During his testimony before the House Budget Committee, when asked about the recent move in the price of gold to a fresh all time high, the Princetonian, who usually has an answer for everything, was stumped: "the signal that gold is sending is in some ways very different from what other asset prices are sending" he said, adding that "the spread between nominal and inflation-indexed bonds, the break even, remains quite low, suggesting that markets expect about 2 percent inflation over the next 10 years." The fact that TIPS are linked to the most manipulated indicator in the government's arsenal the CPI, was not mentioned. But back to gold, Ben Shalom concluded "gold is out there doing something different from the rest of the commodity group." Yes, Ben - it is indicating that your policy of endless fiat dilution is about to come to a forced end. But don't take our word for us. Here is a report from Credit Suisse which explains not only why the firm sees gold rising promptly to $1,360 but possibly going much higher - and this is from a bank whose very existence is contingent on gold prices staying sufficiently low for some marginal credibility in fiat to still remain.
Here is what CS has to say about gold:
We on the global strategy team remain overweight of gold (last October we forecast a $1,200 gold price) – and see the risk that the gold price could rise another 10% to 20%. We acknowledge that our view on gold is more positive than the house view (now under review) – and that there are short-term downside risks (most importantly, a pull-back in worries about sovereign debt). However, we believe the following factors are supportive of the gold price:
- The macro environment: gold tends to do well when the real Fed Funds rate is below 2%, as it is now. We expect that the inflation-adjusted Fed Funds rate will remain below 2% for at least the next three years (the 10-year inflation swap is 2.5%, while the end-2011 Fed Funds future is 1.2%, implying a real Fed Funds rate of negative 1.3%). The Fed normally does not raise rates until 19 months after the peak in unemployment, which would imply March 2011, and this time around there are plenty of reasons why tightening could be postponed further (the output gap is -5%, bank credit is contracting at 2% yoy and net fiscal tightening is nearly 2.6% of GDP next year);
- We see a 80% chance that the macro environment will be supportive for gold. There are, we think, five possible macro scenarios, in three of which gold is likely to do well: i) a renewal of QE, either as a response to a sovereign credit crisis or a double dip (35% chance); ii) an economic recovery during which central banks keep policy abnormally loose (40%); iii) a major sovereign default, outside of Greece (5%). The scenarios which would be bad for gold have, we believe, a lower aggregate probability: (iv) a normal recovery with the normal amount of monetary tightening (15% chance); (v) renewed deflation with no renewal of QE (5%). If there were a double dip, we feel that QE would be renewed more quickly than fiscal policy would be eased. After all, the US/UK have done QE, the ECB is half way there and the BOJ thinks of itself as doing QE at the moment.
- A low proportion of FX reserves is in gold. Just 1.6% and 2.5% of China and Japan’s reserves are in gold, compared to 70% and 66% for the US and Germany. If the PBoC and BoJ were to put 10% of their reserves in gold, the increase in demand for gold would be 3.5x annual mine production.
- Shortage of a reserve currency. There are no safe big-cap currencies: the Yen has been strong, but the BOJ is engaged in QE; the US is still running a current account deficit, has c1.5$trn of excess consumer leverage and a primary budget deficit of 7.5%; and ECB will, we believe, embark on QE. The only currencies that look relatively safe tend to be either commodity plays (and hence too cyclical) or in NJA (and hence do not represent diversification for the PBoC).
- Low aggregate weightings in gold. Global ETFs may have seen strong inflows, but still represent just 0.7% of global funds under management.
- The real gold price is still 34% off its all time high and the behaviour of gold is not yet typical of a bubble.
- Credit Suisse gold analyst Dr David Davis believes that the cost of producing gold will be $1,400 by 2015, but the future market price is only $1,360. [uhm, that makes sense] Gold stocks still look relatively cheap. We continue to recommend clients buy the cheap gold stocks (Newmont Mining).
Full report with numerous pretty charts here.