Perspectives on bullion

Perspectives on bullion Commodities United States 5 May 216 James Steel Analyst HSBC Securities (USA) Inc. james.steel@us.hsbc.com +1 212 525 3117 Issuer of report: HSBC Securities (USA) Inc Disclosures & Disclaimer: This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it <Country>

World events and gold 2, 1,8 1,6 1,4 1,2 1, 8 6 4 2 Jan 8: Mar 8: China opens first gold Gold breaks USD futures market in Shanghai 1,/oz Dec 7: China becomes the world's largest gold producer overtaking South Africa Oct 6: Dow closes above 12, for the first time Dec 8: Fed funds rate lowered to.25% Sep 8: Nov 8: Financial market collapses Fed announces Lehman Brothers files for QE1 bankruptcy Aug 11: Gold hits nominal record high of USd1,921/oz......after S&P downgrades US credit rating Dec 9: Greek debt crisis springs up Nov 1: Fed announces QE2 Sep 12: Fed announces QE3 Apr 13: Gold drops by USD 24/oz in 3 days Dec 12: Fed announces "new" QE4 Oct 13: US government shutdown Dec 13: Fed announces QE tapering to begin Jun 15: Greece misses a payment of $1.5b to the IMF Aug 15: Concerns with China trigger global stock market sell-of Dec 15: Fed raises Fed funds rate for the first time since 26, by.25% Jan 15: Oil falls below $5 a barrel Jan 16: Oil falls below $3 a barrel Feb 16: UK referendum scheduled for June 25 26 27 28 29 21 211 212 213 214 215 216 US Recession Gold, USD/oz (LHS) Source: Bloomberg, HSBC 2

Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 The Fed and gold 1,9 1,8 1,7 1,6 1,5 1,4 1,3 1,2 1,1 1, June 7: Bernanke Testimony to J.E.C Sep 13: QE3 & "Mid- 215"guidance Aug 31: Bernanke Jackson Hole Speech Feb 29: Bernanke Testimony to Congress Dec 12: FOMC announces new QE Dec 18: Fed announces QE 'taper' Mar 19: Fed announces third QE 'taper' Jan 29: Fed announces second QE 'taper' Apr 3: Fed announces fourth QE 'taper' Dec 16: Fed raises Fed funds rate for the first time Mar 18: since 26, by.25% Fed removes 'patience'guidance Oct 29: Fed ends QE Jul 15: Yellen Testimony to Congress Sep 17: Fed does not raise rates, citing volatility in global financial markets March 16: Fed does not raise rates at March meeting Feb 1: Yellen testimony to Congress April 27: Fed opens door for June hike at April meeting Gold, USD/oz (LHS) Source: Bloomberg, HSBC 3

Gold recovery USD rally challenged in 216 HSBC forex strategy team suggests a weaker USD in 216 USD tends not to rally after Fed raises interest rates; gold tends to rally Negative interest rates a positive for gold Market expectations of Fed rate rises weighed on gold in 213 and 214; fewer-than-expected rate rises are leading to gold recovery Investment shift Marked recovery in gold ETFs Rebuilding long positions on Comex Physical market reacting to higher prices A significant discount in India to world prices, implying no import demand Indian authorities increased taxes on gold jewelry Coin and bar demand volatile in China Room is open for central bank gold purchases if USD is seen as weakening but forex holdings are falling Supply constraint Gold mine production likely topping out; 215 may be peak year Scrap market is down due to low prices 4

Negative rates : The new trend for some central banks Highly supportive of gold based on: Distress Lack of opportunity cost More central banks have breached the zero bound % Policy rate 5 4 3 2 % 5 4 3 2 Flat yield curve Substitute for cash Safe-haven appeal Central bank intervention free 1 1-1 -1 25 27 29 211 213 215 Sweden Denmark Eurozone Japan Source: Thomson Reuters Datastream 5

Global bonds Roughly a quarter of global government bonds now have a negative yield Gold began its current rally as the percentage of negative bonds increased Global bonds with negative yield % market % World government bonds with negative yield 3 25 2 15 1 5 % market 3 25 2 15 1 5 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 Source: HSBC, Bloomberg. Note: Share of Bloomberg global government bond index with a yield to maturity of less than %, calculated using amount outstanding. 6

