Gold was one of the main winners of 2017. Intensifying geopolitical tensions, particularly on the Korean peninsula and in the Middle East, combined with the dollar’s sharp plunge helped gold prices to finish the year more than 13% higher. Heading into 2018, the outlook for the precious metal continues to appear positive, as geopolitical risks are unlikely to go away anytime soon, and the US dollar does not seem ready to make a strong comeback yet.
Trying to forecast geopolitical developments is inherently difficult. Not only due to the vast number of variables involved, but also because a political narrative can change almost instantly, without any warning signs. Pricing geopolitical risk can be equally challenging, as major events such as military conflict can have a very high impact on markets, but are usually low-probability outcomes. This was perfectly demonstrated by the crisis on the Korean peninsula this past year, with traders appearing uncertain over how much they should react to the erratic and unpredictable missile launches by North Korea.
How, and whether, the Korean story develops could be a major determinant for gold’s forthcoming direction. Even though the latest headlines suggest that tensions may be finally easing – with South and North Korea agreeing to talk- that could change practically overnight, as mentioned above. Another point to watch is the ongoing proxy war between two of the Middle East’s biggest powers; Saudi Arabia and Iran. A potential escalation in either of these crises would likely prove beneficial for the yellow metal, due to its safe-haven status. Elsewhere, political uncertainty may be set for a comeback in Europe. Italy will hold its General Election in early March, and one of the main parties has previously advocated for holding a referendum on the euro. Then, there is the ongoing Catalonian crisis to consider as well. These risks could continue to provide support for gold in 2018, even in the absence of any "black swan" events to add further to gold’s appeal – black swans being unpredictable risk-off events with extreme consequences, such as the 2008 meltdown.
Politics aside, the other crucial subject for gold prices is how the US dollar will perform. Fluctuations in the greenback can have massive effects on the yellow metal, which is denominated in dollars. This implies that when the dollar declines, it becomes cheaper to buy gold with other currencies, thereby increasing the demand for the precious metal. A stronger dollar, on the other hand, makes gold seem comparatively more expensive and thus usually hurts demand and prices.
While a big fall in the dollar from current levels is not very probable, traders are not betting for major gains either given that monetary divergence between the US and other major economies will likely continue to narrow. Instead, the greenback’s performance may depend to a significant degree on the performance of its counterparts, a view enhanced by the latest polls from Reuters, which indicate that the USD is expected to gain against the yen, but underperform the euro in 2018. If this is the case indeed, the greenback may be a relatively neutral factor for gold prices in 2018.
Overall, the medium-term outlook for gold appears cautiously bullish. The metal could finish 2018 somewhat higher, perhaps near its recent highs at $1357. An upside break of that zone may set the stage for advances towards the $1375 territory, but for gold to rally much further than that, it may require a major risk-off event and/or continued weakness in the USD. On the other hand, in case geopolitical risks remain subdued or the dollar regains some strength, the precious metal could drift lower. A potential break back below $1300 would bring the metal back within the sideways range between $1200 – $1300, and could be the catalyst for further declines, perhaps towards the lower bound of that range.
