Gold’s bull market called into question by bank analysts

In the Lead: “Sachs and the Citi”

At the same time, the giant financial institution lifted its platinum price projections by 1.5% to $1,700 the ounce for the current year. Citi anticipates that a balanced supply/demand situation might not materialize in the noble metal until sometime between 2014 and 2017. As regards palladium, Citi analysts opine that the metal will tally a shortfall on the order of 336,000 ounces in the current year. Citi has now joined a growing list of pared-back institutional 2013 gold price forecasts.

One possible factor in Citi’s revised price outlook for gold is the overall performance that has been observed in the commodities’ niche since last fall. One market expert remarked that “The poor performance of commodity investments since the third tranche of quantitative easing in the U.S.… has undermined the claim that liquidity injections boost prices irrespective of fundamentals.  Ninety-seven percent of last year’s $20 billion of [commodity investment] inflows went solely into precious metals (mostly gold-backed ETPs).” As we have noted here before, that kind of overdependence on a sole source of demand does not a healthy bull market make.

The Citi forecast occurred even as Goldman Sachs reiterated its own gold price prediction calling for $1,825 per ounce within 90 days (largely on U.S. debt ceiling-related fireworks that might materialize). Recall that gold has fallen 5.5% in the final trimester of 2012 — its worst showing since 2008 — and that Goldman stands by a projection that gold prices will soften in the second half of this year on the back of a rebounding U.S. economy. Other market analysts do not see gold being able to post price prints too much higher than the low $1,700s before heading lower later in the year and in 2014.

Bloomberg News relays that “Gold’s bull market is over,” Allan Hochreiter Chief Executive Officer Rene Hochreiter, the top forecaster in the London Bullion Market Association’s 2012 poll, said this month. The metal’s appeal is set to diminish as so-called fear trades fade, according to Credit Suisse’s Tom Kendall, head of precious-metals research and the most accurate precious-metals forecaster in the past eight quarters tracked by Bloomberg.”

The same Goldman Sachs that was quoted above, BTW, envisions gold trading at or near $1,200 an ounce by 2018. The Business Insider informs that “In a note to clients, Goldman analysts Christian Lelong, Max Layton, Damien Courvalin, Jeffrey Currie, and Roger Yuan write, "Assuming a linear increase in U.S. real rates back to 2.0% by 2018, as proxied by the 10-year U.S. TIPS yield, we expect that gold prices will continue to trend lower over the coming five years and introduce our long-term gold price of $1,200/oz. from 2018 forward." The GS team’s 2% U.S. real interest rate target is actually quite conservative — some analysts have projected that interest rate normalization will result in a 4% real rate paradigm within five years.

Assuming that the $1,825 “peak gold target” does materialize this year, one can calculate a roughly 35% possible decline in the metal’s value over the next five years. Even if that translates into an average 7% easing in annual gold prices, the take-away is that unlike the past five years, when average annual increases on the order of 12%+ have been the ‘new normal’ for many, the period that lies ahead might offer a different “paradigm” — even if we do not label it as a “brutal collapse.”

Some folks will invariably question the value of a 2018 gold price forecast, especially since we might be on the verge of what the very same firm sees as a debt ceiling-driven potential 7.5% rally in the value of the yellow metal. Yes, but as you recall, almost everyone who has made a name for themselves in the gold analysis and forecasting arena over the past five years has depended nearly 99.99% on the argument that low and/or negative real interest rates have been, are, and will continue to be, the principal driver of gold prices. Some have even argued (successfully we might add) that gold is not linked to inflation(!). It is intrinsically and inexorably tied to low real interest rates and little else, in fact.

In that sense, the Goldman 2018 forecast is nothing less than pivotal in its importance. The aforementioned Goldman client note contains this passage: “Our framework for evaluating gold prices relates the real (inflation-adjusted) price of gold to real interest rates and the monetary demand for gold.” Evidently, GS envisions the path towards interest rate normalization (read: gradual increases) as being open in the wake of recent Fed posturing and certain statements.

The GS client “note” (and you just know that this means “advice” to the crème de la crème of high net-worth investors out there) went on to posit that “Even if higher inflation materializes, its impact on gold prices could be offset by: (1) U.S. real interest rates rising more quickly than we anticipate if the economic recovery is accelerating, or (2) an end to the Fed’s aggressive balance sheet expansion if inflation expectations become unhinged.” In other words, notes the Business Insider’s Matthew Boesler, “Goldman expects the effect from higher interest rates to weigh more heavily on gold than the boost the shiny yellow metal would get from continued monetary easing and inflation.”

Translation: The one asset that has benefited the most from the Fed’s campaign or easy money up to this point also stands to possibly be affected the most when such policies go into reverse. Whether or not such a battleship turn takes one year or five is not the issue; the important fact is that it will not occur without collateral “damage.” None of the above obviates the need to keep a core 10% gold allocation in one’s portfolio. It does however bring into question the wisdom of getting carried away with an “all-in” bet at a time when the “tide” might just be rolling out, ever so slowly.

Until next time.

About the Author
Jon Nadler

Jon Nadler is senior metals analyst with Kitco Metals Inc. in Montreal.

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