Societe Generale SA’s Michael Haigh correctly predicted this year’s rout in gold by using a math problem to measure a feeling. His arithmetic says there’s worse to come.
Haigh’s algorithm, called the Principle Component Analysis model, uses 27 indicators ranging from the value of the Indian rupee to the yield on 10-year German bunds to determine what percentage of a commodity’s price movement is influenced by supply and demand, and how much is related to macroeconomic concerns, liquidity and fluctuations in the dollar.
Three months ago his formula showed investors were becoming more bullish on economic growth while gold’s outlook was bearish. On April 2, Haigh and the 10 analysts he leads issued a report laying out the case for a crash. Bullion tumbled into a bear market 10 days later, with its biggest two-day retreat in more than 30 years. Societe Generale predicts a fourth-quarter average of $1,200 an ounce, or 7.3% less than now.
“The investors in gold are treating it differently than they were before by ignoring these bigger outside factors,” said Haigh, 43, the bank’s global head of commodities research in New York. “They are basically putting to the sidelines the macro outlook and sentiment outlook, and just dumping gold. Investors are just getting out.”
Assets in exchange-traded products backed by gold slumped by 174 metric tons in April, valued at $8.3 billion at the time and the biggest drop on record. Holdings are now at a two-year low as sales extend into a sixth month, the longest losing streak in data compiled by Bloomberg and a sign of how some investors have lost faith in bullion as a store of wealth.
Prices Tumble
Gold tumbled today to the lowest since September 2010 after U.S. Federal Reserve Chairman Ben S. Bernanke said asset purchases may be reduced later this year. The price is down 23% this year to $1,293.84, on track for its first annual loss since 2000. Bullion’s 12-year run of gains was the longest since at least 1920, according to data compiled by Bloomberg. It peaked at $1,921.15 in September 2011, still less than prices reached in 1980 when adjusted for inflation. Its 1980 record of $850 is equal to $2,409 today, data compiled by the Federal Reserve Bank of Minneapolis show.
U.S. inflation is below the Fed’s target of 2%, reducing demand for gold as a hedge, while buyers sold haven assets including precious metals in favor of equities. The Standard & Poor’s 500 Index reached a record last month and more than $3.4 trillion was added to the value of global stocks since the start of the year. Global bond markets posted their biggest monthly loss in nine years in May.
Predicting Turmoil
Haigh is not alone. Nouriel Roubini, professor of economics and international business at New York University and known as Dr. Doom for predicting turmoil before the global financial crisis began in 2008, says gold may drop to $1,000 by 2015. Goldman Sachs Group Inc.’s Jeffrey Currie, the New York-based analyst who also predicted bullion’s plunge, has said it may fall below $1,200 temporarily. Societe Generale’s Haigh expects prices to average $1,150 in 2014.
In August, when heightened concerns over the 17-nation euro region’s debt crisis made the economic outlook more uncertain, macroeconomic issues, liquidity and the dollar contributed to about 50% of the moves in gold, Haigh said. Supply and demand, including hedge fund flows, central bank buying and coin sales, accounted for the rest, according to Haigh’s algorithm.
On April 2, the day Societe Generale put out its report on gold, the influence of macroeconomic issues, liquidity and the dollar was down to 24%, said Haigh, who leads analysts in London, Paris and Singapore.
Interest Rates
“Around the start of the year, the variables that were important for gold like the dollar and interest rates started to become much, much less important, to the point that they became largely insignificant by around March,” said Haigh, who considers the April call on gold the best of his career. “The fundamentals like central-bank buying and hedge-fund flows really started to change shape around the same time.”
The metal surged 70% as the Federal Reserve bought $2.3 trillion of debt from December 2008 through June 2011, flooding the financial system with cash. Gold tumbled this year amid speculation that improving growth would spur the Fed to taper stimulus. The S&P GSCI gauge of 24 commodities dropped 4.2% this year, on track to outperform gold for the first time since 2009. The MSCI All-Country World Index of equities rose 4.6% while a Bank of America Corp. index shows Treasuries lost 1.9%.
