Rupert Hargreaves: “We believe that precious metals remain a relevant asset class in modern portfolios, despite their lack of yield,” said Goldman Sachs in a recent report on the dilemma of what investors should do about falling gold price . “They are neither a historic accident or a relic,” the report, titled “Fear And Wealth” continued.
Following the financial crisis, demand for gold skyrocketed as investors looked to protect themselves from the much-feared rampant inflation following QE that was about the grip the world. This inflation never materialized, and now that the Federal Reserve is beginning to wind down its asset buying, demand for gold is evaporating.
However, according to Goldman, investors shouldn’t give up on the asset completely. Sentiment towards gold tends to move quickly, as uncertainty grows/falls. That’s why the asset should continue to hold a place in investors’ portfolios:
“Stated more simply, we are talking about the drivers of ‘risk-on, risk-off’ behavior in markets…This factor matters so much to gold precisely because it is a safe-haven asset. Accordingly, as uncertainty increases, preferences shift towards having more gold in the portfolio, driving prices higher. Fear can spike or fall quickly, and since DM economies tend to have more wealth to reallocate as the world gets riskier, this is both a medium- to short-run driver and more one exposed to the DM growth outlook.”
There’s also the long-run demand picture to consider:
“As more EM economies — including China — are set to grow to these income levels over the next few decades, the underlying long-term demand picture remains supportive of gold prices…While fear can spike or fall relatively quickly, wealth tends to accumulate slowly. This makes wealth an important, but easy to overlook in short-term forecasting, driver of gold.”
Gold prices have been on the backfoot since reaching records in 2012. For 2012 the price of gold averaged $1,669 an ounce, compared to $1,249/oz year to date.
Analysts at Incrementum AG note blame the recent price weakness on rising global equity markets. In the firm’s 11th annual “In Gold we Trust” report, the analysts point out that today, with the falling gold price and rising equity markets, relative valuation of commodities to equities seems extremely low compared to history. Specifically, in relation to the S&P500, the GSCI commodity index is currently trading at the lowest level in 50 years. Also, the ratio sits significantly below the long-term median of 4.1.
With gold prices looking cheap on a technical basis, the analysts at Incrementum also like the look of gold from a fundamental perspective. As mentioned above, the post-crisis thesis for gold prices was that central bank money printing would lead to rampant inflation. For the past decade, inflation has remained subdued, but now it looks as if it is picking up again — a positive sign for gold and other commodities investors.
Finally, the case for 5,000 gold prices below, caveat emptor.
Peter Schiff – News of hotter than expected inflation numbers caused gold to sell off Tuesday. The markets seem to think rising inflation is bullish for the dollar and bearish for gold prices.
But is it really? Is higher inflation really bad for gold prices?
As Peter Schiff points out in his latest podcast, this whole notion is rather absurd.
The news of the day Tuesday revolved around import/export prices.
Import prices were expected to rise 0.5 and were up 0.7. Export prices also came in stronger than expected, rising 0.8 compared to an expected increase of 0.4. Year-over-year, import prices are up 2.7%. This is well above the 2% level the Federal Reserve is looking for.
Of course, the Fed fixates on the consumer price index, but obviously, import/export prices have a major impact on overall consumer prices. In fact, Peter says he thinks the import/export price number represents a better gauge of inflation than the CPI because the methodology is more objective.
The immediate market reaction to the import/export numbers was to buy the dollar and sell gold. But Peter raises an important question: Why is higher inflation bad for gold?
After all, the main reason to buy gold is an inflation hedge. If you think there’s going to be more inflation, you buy gold. But perversely, the way the markets work now, you sell gold if you think there’s going to be more inflation. In fact, you buy the currency of the country that is experiencing more inflation, which is kind of counter-intuitive because inflation by definition is the currency losing value. So, if the currency is losing its purchasing power, why would you want to buy more of it?”
As Peter pointed out, speculation about what the Federal Reserve may or may not do now drives the market more than this fundamental truth. Everybody thinks higher inflation increases the likelihood the central bank will raise interest rates and embark on tighter monetary policy.
