Commodities | Mar 01 2013
– CIBC sees a lower gold price ahead
– Denounces the monetary inflation argument
– Denounces the CB and ETF support argument
By Andrew Nelson
It’s been an amazing decade for gold. Prices have rallied some 500% since 2002, making it one of the best performing assets classes around. But things have slowed down a bit of late and every day gold holds steady, posts a gain, or books a decline, investors are forced to wonder whether it can hang on to that 500% run.
Commodities analysts from CIBC World Markets are starting to think that at least some of it must go. The Canadian bank notes that many of the forces that made gold such an attractive buy are starting to fade and that expectations for new supportive factors are unfounded. Sure, gold will shine brightly again one day, but it probably won’t be over the next few years.
CIBC explains that the metal is mainly bought as an investment instrument for two reasons that have everything to do with its asset opposite: cash money. Those reasons are inflation and currency depreciation. Over the past ten years or so it has been inflation, sometimes coupled with steep currency depreciation, that has provided the main impetus for holding gold rather than its most popular alternative, the US dollar.
Inflation is pretty unlikely, says CIBC. CPI inflation has all but melted away in the US and pretty much across the rest of the developed world. There are a few blips on the radar, like rising activity in the developing world and India might have something to keep an eye on. But the bank thinks Indians would likely be better off holding assets in an alternative currencies, like the dollar, rather than piling into gold.
Monetary conditions are pretty much super-easy everywhere, but there is nothing to give even a hint of in inflation the US, Europe and Japan. Even wage pressures remain moderate. The bank reckons the only thing supporting what is currently an inflation myth is a distinct lack of understanding about what the Fed and other major central banks are trying to accomplish with current monetary policy.
The fear is that central banks, especially the Fed, have been printing money with such reckless abandon that some form of super inflation will be the last chapter of the story. And of course gold is the magic hedge against such a loss of purchasing power. This view is simply unfounded, the bank noting that in reality, money growth really hasn’t been all that brisk.
We need to remember that the Fed's buying of bonds doesn’t cause new cash to be printed. Thus, reserves of some US$1.5 trillion are not money and don’t actually count in overall money supply. Sure, reserves are held for things like lending, but they are not the only driver. One must account for capital requirements, risk tolerance and loan demand, which help to keep in place a natural curb. Remember, the reason we have all of this cheap money is because credit collapsed and still has a ways to go to catch up. This means there is plenty of time for rates to be reined in and it might be worth worrying about when growth does improve and inflation is actually a visible threat.
So that’s inflation put to bed, but what about US dollar devaluation? CIBC points out that from 2002 to 2008 the greenback lost serious ground against most other majors like the euro, yen, Canadian dollar, Aussie dollar, sterling the Swiss franc etc. But the bank points out that this was all about a seriously overvalued dollar. A dollar that still looks rich against the Chinese yuan. The bank reckons this old chestnut has already been put to bed as well and will be asleep soon given the trade balance is quickly being addressed by US crude production and moderating gasoline demand, which is slowing imports.
You also have Europe in the mix. CIBC points out that Europe is indeed in recession again, making it likely that US monetary policy will tighten long before that of the ECB. Thus, the dollar is likely to recoup more of its earlier weakness against the euro.
So now we have no inflation support, and no dollar devaluation support. So what’s left?
There is gold price support still coming from the return of central banks as gold buyers. Yet, CIBC points out that these banks really haven’t made much of a dent over the past ten years as buyers. Sure, when banks were net sellers gold rallied 250% from 2002 to 2009, but CIBC notes that gold has now peaked just as some central bankers are adding weight. Thus, there is little support to be had from this factor.
ETFs, on the other hand, have had an impact. Right now, these funds are holding more than 2,500 tonnes, which is close to that of the IMF. But ETF buying has had little to do with currencies; rather they have been seen as a viable investment alternative to equities that were incredibly volatile.
The problem with the ETF support theory is that since 2009, while still active buyers, the ETF crowd have had little effect in pushing up prices. CIBC sees the ETF stockpile and less so long positions in futures markets as representing a significant risk to gold. Should investors all of a sudden decide that their money would do better elsewhere then the selling would commence in earnest.
And we all know, at least anecdotally, that cash has already started moving from the sidelines into equities markets.
Ultimately, CIBC sees US rate hikes in 2015 with a year’s worth of talk preceding them. This will push up bond yields, so the opportunity cost of holding a gold bar with a zero yield will also be increasing .Given the view of a rapidly improving US and China in 2014 and we should see significant support emerging for shares. In fact, CIBC reasons one of the reasons ETF buying has slowed since 2011 is that investors are trying to ready themselves to jump back into stocks.
It shouldn’t add up to a freefall for gold, it will take time for the gold bugs to feel comfortable with the Fed and other central banks in their efforts to keep inflation under control as the economy recovers. This process will unfold slowly. But a continued slide to US$1,500 an ounce would still mean that gold will underperform equities over that two-year period.
Commodities analysts at ANZ Bank have cut their forecast for the average price of gold in 2013 to US$1,690/oz, down 6.7%. The revision partly reflects a shift in the market's perception towards previous USD weakness and the ongoing debate within the US on the Fed's eventual quantitative easing exit strategy. ANZ also sees pressure coming from from slowing investment demand for gold in the West and a move towards more growth-oriented assets.
Analysts at Deutsche Bank also reckon the market has lost interest in gold this year, noting other so called safe havens such as the Japanese yen, Swiss franc and US Treasuries are now attracting the flows. Concurring with CIBC, Deutsche sees the recent softness in gold as a function of the US equity risk premium, the US dollar and holdings in physically backed gold ETFs.
Deutsche expects gold returns will eventually recover, although it believes this will need a slowing in growth expectations accompanied by a correction in global equity and interest rate markets.
Analysts at CIMB are on a completely different page than those at CIBC, ANZ and Deutsche, having maintained a positive stance on gold in the short term given the prospect for further monetary easing, central bank buying and rising inflation. The bank does admit gold is flat right now and notes it will require a major catalyst to move higher in the short term.
The catalyst? Upcoming US debt ceiling negotiation is the main one, says CIMB.
Lastly and on a technical note, UBS says the charts are indicating gold is approaching a major support level at around US$1535/oz. If we were to see a breach at this level, the next stop could potentially be the Fibonacci 38.2% retracement level of US$1440/oz, or even the 50% retracement level of US$1300/oz.
Conversely, were the US$1535/oz level to hold, the price could potentially bounce to a resistance target of US$1790/oz. At least that’s what UBS suggests.
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