A rebound in 2017 after a rough end to 2016
Thoughts from Ani Markova
Ani Markova, MBA, LIFA, CIM, CFA
Vice-President & Portfolio Manager
AGF Investments Inc.
Following a 12% correction in the gold price post-U.S. elections in the last quarter of 2016, we have seen a
healthy 9% rebound in gold since the lows last December. For the full year, gold managed to keep a 9% gain in
USD terms. We believe gold is positioned for strong, but volatile performance in 2017, as sentiment continues to
recover from extremely bearish levels at the end of 2016. Further, potential for higher inflation, disappointing
economic data, geo-political uncertainty and favourable supply demand dynamics bode well for the metal’s
performance particularly in the second half of the year.
The gold price came under pressure in the final two months of 2016 on expectations that the Trump
administration would be able to deliver on a significant fiscal package of tax cuts and infrastructure spending, as
well as on various deregulations. This led to weaker investment demand, as investors rotated out on gold
exchange traded funds into cyclical investments. This rotation happened at a time when physical gold demand
was also weak owing to monetary reform in India and limited Chinese imports.
Since the beginning of 2017, sentiment on the gold sector has recovered from excessively negative levels at the
end of 2016 to more neutral levels (Figure 1), which signals to us that the gold price is likely to be range-bound in
the short term.
Figure 1. Daily Gold Sentiment Composite
Source: Ned Davis Research, February 14, 2017
Looking back over the last 10 years, when the sentiment reading has been between 35 and 68, the gold price has
realized an average annual gain of 8%1. The jitteriness in investor sentiment presents an attractive entry point for
the sector. We believe that within the next few months there will be good opportunities to buy gold and gold
equities. We anticipate that short-term headwinds will come from the U.S. Federal Reserve (Fed), which is in
tightening mode and could in turn cause a spike in the U.S. dollar and U.S. real rates. Investors are also awaiting
proposals for new fiscal budgets and assessing the impact of protectionist trade policies. We expect that gold will
resume its upward momentum in the second half of the year on the back of retaliatory currency tactics and
creeping inflation. Similar to 2016, we expect investor demand to once again be the main catalyst behind the gold
price.
THE PHYSICAL MARKET
Physical demand from the two main gold importing countries, India and China, was subdued last year and
therefore failed to provide support to the gold price in the face of waning investment demand in the final quarter of
the year. In the first few months of this year, jewelry demand has remained subdued.
WHAT IS GOING ON IN INDIA?
Indian jewelry demand, which accounts for a significant portion of physical demand, came under pressure at the
end of last year following steps taken by the government to clamp down on undeclared income. Prime Minister
Narendra Modi cancelled 500 and 1000 rupee bank notes, which caused a sudden rush for gold, as holders of the
small bills exchanged them for bullion. However, the demand surge was short-lived and a liquidity squeeze
followed, which weighed on gold demand. Industry sources estimate that the government efforts to curb
undeclared money are likely to weigh on demand for the next 1-2 years, with the potential loss of 100-150 tons of
demand per year2. For instance, in order to reduce the use of cash, cash transactions above 300,000 rupees
have been made illegal, which negatively impacts gold demand as around 70-80% of jewelry business is cashbased.
Ultimately, Indian demand is driven by three main factors – cultural affinity, income and the price of gold. In the
longer-term, India’s middle class is undergoing a substantial transformation, estimated to double in size by 2025 3,
exceeding 500 million people as reforms from the 1990’s are now starting to bear fruit. As this new generation of
middle-class consumers grows, so too should domestic income. And as income rises, demand for gold should as
well.
WHAT IS GOING ON IN CHINA?
Chinese demand was also under pressure in Q4 2016 amid efforts by the Chinese government to stem capital
outflows. While gold jewelry demand was below expectations during October’s ‘Golden Week’ national holiday,
sentiment rallied in December in part due to lower prices. In anticipation of strong demand during late-January
Chinese New Year, retailers placed significant orders with manufacturers. However, a tightening of capital
controls has been negatively impacting gold imports. Given concerns among Chinese residents over yuan
devaluation, we expect demand by Chinese investors to remain healthy. The risk is of course that the government
Ned Davis Research, December 31, 2016.
Metals Focus, “Gold Five-Year Forecasting Quarterly,” February 2017
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continues to clamp down on capital outflows, limiting Chinese ability to import gold.
Figure 2. Indian and China gold imports
Source: Metals Focus, February 2017
WHAT WILL DRIVE GOLD HIGHER IN 2017?
With the backdrop of uncertain and unconventional political leadership, investors should keep their gold portfolio
insurance. For the remainder of 2017, we remain optimistic given potential for:
 Higher inflation – Gold tends to fare well when inflation expectations rise faster than nominal rates.
Although yield curves have started to steepen and the Fed is moving towards steady normalization of
rates, inflationary pressures are starting to build. It is our expectation that we will continue to be in an
environment with low real interest rates – an environment that has historically been conducive to
continuous gold price appreciation.
 Disappointing economic data - While economic growth expectations were revised higher at the end of
2016, in turn weighing on gold, it is uncertain if the speed of implementation and magnitude of fiscal
stimulus in the U.S. will be able to offset already tightening financial conditions resulting from a strong
U.S. dollar, a steepening yield curve, Fed tightening and oil prices almost doubling from prior lows. It is
possible that growth disappoints in the near-term, in turn driving a correction in equity markets and driving
investors back to safe haven assets such as gold.
 Geo-political uncertainty – Historically bullion has moved US$50-100 per ounce on the back of
geopolitical events. Protectionist rhetoric under a Trump Presidency could lead to further regional
conflicts. Other geo-political events that could influence markets include hard Brexit negotiations,
elections in Europe, U.S.-China negotiations, Middle-Eastern conflict escalations among others.
 Favorable supply/demand - We expect years of reduced exploration and curtailed capital expenditures
spend by gold miners to result in reduced gold mine supply.
CONCLUSION
We will continue to use any pull backs in the gold price as an opportunity to deploy our cash into quality gold
companies at more attractive prices. In addition to the potential for an appreciation in the gold price to drive gold
equities higher, we expect merger and acquisition activity to pick up as senior and mid-tier gold producers look to
replenish their reserves. This should benefit junior miners with prospective land packages and exploration
success.
For more information, speak with your AGF representative or visit AGF.com/Institutional.
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The commentaries contained herein are provided as a general source of information based on information available as of February 8,
2017 and should not be considered as personal investment advice or an offer or solicitation to buy and / or sell securities. Every effort
has been made to ensure accuracy in these commentaries at the time of publication, however accuracy cannot be guaranteed. Market
conditions may change and the manager accepts no responsibility for individual investment decisions arising from the use or reliance
on the information contained herein.
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This document is for use by accredited investors only.
Published Date: February 22, 2017
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