5 Reasons Why Gold ETFs Can Regain Their Mojo

Tensions may have started piling up in the gold ETF investing space on Fed hike talks and the likely strength of the greenback, but investors possibly should not be bogged down. The yellow metal had an astounding rally this year on a flight to safety amid global growth issues and a major event like Brexit at June end. In fact, gold price saw the best the first half (+25%) in over 35 years (read: ETF Winners & Losers Post Jackson Hole Meet).

Even after the sell-off in late August triggered by Fed rate hike speculation, the largest gold bullion ETF SPDR Gold Shares (NYSE:GLD) ETF (LAGOS:GLD) is up over 24% so far this year (as of September 1, 2016). At present, the metal is loitering below the $1,330 level, but could spring back to lofty levels again in the coming days.

Below we profile a few reasons which explain why gold has more room to run:

Downbeat U.S. Economic Data Points

Investors should note that the recently released key U.S. economic indicatorsare not too strong to lead the Fed to a sooner-than-expected rate hike. The “second estimate” of Q2 GDP came in at 1.1%, lower than the prior estimate of 1.2%. The ISM manufacturing number for the month of August suddenly came in weaker. As per the reading, U.S. manufacturing shrank last month for the first time since February, as new orders and output declined and factories shed jobs.

U.S. construction spending was also flat in July. And if these were not enough, the all-important the U.S. job report – one of the prerequisites for the Fed policy – came in weather than expected for the month of August. The non-farm payroll reading of 151,000 was below the estimated 180,000 and the upwardly revised prior-month reading of 275,000.

All these raised concerns over the health of the economy all over again and can cause crinkles on the forehead of the Fed as its activity is mostly data-driven. This can be a golden opportunity for gold bugs as chances of a Fed hike waned with the sudden setback in economic readings.

Fed to Go Slow

Chances of a September hike appears dim now and the presidential election slated for early November makes matter pretty unclear for a December hike. Still, if the Fed hikes rates in the near term trusting the near-full employment job data, it would not be more than 25 bps, which looks pretty tolerable for gold. This kind of a slow rate hike trajectory will likely keep the greenback from shooting higher and would continue to usher in a golden spell (read: Fed or Trump: Who Will Decide the Fate of Gold ETFs?).

Inflation Is Never a Worry for Gold

The inflationary backdrop is still lagging in the U.S. It slackened to a seven-month low of 0.8% in July. But even if inflation picks up at any point of time with a recovery in energy prices (as lower oil price is one of the main causes of subdued global inflation), there is no threat to gold.

Gold is often viewed as a hedge against inflation. One of the pre-requisites of the Fed hike is higher inflation. So, if the Fed makes any move going forward, there has to be some noticeable uptick in inflation, which in turn is likely to boost demand for inflation-protected assets like gold.

Favorable Demand-Supply Backdrop

In the first half, demand for gold (up 15%) outpaced supply (up 1%). Supply saw the slowest first-half in eight years, as per World Gold Council. The ETF industry is presently the main driver of gold prices. The value of gold-backed ETF AUM surged 69% in the first half of 2016 to $93 billion, their highest level since Q3 2013 (read: Are ETFs Driving Up Gold Prices?).

Investors should also note that in Q4 of 2015, when the Fed first hiked interest rates after almost a decade, gold demand grew 4% and supply dropped 10%, implying a favorable demand-supply scenario despite a tough investing backdrop. Purchases from central banks and other institutions rose a whopping 25% then.

Though gold purchases from central banks declined 40% in Q2 of 2016 – marking the slowest clip of central banks’ purchases since 2011, the reserves are now worth 32,800 tons valued at about $1.4 trillion. Gold now represents about 3% of total reserves at emerging markets’ central banks, up from zero in 2007 (read: 5 Reasons Why Emerging Market ETFs Are Still a Buy).

Festive Season in India Approaching

Gold prices receive great help from retail demand from the two top consuming countries China and India. With the forthcoming wedding and festival seasons in India, gold prices will have another reason to run. However, demand from China is sluggish.

Bottom line

All in all, gold is likely to win ahead with rock-bottom interest rates prevailing in most corners of the developed world. The recent dip in prices also steers clear of overvaluation concerns in gold, giving it a fresh way to run. There are analysts, who still foresee a $1,400-an-ounce level later this year. According to UBS, bullion could rally to $1,500 an ounce in 2017.

In a nutshell, gold is likely to inch up in the coming days, though at a slower pace. If real interest rates on benchmark U.S. Treasuries continue to crawl up, gold investing may see a gradual, not steep, uptrend.

ETFs to Play

Apart from GLD, a few gold ETFs that should be on investors’ radar are iShares Gold Trust ETF (AX:IAU) , PowerShares DB Gold Fund (HN:DGL) , ETFS Physical Swiss Gold Shares ETF SGOL and Van Eck Merk Gold Trust ETF OUNZ.

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