Three reasons for coming gold price correction

Gold advanced to an eight-week high on Monday in relatively brisk holiday trading in the US as the metal find support from safe haven buyers worried about the broader geo-political impact of the incoming Trump administration, the fallout from Britain's exit from the EU and upcoming elections in Germany and France.

Gold for delivery in February, the most active contract on the Comex market in New York, hit a high of $1,208.70 in early dealings, up 1% from Friday's close before giving up some of those gains. Gold ended the day above $1,200 for the first time since November 22.

Gold is now up just shy of 5% in January, but is still trading down $130 an ounce from an initial but brief surge on election night as results showed a likely victory for Donald Trump in the presidential race.

Three reasons for a gold price correction

Source: Bloomberg, Capital Economics

Gold has come under pressure because of bets that a Trump administration will lead to strong US economic expansion, higher interest rates and a stronger dollar.

Higher real interest rates boosts the value of the dollar and makes gold less attractive as an investment because the metal is not yield-producing and investors have to rely on price appreciation for returns.

Gold also has a habit of starting off well in a new year – since 2000 gold prices rose in January nearly two-thirds of the time, but a new note from analyst Simona Gambarini at London-based Capital Economics warn that gold's advance in 2017 may be shortlived.

First, we expect the Fed to tighten monetary policy by more than investors are discounting, as inflationary pressures in the US build – our forecast is that the central bank will raise the federal funds rate by 25bp on four occasions. Against this backdrop, we expect the real yield of US 10-year TIPS [Treasury Inflation Protected Securities} to climb, increasing the opportunity cost of owning a real asset like gold that pays no interest.

Second, we expect the US dollar to continue to strengthen a little, as the contrast in the monetary policies of the Fed and other central banks proves to be much starker than investors are currently anticipating.

And third, we forecast that physical demand for gold from emerging markets and central banks will remain subdued.

Capital Economics forecasts gold to trade at $1,050 by the end of the year, in line with lows hit towards the end of 2015.