It is the expectation that these higher numbers will produce a tighter Fed – that is what rallies the dollar. That is what hurts gold prices. It’s the anticipation of higher rates to fight off the inflation.”
This also explains why we’ve seen some headwinds in the gold market and a strengthening dollar as speculation swirls around who Trump will tap to serve as Fed chair when Yellen’s term ends next year. Many analysts think the president will pick a “hawkish” policymaker” who will hold interest rates higher.
Peter says fixating on the Fed and inflation is a mistake.
Reality is the Fed will ignore the higher inflation numbers and do nothing. Whatever it’s going to do with rates, it’s going to do it regardless of these numbers. And ultimately, if the Fed has to make a choice between fighting inflation and unemployment – because the Fed believes in this Phillps Curve tradeoff between inflation and employment – the Fed will always choose to fight unemployment or to prop up the labor market and sacrifice its inflation goal. It doesn’t care if inflation goes up. It’s more concerned about employment, or the economy, or maintaining asset bubbles, or propping up the US government and making it so it doesn’t have to default on its debts. The reality is higher inflation is not going to produce a tighter monetary policy.”
Peter compared inflation to a fire. The Fed is going to have to ignore the fire. That means it will get worse. The fire will get bigger because the central bank thinks putting it out will do more harm than letting it burn.
If traders understood this – that higher inflation just means that it’s going to get even worse – then they would be dumping the dollar. They would be buying gold.”
The real interest rate equals inflation minus the nominal interest rate. So, even if the Fed pushes up nominal rates, the real rate can continue to fall in a high inflation environment. Peter said even if the Federal Reserve does push interest rates higher, it probably won’t be able to keep ahead of the inflation curve.
So, the markets have got it completely wrong when it comes to how to react to inflation. Inflation is good for gold prices and bad for the dollar. So, when you see these kind of selloffs like we saw today – these are buying opportunities. This is an opportunity to buy from people who don’t know what they’re doing because they’re just focusing on this short-term relationship that is wrong.”
Goldman Sachs says precious metals remain a “relevant asset class” sought as a safe haven in response to “fear” in developed-market economies, while purchases tend to be tied to growing wealth in emerging-market economies.
The bank released a report Tuesday, titled “Fear And Wealth,” that was not a traditional investment-bank gold forecast but assessed the factors that tend to influence demand in both developed and emerging economies. This combination of fear and wealth accounted for a greater-than-400% rise in gold prices over the two decades since the metal bottomed in the late 1990s, Goldman said.
“We believe that precious metals remain a relevant asset class in modern portfolios, despite their lack of yield,” the bank said. “They are neither a historic accident or a relic.”
The physical properties of an ideal long-term store of value — durability, portability, divisibility and intrinsic value – explain why precious metals were initially adopted and why they remain relevant today, Goldman said.
The so-called fear factor tends to be more important in the short to medium term in developed nations, Goldman said. While real interest rates and economic expectations play a role in gold demand, so do debasement, sovereign balance-sheet, geopolitical and other market risks.
“Stated more simply, we are talking about the drivers of ‘risk-on, risk-off’ behavior in markets,” Goldman said. “This factor matters so much to gold precisely because it is a safe-haven asset. Accordingly, as uncertainty increases, preferences shift towards having more gold in the portfolio, driving prices higher. Fear can spike or fall quickly, and since DM economies tend to have more wealth to reallocate as the world gets riskier, this is both a medium- to short-run driver and more one exposed to the DM growth outlook.”
The global financial crisis highlighted the purchasing that occurs based on fear, Goldman said.
“The re-emergence of structural tail risks in developed markets led to a significant rotation towards more defensive portfolios and a reassessment of central bank’s gold-selling policies. This has been manifested in higher retail and ETF [exchange-traded-fund] purchases — still more than twice as high in 2016 as in 2006 — and DM central banks halting all sales of gold stocks since 2009.”
