowed down sharply in 2019. So they could continue climbing, possibly towards $2,500 per ounce or even higher.
Platinum
2019 was a turnaround year for platinum. Despite a lacklustre automotive market, the metal gained
more than 21% in 2019.
The main reason for this upturn is that producers finally decided to scale back their output. The metal is
produced mainly in South Africa (80% of global output), so the downturn in platinum prices hit producers
hard. For political reasons and other reasons relating to their product mix (platinum mining companies
often produce palladium too, which has been highly profitable in recent years), producers took a long
time to reduce their output despite struggling financially. But in late 2018, Impala Platinum (one of South
Africa’s major platinum producers) announced plans to shut down 5 of its 11 main production sites and
lay off 13,000 of its 40,000 workers over a two-year period. This will reduce the global supply of this metal
by around 3.5%.
Meanwhile, although demand for this metal has decreased significantly in recent years, it appears to be
showing signs of stabilising. Platinum is used mainly to manufacture catalytic converters for diesel-powered
vehicles, so the slump in this market following the “dieselgate” scandal (diesel’s market share in Europe
dropped from 44.0% to 35.9% in the space of a year) dragged consumption down. But we can now see that
the downturn in the diesel market for private cars is beginning to level off, while the market for corporate
fleets remains robust. So demand for platinum could stabilise or even trend slightly upwards again as
environmental standards become more stringent.
OUTLOOK
With South African output being scaled back, the diesel market recovering and emissions standards
for the automotive industry becoming stricter, we think platinum prices could continue to climb,
especially if car sales perk up a bit. Our price target therefore lies between $1,050 and $1,100 per
ounce, slightly north of current prices.
EXPERT VIEW • Precious metals: review and outlook for 2020 | 7Conclusion There is still a great deal of uncertainty surrounding the economic environment and the world’s major economies are heavily in debt, so it will be difficult for central banks to consider monetary tightening unless inflation makes a comeback. Higher real interest rates would soon become unsustainable for the public finances of countries (such as the US) whose debt ratios exceed 100% of GDP. Real interest rates should therefore remain low for a long time, which is the best form of support for precious metal prices. Meanwhile, specific circumstances surrounding certain metals such as palladium could lead to another year of exceptional price gains in 2020.
Benjamin LOUVET
Commodities manager
+ 33 (0)1 40 68 12 74 • blouvet@ofi-am.fr
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EXPERT VIEW • Precious metals: review and outlook for 2020 | 9ion Gestion, performance, optimisation Middle Office Validation
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