Colin Hamilton: Gold Seen Trending Up, Silver Opportunity Emerging

This year has seen the world change in unprecedented ways, but for BMO Capital Markets’ Colin Hamilton, 2020 is set to be a profitable year for the gold market.

“Most of the elements that have helped gold price gains in the past are in place — particularly very loose monetary policy and low yields,” Hamilton said last week at the World Gold Forum, an online event.

Gold has been holding above the US$1,700 per ounce level since earlier this month, with the metal gaining more than 11 percent since the start of the year.

For the expert, one of the key trends this year will be gold demand flowing predominantly from macro asset allocation, with the pace of this allocation dictating price performance.

“This makes gold more pro-cyclical than seen previously,” he said, adding that wider assets under management are an important metric to keep in mind.

Gold demand easing

When looking at demand, BMO sees three types of gold consumers: central banks, particularly in emerging markets; macro asset allocators, which are attracted to gold for its liquidity; and micro asset allocators, which see gold as a store of value.

“This year we will see more flow into the exchange-traded funds (ETFs) and central banks,” he said, adding that the pace of ETF flows is important for gold price moves both to the upside and downside.

Hamilton expects gold to have good support through Q2 and the latter part of the year. He warned that the market might see corrections, but it’s still a steady and upward trend for the precious metal.

Speaking about government policy and its impact on gold, Hamilton said that falling yields, along with highly accommodative policies, such as those implemented recently by the US Federal Reserve, keep offering support to the yellow metal.

“In the next couple of years I don’t see a situation where interest rates will rise aggressively and yields are recovering, and with that it still makes gold a good bet from an asset allocation perspective,” he said.

Gold and the US dollar

Typically a strong US dollar would make buying gold more expensive for investors using other currencies, impacting demand for the yellow metal, and in return prices.

“However, the relationship often disconnects, where gold prices have stayed constant or even increased during periods of US dollar strengthening,” Hamilton explained. “We often see that happen when gold’s safe haven is key — it’s when the world is concerned, as it is at the current time.”

He added that at the moment, the US dollar has limited impact from a macro asset allocation perspective, but that is not to say that will always be the case.

“As we get recovery going through, I think we will see more influence of the dollar, but for now it’s about gold’s safe haven role,” he said.

Physical gold shortage

Commenting on the shortage of physical gold, Hamilton said there have certainly been dislocations in the futures market over a temporary lack of the right type of gold for delivery against contracts.

“But the big spike we’ve seen in COMEX inventory over the past few weeks shows there’s sufficient gold around, and the futures prices have done what they are meant to do,” he said. “There’s plenty of gold to cover the ETFs and the futures contracts, but there’s always potential for a temporary dislocation.”

Hamilton also touched on China’s crucial role in the gold market, which is often overlooked.

The Asian country is the world’s largest gold miner, but its output is sinking, with production declining for the fourth consecutive year in 2020, while refineries have been impacted recently.

“More importantly than the supply side is the demand side,” Hamilton said. “There has been much more volume passing through the main Shanghai Gold Exchange contract over the past two months.”

Not all good news

Despite seemingly very supportive catalysts for gold, Hamilton said demand for the precious metal might well drop 10 percent year-on-year in 2020 — the biggest drop seen in consumer history.

“Gold is now expensive in other consumer currencies, and of course when we look at central banks they have many other fund priorities,” he said. “The weight of asset allocation is still key for price formation but it is not all a one-way trade.”

On the supply side, Hamilton expects a natural output decline to happen from 2020 to 2025.

“What I would like to highlight is that the gold supply is more diverse now than in any other point in history,” he said. “That allows it, in times of economic distress like we have now, to be much more resilient to individual problems. So we are still expecting to see a relatively resilient gold supply output even with the pressure we are seeing.”

One of the reasons gold supply is more resilient is profitability, he added. “We have a situation where we have rising prices and falling costs — this is great if you are a gold producer,” Hamilton said. “It should be a very profitable year, it is up to the industry to sustain those margins.”

But improving miners’ free cash flow will be key to bringing generalist investors back into the market.

What about silver?

Even though most attention is always on gold, Hamilton does see an opportunity emerging in silver.

“The silver demand outlook is likely to experience a bit of a shakeup as new technologies come forth,” he said. “We increasingly believe the use of 5G and photovoltaic will position silver as more of an infrastructure commodity.”

As the world starts to recover, keeping an eye on the fiscal stimulus moving forward will be very important, Hamilton added, with China leading the way with 5G and solar.

Despite the fact that silver ETF flows remain sporadic, asset allocation can be more meaningful in the silver market, with potential dramatic shifts in silver price.

In terms of supply, the analyst expects to see a significant drop in output in 2020.

“For us, silver cannot decouple from gold, but we do see it outperforming, certainly during that recovery period in the second half of this year,” Hamilton added.

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Securities Disclosure: I, Priscila Barrera, hold no direct investment interest in any company mentioned in this article.