Plenty of shine awaits the yellow metal

Gold remains out of favor with Western investors focused on the prospect of tighter US monetary policy and further dollar strength. But we see scope for a decent recovery in the price of the precious metal over the next year or two, with a target of $1,400 an ounce for the end of 2016.

The recent performance of gold has not been as poor as many of the headlines suggest. It is true, of course, that the current price of about $1,200 per ounce is well below the record high of $1,900 seen briefly in 2011. But the bulk of the fall from that peak was completed by mid-2013. Since then, the price of gold has mostly fluctuated within a range of $1,200 to $1,400.

Looking ahead, the main downside risk for the gold price is that the US Federal Reserve may tighten its monetary policy more aggressively than generally anticipated. We (Capital Economics) forecast the US central bank to start raising interest rates in the first half of next year and perhaps as early as March, which would be much sooner than most experts expect. Other things being equal, higher interest rates should strengthen the dollar, undermine the demand for protection against inflation, and increase the opportunity cost of holding an asset that pays no income - all potential negatives for gold.