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More Pain or Relief Ahead for Gold ETFs in 2017?

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Gold ETFs have had a roller coaster ride in 2016. The metal recorded its highest two-quarter percentage increase since 2007. The wind beneath the wings was the rise in safe-haven demand in the wake of heightened volatility in the global market in Q1 and Brexit at the end of Q2. Also, a subdued greenback worked a miracle for the metal – which in fact saw its third consecutive annual decline in 2015 (read: Gold ETF Rally Unstoppable after 2 Beaming Quarters ).

However, the wining steak lost momentum going into Q4. The possibility of faster Fed policy tightening and the resultant strength of the greenback as well as a Trump rally in the stock market led to a 12% drop in the metal in Q4 – marking “its second-worst quarter in 18 years” and “its worst quarter since the second quarter of 2013.”

Investors should note that increased inflationary expectations and a Fed rate hike boosted U.S. Treasury bond yields rapidly post Trump win, which in turn, marred the appeal for non-interest bearing asset gold.

Nevertheless, gold bullion ETF SPDR Gold Shares (GLD - Free Report) has gained about 7% so far this year (as of December 27, 2016).

What Lies Ahead in 2017?

As of now, chances of a rebound in gold in 2017 are slim given the improving global economic scenario. While Goldman Sachs expects global growth “to stay in the same range it’s been in for the past five years of 3% to 3.5%,” Fidelity believes that global growth outlook is brightening. The Fed has also projected three more rate hikes for 2017 (read: Sole Fed Hike of 2016 Put These ETFs in Focus).

To add to gold’s woes, consumer demand plunged 39%, 18% and 28%, respectively, in the quarters to March, June and September. Higher prices in the first half of 2016 weighed on investment demand. India – one of the key gold consumers – has been undergoing demonetization currently, which will likely have an adverse impact on gold demand at the beginning of 2017.

Hedge funds in fact reduced their bets on a gold rally to the lowest level since February. So far in the fourth quarter, GLD has seen about $4.70 billion of assets gushing out. Raymond James cut the 2017 forecast by 11% to $1,250 a troy ounce, while BMO Capital Markets slashed its outlook for gold to $1,175 a troy ounce in 2017, down 16.8% from its earlier projection.

What Can Revive Gold Prices in 2017?

Inflation: A Friend

Inflationary outlook is finally looking up in developed economies, albeit slowly. Prolonged easy money policies by global central banks, the OPEC move and the Trump effect made it happen. Expectations of a spurt in global inflation are now at the highest level in over 12 years.

If energy prices continue to recover and translate into inflation, it may act as a catalyst for gold. Gold is often viewed as a hedge against inflation. However, as of now, global inflation level is not too steep to give a material boost to gold prices.

Ebbing Overvaluation

The recent drop in gold prices also steers clear of overvaluation concerns for gold. The relative strength index for GLD is presently 33.44, indicating that the fund is approaching the oversold territory and might see a reversal in the medium term, if something positive comes up in the space.

If the Trump Rally Stalls

So far, the U.S. market rally has been propelled by Trump’s pledges for fiscal reflation. However, it is to be seen how many of the vows will be transformed into reality. If economic measures taken by Trump fall short of expectations, there could be a marked correction in stocks in early 2017. Volatility levels might flare up, opening up scope for a gold rush.

Recovery in China Likely

After faltering this year, the Chinese economy is probably shaping up well for 2017.With this, China's gold demand – one of the highest in the world – should be decent in 2017. In fact, gold demand is likely to escalate in Yuan terms given the weakness in the Chinese currency.

Bottom Line

Investors should note that though gold ETFs lost their sheen lately, escalation in geo-political risks or break-up fears in the Euro zone crisis can shore up prices. Till then, it is betters to remain on the sidelines.

So, investors intending to profit out of the gloom in the gold space may consider inverse ETFs like VelocityShares 3x Inverse Gold ETN DGLD, ProShares UltraShort Gold GLL and DB Gold Double Short ETN DZZ as a short-term investment (read: These 5 Inverse ETFs Could be Great if Rates Rise Further).

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