Nevertheless, the bank said, with the global economy strengthening and more rate hikes expected from the U.S. Federal Reserve in 2018 and 2019, “we expect that the fear factor will moderate over the next 12 months, likely driving a moderate rotation out of gold for DM investors.”
Meanwhile, gold demand in emerging economies tends to rise when wealth does likewise. Rapid accumulation of gold tends to occur when per-capita gross domestic product reaches roughly $20,000 to $30,000, Goldman said.
“As more EM economies — including China — are set to grow to these income levels over the next few decades, the underlying long-term demand picture remains supportive of gold prices,” Goldman said. “While fear can spike or fall relatively quickly, wealth tends to accumulate slowly. This makes wealth an important, but easy to overlook in short-term forecasting, driver of gold.”
A boom in income and savings in emerging-market economies since 2000 created new consumers for gold demand, Goldman said. In fact, the bank pointed out, China’s and India’s combined share of the gold jewelry market increased from 25% to over 60%.
China’s jewelry and investment demand is around 0.5 gram per person per year, Goldman said. “Our modeling, based on the historical experiences of 29 countries at various stages of development since the early 1990s, suggests that this is still very far from peak annual demand,” the bank said.
As for other precious metals, Goldman said silver primarily moves in response to gold prices and industrial demand.
“In the medium term, divergence between the two prices is primarily driven by changes in industrial demand for silver and to a lesser degree, silver supply. This means that silver tends to outperform gold during the expansion phase of the business cycle when industrial demand growth is strong,” the bank said.
“It should be noted however that since 2011, silver industrial demand diverged from the global business cycle due to the substitution for base metals (initiated by the 2011 silver price spike), but we expect this disconnect to be temporary.”
Meanwhile, due to less safe-haven investment demand and the potential for physically tight markets, platinum group metals tend to be priced like other industrial commodities.
“The price of a basket of PGMs must reflect the price of the incentive mine project necessary to balance the market,” Goldman said. “The ratio of individual PGM prices then has to be determined as a function of relative on-ground stocks and market balances.” – Allen Sykora
As gold prices retreated below its key psychological level of $1,300 in after-hours trading Monday, one precious metals expert remained optimistic, saying that the metal could hit new all-time highs by 2020.
“By 2020–2022 we would see record high gold prices in terms of nominal annual average prices,” the managing director of CPM Group Jeff Christian said in an interview with Macro Voices. “For the annual average price to be $1,650 or $1,700, that means that you’re going to have gold prices knocking on the door of $2,000.”
In the short-term, Christian said good things are in store for the yellow metal, with prices going as high as $1,360 an ounce.
“Over the next few months the price is probably going to move back up toward $1,340 to $1,360 – into late November and December,” Christian said. “Then getting into 2018, depending on what happens in the global financial markets, we think that the gold price will probably continue to rise at perhaps a slightly faster rate than it has risen in the last couple of years.”
As Asian markets opened, spot gold on Kitco.com was last seen trading at $1,293.50, down 0.08% on the day.
Christian is not as excited about silver, adding that his outlook for the white metal has a “firm ceiling” at around $19 over the next several months.
“We’re looking for silver to move sideways,” he said. “Silver is a financial asset, to some extent, like gold. But it’s much more of an industrial metal and an industrial commodity . . . One of the things that you see is that investment demand really drives prices higher or lower, and investors are much more focused on gold right now, it seems, than they are on silver.”
In terms of future drivers for the metals, the search for a new Federal Reserve Chair should not have much of an impact, according to the expert.
“Concerns over who comes in at the Fed will ruffle the markets, and you’ll see the usual little volatilities as people jockey, but that’s largely meaningless to the bigger issue, which is that the Fed probably will continue to suffer from a diminution of respect on a global basis,” Christian said.
This distrust of what the Fed is doing to the U.S. economy could translate into higher gold prices, he explained. “Part of our view of gold prices rising over the next five years is predicated on the view that there’s going to be concerns about the future of monetary management in the United States and on a global basis.” – Anna Golubova
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