Gold and rate hikes Based on the last four Fed tightening cycles, gold prices tend to weaken going into rate hikes and then rally for the next 12 trading days December 1986 rate hike 7 5 6.8 6.6 45 6.4 6.2 4 6 5.8 35 5.6 5.4 3 6-Aug-86 6-Nov-86 6-Feb-87 6-May-87 Fed Funds Rate (LHS) Gold (USD/oz) (RHS) Source: Bloomberg, HSBC June 1999 rate hike 5.6 33 5.4 32 5.2 31 3 5 29 4.8 28 4.6 27 4.4 26 4.2 25 5-Feb-99 5-May-99 5-Aug-99 5-Nov-99 Fed Funds Rate (LHS) Gold (USD/oz) (RHS) February 1994 rate hike 4.5 4 4 3.5 39 3 38 2.5 2 37 1.5 36 1.5 35 34 16-Sep-93 16-Dec-93 16-Mar-94 16-Jun-94 2.5 2 1.5 1.5 Fed Funds Rate (LHS) Source: Bloomberg, HSBC June 24 rate hike Gold (USD/oz) (RHS) 46 44 42 4 38 36 9-Feb-4 9-May-4 9-Aug-4 9-Nov-4 Fed Funds Rate (LHS) Gold (USD/oz) (RHS) Source: Bloomberg, HSBC Source: Bloomberg, HSBC 7

Currency wars: give peace a chance The end of the Currency Wars as suggested by the HSBC forex research team is a positive for commodities, including gold End of the currency war: stronger JPY & EUR Weaker USD Less pressure on the RMB, smaller chance of devaluation Positive for Asian FX Positive for commodities Source: HSBC More positive outlook for EM FX 8

% of periods of USD strength which produce positive returns USD IG REITs Global High Yield USD HY MSCI World Hungary Equities Turkey Equities Shanghai A Hang Seng Oil MSCI EM Gold India Equities Euro Stoxx Brazilian Bovespa Mexico IPC Copper Zinc Average TR in periods of dollar strengtrh Dollar strength scenario Investment-grade credit, REITs and high yield do well in periods of dollar strength while commodities (including gold) and certain equity markets suffer Effect of USD strength on assets 8% 7% 6% 5% 4% 3% 2% 1% 1% 8% 6% 4% 2% % -2% -4% % -6% Since 1988 Since 2 Since 21 Average TR in periods of dollar strength (RHS) Source: Bloomberg, HSBC, Thomson Reuters Datastream 9

Gold and inflation breakeven Gold fell in the absence of inflationary pressures A turn higher in expectations may lend some support to gold More important, low inflation expectations trigger expectations of easy monetary policy, which supports bullion Gold moves with inflation expectations 1,9 1,8 1,7 1,6 1,5 1,4 1,3 1,2 1,1 1, 212 213 214 215 216 2.7 2.5 2.3 2.1 1.9 1.7 1.5 1.3 1.1 Gold, USD/oz (LHS) US inflation breakeven 1Y, % (RHS) Source: Bloomberg, HSBC 1

Gold and China s stock market Equity strength weakened gold Eventually, equity declines rekindled interest in gold 2, 1,9 1,8 1,7 1,6 1,5 1,4 1,3 1,2 1,1 1, 212 213 214 215 216 6, 5,5 5, 4,5 4, 3,5 3, 2,5 2, 1,5 1, Gold, USD/oz (LHS) Shanghai composite index (RHS) Source: Bloomberg, HSBC 11

Global trade Global trade remains weak Gold prices tend to have an inverse relationship with world trade patterns % G7 export volumes % 2 2 1 1-1 -2-3 -4 96 98 2 4 6 8 1 12 14 16 % Qtr Annualised % Yr -1-2 -3-4 Source: HSBC, Thomson Reuters Datastream 12

Gold tracks economic policy uncertainty Gold tracks economic uncertainty The Economic Policy Uncertainty Index rose during the crisis Gold also rose as rising uncertainty triggered bullion demand Both peaked in the same month and eased lower until this year Economic policy uncertainty index and gold 2, 1,8 1,6 1,4 1,2 1, 8 6 27 28 29 21 211 212 213 214 215 216 Gold, USD/oz (LHS) US Economic Policy Uncertainty Index (RHS) 25 23 21 19 17 15 13 11 9 7 5 Source: HSBC, Bloomberg 13

Commodity prices The sharp fall in oil prices over the past 18 months has brought aggregate global commodity prices back to the 199s average level, when adjusted for inflation Index 3 25 2 Real commodity prices at 199s levels Aggregate Commodity Prices* Index, 199s average = 1 Real prices** (LHS) Index 3 Index 25 5 2 4 Energy and metals are down sharply Real Commodity Prices by Type Index, 199s average = 1 Energy Index 5 4 The 12-year supercycle has now run its full course A recovery may lend support to gold 15 Real prices, ex oil** (LHS) 1 Real Average 199s 5 * IMF All commodity price index ** Real base = June 212, deflated by US CPI 1992 1994 1996 1998 2 22 24 26 28 21 212 214 15 3 Metals 1 2 Food 51 Agricultural raw materials 1992 1994 1996 1998 2 22 24 26 28 21 212 214 3 2 1 Source for charts: Thomson Reuters Datastream, HSBC 14

