Alarm bells are ringing everywhere as Goldman (which joins UniCredit in boosting its gold price target) may have just picked the short-term top in gold, after it revised its 12 month target from $1,365 to $1,650. And while David Greely's track record is nowhere near as atrocious as that of Goldman's FX team which manages to top tick the EURUSD every single time, the fact that Goldman is now opening Long Gold recommendations (to go with its current trading recommendations of long Corn, Copper, Platinum and WTI) is reason for big worry. Recall which bank was getting its clients to go all in in crude 2008 when oil was $140+. We would be very cautious when Goldman is on "your" side of the trade. Nonetheless, the firm is pretty much spot on "We believe that a return to quantitative easing will act as a strong catalyst to carry gold prices to even higher levels."
Here is Goldman's full revised target. Compare this to the most recent 12 month gold target by Greenlaw from August of $1,365.
And here is Goldman's extended thesis on gold, which is a simple one, and fundamentally identical to what we have been saying for years: buy gold until the Fed begins to tighten. Which means forever and never.
Gold rally to continue, for an extended period
Gold prices have rallied strongly since early August. The rally began as net speculative long positions rebounded from what we argued were oversold levels (see Precious Metals Update: Gold market poised for a rally as US real rates head lower, August 11, 2010). The initial rebound, however, extended into a new rally as 10-year US TIPS yields plummeted with the growing prospect of another round of quantitative easing by the US Federal Reserve, sending the price of gold through our $1,300/toz 6-month price target and to new record nominal highs above $1,350/toz, just shy of our $1,365/toz 12-month target (Exhibit 1).
US real interest rates have fallen with the slowdown in the pace of the US economic recovery and the growing prospect of another round of quantitative easing. With TIPS yields now closer to 0.50% then the 1.00% embedded in our prior forecast, we expect gold prices to continue to climb (Exhibit 2). Despite the rebound in net speculative length, it remains well-below levels consistent with the current low US real interest rate environment.
We expect positions to continue to climb with quantitative easing a catalyst to lift positions and prices higher. Accordingly, we are now raising our gold price forecasts to $1,400/toz, $1,525/toz, and $1,650/toz on a 3, 6, and 12 month horizon, respectively. This raises our 2011 average gold price forecast to $1,575/toz, $175/toz higher than previously. We are also opening a trading recommendation for a long position in the Dec-11 COMEX Gold contract.
While we view the level of US real interest rates as the primary driver of gold prices in the current environment, stronger monetary demand for gold from both gold-ETFs and central banks than we currently expect creates upside risk to our gold forecast. In particular, gold- ETF holdings have been quite stable in recent months, suggesting that gold prices could move even faster to our year-end target should ETF buying return following the new record highs in gold prices and the announcement of quantitative easing, which our US economics team expects to occur as early as the November FOMC meeting.
Speculative positions rebound from oversold levels, but continue to chase falling US real interest rates
Gold prices have rallied strongly since early August, trading through our 6-month $1,300/toz price target and setting new nominal highs above $1,350/toz. The first leg of this rally took place in August with prices returning to their June $1,260/toz highs on the back of a strong recovery in COMEX net speculative length from what we argued were oversold levels (see Precious Metals Update: Gold market poised for a rally as US real rates head lower, August 11, 2010). Speculative long positions tend to move inversely with US real interest rates (see Exhibit 3), with more speculative length translating lower US real interest rates into higher gold prices. As of early August however, there had been a large disconnect between the light COMEX net speculative positioning and low US real rates.
Specifically, net speculative length had declined to near year-to-date lows just as US real rates, as measured by the 10-year US TIPS, dropped to a decade low 1% (Exhibit 4). As we argued then, the real rate to net speculative positioning relationship suggested that a correction would increase net speculative length by 9 million toz. This move has mostly taken place.
