Gold Holds Steady but Significant Risk Lurks

At its June meeting, the U.S. Federal Reserve once again raised the federal-funds target rate 25 basis points to a range of 1.75%-2%. In addition, the majority of officials at the central bank now expects four rate hikes in 2018, compared with an even split between three and four hikes at the March meeting. The June rate hike was largely expected by the market, as options prices implied a more-than 91% probability prior to the announcement. Furthermore, the market appears largely unfazed by an additional rate hike this year, as gold prices remained largely flat.

Today's rate hike doesn’t change our view that the investment case for gold will weaken. As such, we continue to expect gold to fall to $1,225 per ounce by the end of 2018 as the rising nominal interest rate environment increases the opportunity cost of holding gold. Additionally, although the recent rise in inflation bodes well for gold, we think that higher inflation will only spur a more rapid pace of rate hikes. As a result, the fair value estimates and moat ratings for all gold miners under our coverage remain intact.

Longer-term, most committee members continue to anticipate the federal-funds rate to rise to around 3%. Furthermore, despite continued weakness in inflation in the near term, the committee continues to expect long-run inflation of about 2%. As a result, the case for gold as an investment should remain weak in the longer term.

As investment demand falls, we expect that and Indian jewelry demand will fill the gap over the long term. However, the rise of consumer demand will take time, while investment demand can change rapidly, which means significant risk to gold prices in the near term.

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