Gold and investments The decline in investment is seen clearly by the drop in ETF holdings Declines have reversed as riskoff has encouraged gold purchases ETFs are rebuilding and we look for further build in 216 based on risk-on and safe-haven demand Gold and investments 12 1 8 6 4 2 25 26 27 28 29 21 211 212 213 214 215 216 Spec positions in COMEX, Moz (LHS) Gold in ETFs, Moz (LHS) 2,1 1,9 1,7 1,5 1,3 1,1 9 7 5 3 Source: Gold Bullion, ETF Securities, Bloomberg, CFTC, HSBC 15

China s gold import from Hong Kong The drop in prices in 213 set off a wave of demand in price-sensitive gold-consuming nations Lower prices at end-214 stoked demand Demand has softened more recently but remained historically high until this year 14 12 1 8 6 4 2-2 China: Gold imports from Hong Kong Jan-8 Jan-9 Jan-1 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 China net gold imports from Hong Kong, tonnes Source: Hong Kong Census and Statistics Department 16

Hong Kong UAE Singapore Thailand Saudi Arabia Turkey Belgium Germany Canada Australia Taiwan Iran Vietnam South Korea Japan China India Egypt United Kingdom Russia Gold consumption India and China are the world s two largest gold consumers Gold consumption per capita However, gold consumption per capita is still relatively small, with plenty of room for expansion 9. 8. 7. 6. 5. 4. Economic growth and rising wages are the driving forces behind our expectation for India s gold demand to rise in the long term 3. 2. 1.. Source: Thomson Reuters GFMS 17

US Germany IMF Italy France China Russia Switzerland Japan Netherlands Gold as a percentage of currency reserves among largest holders Western central banks hold a large percentage of their foreign exchange reserves in gold Most other countries have smaller allocations of gold in their foreign exchange reserves Emerging market central banks are net buyers, while Western central banks have effectively stopped selling gold Gold as a % of currency reserves 9, 8, 7, 6, 5, 4, 3, 2, 1, 8% 7% 6% 5% 4% 3% 2% 1% % China is the secondlargest importer of gold and the largest producer Source: WGC/IFS Gold (tonnes) % of reserves 18

Disclosure appendix Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: James Steel Important Disclosures This document has been prepared and is being distributed by the Research Department of HSBC and is intended solely for the clients of HSBC and is not for publication to other persons, whether through the press or by other means. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy the securities or other investment products mentioned in it and/or to participate in any trading strategy. Advice in this document is general and should not be construed as personal advice, given it has been prepared without taking account of the objectives, financial situation or needs of any particular investor. Accordingly, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to their objectives, financial situation and needs. If necessary, seek professional investment and tax advice. Certain investment products mentioned in this document may not be eligible for sale in some states or countries, and they may not be suitable for all types of investors. Investors should consult with their HSBC representative regarding the suitability of the investment products mentioned in this document and take into account their specific investment objectives, financial situation or particular needs before making a commitment to purchase investment products. The value of and the income produced by the investment products mentioned in this document may fluctuate, so that an investor may get back less than originally invested. Certain high-volatility investments can be subject to sudden and large falls in value that could equal or exceed the amount invested. Value and income from investment products may be adversely affected by exchange rates, interest rates, or other factors. Past performance of a particular investment product is not indicative of future results. HSBC and its affiliates will from time to time sell to and buy from customers the securities/instruments, both equity and debt (including derivatives) of companies covered in HSBC Research on a principal or agency basis. Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment banking, sales & trading, and principal trading revenues. Whether, or in what time frame, an update of this analysis will be published is not determined in advance. For disclosures in respect of any company mentioned in this report, please see the most recently published report on that company available at www.hsbcnet.com/research. 19

Additional disclosures 1 This report is dated as at 6 May 216. 2 All market data included in this report are dated as at close 5 May 216, unless otherwise indicated in the report. 3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBC's Investment Banking business. Information Barrier procedures are in place between the Investment Banking, Principal Trading, and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner. 4 You are not permitted to use, for reference, any data in this document for the purpose of (i) determining the interest payable, or other sums due, under loan agreements or under other financial contracts or instruments, (ii) determining the price at which a financial instrument may be bought or sold or traded or redeemed, or the value of a financial instrument, and/or (iii) measuring the performance of a financial instrument. 2

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