However, even as speculative longs were moving back in line with low US real interest rates, US real interest rates began to plummet with the growing prospect of another round of quantitative easing by the US Federal Reserve. After gold prices stalled at their June highs, the break to the upside came on September 13 amid a heightened market focus on the potential for a return to quantitative easing, with US 10-year Treasury and TIPS yields falling, and the US dollar declining against the euro. Gold prices were further propelled to their current new highs after the US Federal Reserve signaled in the September FOMC statement that it was willing to ease further. However, as US real interest rates have fallen, the increased in net speculative length in COMEX gold futures has lagged behind, and is well-below levels consistent with the current low real rate environment, pointing to further upside to gold prices.
Specifically, the recent real rate to net speculative positioning relationship would suggest that the current 0.50% US 10-yr TIPS yield should push net speculative length to a record 37 million toz. Historically, a 1 million toz increase in COMEX gold futures long positions translates into a 0.87% near-term increase in gold price (see our report Commodities: Frameworks: Forecasting gold as a commodity, March 25, 2009 for details). This implies that this 7 million toz increase from last Wednesday levels would point to a 6.1% rally in gold prices, all else constant, taking current prices to new highs of $1,425/toz, pointing to further near-term support to gold prices (Exhibit 5).
While the recent decline in US real rates suggests further upside to gold prices in the near term, our US economic outlooks suggests that US real interest rates will stay lower for longer and support a continuing rally in gold prices.
Our US economic outlook suggests US real interest rates will stay lower for longer with renewed quantitative easing an effective catalyst to carry gold prices higher We had previously based our outlook for gold prices on the expectation that US real rates would remain in a 1% to 1.5% range; however, the recent deterioration in the US economic outlook and the prospect for renewed quantitative easing has brought 10-year TIPS yields below 0.50%. Our US economist and fixed income strategist outlooks suggest that these levels are sustainable and we expect this to support COMEX gold net spec positions at significantly higher levels and in turn push USD-denominated gold prices significantly higher.
Specifically, the key driver of the sharp decline in US real rates has first been the re-pricing lower of US growth expectations as the economic recovery has lost a considerable amount of its momentum. Our US economists forecast the significant slowing in US growth in 2H10 to extend in 2011 and, in turn, our fixed income analysts see 2.50%-2.75% as the new likely yield range for 10-year US Treasuries into 2011. Our US economics team also expects that the Fed will return to quantitative easing measures with purchases of US Treasury securities of $1 trillion which in turn should likely keep US bond yields depressed. They further expect that such a program will be announced at the November 2-3 FOMC meeting. The growing likelihood of such a move has been the key catalyst to push US real rates sharply lower since early September. We believe that a return to quantitative easing will act as a strong catalyst to carry gold prices to even higher levels.
These outlooks suggest that the current low US real rate environment will persist and in turn support gold price. At current US TIPS yields of 0.50% and in the absence of net buying or selling from gold-ETFs and central banks, our gold framework points to average gold prices of $1,600/toz (see Exhibit 6). We expect further monetary demand for gold and are accordingly raising our COMEX gold price forecast higher to $1,400/toz, $1,525/toz, and $1,650/toz on a 3, 6, and 12 month horizon, from $1,260/toz, $1,300/toz and $1,365/toz respectively. Our updated forecast points to a $1,575/toz average price in 2011, $175/toz higher than we previously expected. We are also opening a trading recommendation for a long position in the Dec-11 COMEX Gold contract.
Longer term, we continue to expect that prices will come under downward pressure once the US economy strengthens and the US Federal Reserve begins to tighten monetary policy. As discussed by our US economists, models suggest that it might in fact take until 2015 or longer before a rate hike became appropriate although they emphasize that this is a scenario, not a formal forecast (see US Views: Sealing the Case, October 11, 2010). While they do not expect tightening to happen before 2012 at the earliest, we view an earlier than- expected tightening of US monetary policy as the primary downside risk to our gold price forecasts. Specifically, our modeling of gold prices against real rates suggests that a recovery of US real rates to 1.5% would bring gold prices down to $1,220/toz over the medium term.