Another significant driver of the price of gold was the real interest rates. The next chart shows the strong negative correlation which existed in 2017 between them and the gold prices. However, the U.S. dollar influence was much higher – the correlation coefficient was almost -0.84, while for real interest rates it was “merely” -0.52.
The price of gold rose by more than 10% in 2017. It means that it performed slightly better than last year. But the real difference is that in 2016, gold prices did not rally despite many potential catalysts (such as the Brexit vote or the Trump victory), while in 2017, the price of gold did not fall despite many potential blows (such as the three Fed hikes, the strong momentum in economic growth on both sides of the Atlantic, the U.S. tax reform, further gains in the stock market, or the exponential rise of Bitcoin prices). The price of gold did not rise linearly – we can distinguish a bull market until September and bear market since then due to the return of the risk appetite and the rebound in the U.S. dollar.
Will this trend continue in 2018? Well, the geopolitical uncertainty and the revival of the Eurozone (and, thus, the euro against the greenback) may support gold prices. On the other hand, strong economic momentum could make gold struggle in 2018. The Fed expects three interest rates hikes in 2018, while the markets see only two – we believe that there is more potential for hawkish surprise, especially given a new composition of the FOMC and the possibility of increased infrastructure spending in the United States. Inflation should rise, but rather moderately. And given the declines in 2017 and the interest rates divergence between the United States and other major economies, we say that the potential for further declines in the greenback is limited.
Hence, we are neutral to slightly bearish for the gold market in 2018. In the short run, gold price may be under downward pressure because of the impact of tax reform and improved sentiment towards the Trump administration and the U.S. economy, while in the long-run the capital spending should lead to rising wages and inflation expectations, pushing gold prices up. We would be more bearish, but we acknowledge that the U.S. dollar may continue its decline for a while regardless of its medium-term trend (we will dig into the outlook for the greenback in 2018 in the last part of this edition of the Market Overview). One thing is certain: gold’s trading activity has been unusually calm in 2017, though it may finally change.