In its annual commodities forecast, Citi Research posits that while this physical buying (much of it from Asia) is likely to limit the downside for gold prices over the year, the reasons western buyers (particularly institutional buyers) are getting out of the market are unlikely to change in the near term.
The first of these, the bank says, is that “inflation concerns/expectations have all but evaporated” According to the bank, the massive liquidity programmes at work in various countries throughout the world have significantly raised expectations of higher inflation over the last five years, but, it says, these fears have not been realized. As a result, “As inflation expectations evaporated, a negative trend between Central Bank balance sheet expansion and gold price trends has been established, most notably through Q3, though perhaps this could be explained by the extra austerity effect of the Government shut down through October,” Citi says.
That is not to say that inflation can’t or won’t come back. Nor does Citi believe that it won’t have a role to play in the future in supporting gold prices. But, it does say that, “while the US economy and much of the Western world operates well below any meaningful capacity constraints.
A driving force behind renewed gold investment.
To this point it says, the bank’s economists expect inflation rates globally to rise only “very modestly” next year, from a PPP adjusted rate of 3.0% to 3.2%.
The second reason for the western indifference currently being shown to gold is that, according to the bank, the opportunity cost of holding gold as opposed to other assets is high. And, as a result, you are seeing funds moving out of gold and into other asset classes.
“Gold returns for the year are now down 24% versus the S&P 500 index up 24% over the same period,” the bank points out.
It adds, “With economic recovery now the key investor focus, gradually improving macro data continue to support equity performance, and we see little possibility of a reversal of this trend.”
Will 2022 mark the return of the gold ETF investor?
Evidence for this trend, Citi says can be found in the significant outflows from gold ETFs since 2017. While the bank expects outflows to slow from here, it sees little prospect of the trend toward outflows reversing.
And, it says, it is not only institutionally held paper and physical ETF investments that are expected to struggle in the current environment. “We expect direct investment in physical bars to fall significantly next year, with projected uptake some 306 t lower that this year largely on lower Western world investor appetite.”
Others, like the World Gold Council’s Marcus Grubb, however, believe, that investors in gold ETFs could return to the fray next year.
Irrespective of which argument turns out to be correct, it is likely that much of the heavy lifting from a demand point of view will be done by Asia (China in particular) next year – a job the region has proven more than up for. But, as has been seen recently, that doesn’t always show up in the price.