Hedge funds and other large speculators held a record number of short contracts, or bets on lower prices, by May 21, making them the least bullish on gold in more than five years, according to U.S. Commodity Futures Trading Commission data.
Short Gold
The slump in prices spurred demand worldwide for jewelry and coins and the U.S. Mint said June 5 that its sales may be a record this year. That drove a rebound to as high as $1,488.10 on May 3 before the retreat resumed. Investors should short gold if it rallies to $1,400 again, Societe Generale said June 5.
Haigh grew up in Aldwick, a southern English seaside town of about 11,000 people. He earned a doctorate in economics from North Carolina State University in 1998 and went on to teach at the University of Maryland and New York University and was an associate chief economist at the CFTC.
He worked at Societe Generale from 2007 to 2009 before stints at fund-of-hedge-fund manager K2 Advisors LLC in Stamford, Connecticut, and Standard Chartered Bank in Singapore. He has focused increasingly on cross-asset analysis since he returned to the bank in 2011.
Walter Lukken, a former CFTC commissioner who worked with Haigh, remembers him for both his academic approach and his stylish demeanor.
Elvis Costello
“At the time he had these black horn-rimmed glasses and looked like Elvis Costello,” said Lukken, president and chief executive officer of the Futures Industry Association in Washington. “He definitely stood out among the group of economists at the CFTC, not only for his looks, but he was just a smart, outgoing person and an enjoyable guy to be around.”
In addition to the Principle Component Analysis model, the bank has developed an investible Sentiment Indicator that weights commodities in a basket according to investors’ appetite for risk. Since 2008, that indicator has outperformed the Dow Jones-UBS Commodity Index by more than 40%, he said.
Societe Generale’s strategy has brought recognition, with Risk Magazine in February naming it as the year’s best commodities research bank.
Gold first topped $1,000 in 2008 amid the financial crisis that saw the collapse of Bear Stearns Cos. and Lehman Brothers Holdings Inc., the largest bankruptcy in U.S. history. Commodity prices were driven more by macroeconomics than fundamentals at the time and now that’s changing, Haigh said.
Natural Gas
His algorithms aren’t as effective across all commodities. Agricultural products and natural gas have always tended to follow crop cycles and weather conditions, he said.
Nor have all his predictions been as prescient as with gold. A recommendation he made in August 2008 to buy natural gas on the assumption that its discount to coal would increase demand from utilities was among the worst in his career. Prices tumbled 25% that year and slid to a seven-year low in 2009 amid increasing supplies from shale reserves in the U.S.
“These markets are dynamic,” said Haigh, who lives in New York with his wife and one-year-old son, and who still supports West Bromwich Albion, the English soccer club he’s followed since childhood. “In the case of natural gas, it went through a transformation because of its technology, whereas today the markets have gone through a transformation because what influences them is changing.”
“If you ignore either one of those, it hurts,” he said. “You have to continually evolve what you look at.”
Economic Outlook
Demand for gold as a haven tends to increase during periods of uncertainty, while investors take on assets perceived as riskier when the economy improves. The Fed may cut back on its quantitative easing program, reducing expectations for inflation, Haigh said. The central bank is adding funds to the financial system buying $85 billion of Treasury and mortgage debt a month. Policy makers will trim that to $65 billion in October, the median of 59 economist estimates compiled by Bloomberg this month shows.
The U.S. economy expanded at an annualized rate of 2.4% in the first quarter, and that will accelerate to 2.8 in the first three months of 2014, the median of 70 economist estimates compiled by Bloomberg show. The World Bank raised its 2013 U.S. growth forecast to 2% on June 12, from a January prediction of 1.9%.
Even as commodity analysts’ focus shifts back to supply and demand, macroeconomics won’t disappear as a source for predicting price movements, Haigh said.
“We’re in an environment where fundamentals are returning to commodity markets in terms of explaining their price movements,” Haigh said. “But it’s an environment where we will never be independent again from the broader macro picture.”
