It's been a while since Wall Street banks recommended anything to do with either gold or gold stocks, but in a surprising reversal, last week one of Wall Street's biggest bulls Credit Suisse said that the time has come to use gold stocks as a risk off diversifier, while seeing material upside for the precious metal.
Here is why CS' global equity strategist Andrew Garthwaite, believes that it is now time to buy gold:
- First, according to Garthwaite, the valuation of gold stocks is abnormally cheap on both P/E - trading at a 25% discount to the broader market vs a 30% premium normally, and also cheap on a price-to-book basis relative to the market
- Looking at individual stocks, Credit Suisse writes that its "outperform"-rated stocks which screen cheap and have positive earnings revisions are: Newcrest Mining, Newmont, Endeavour Mining, Perseus, Regis Resources, St Barbara, Agnico Eagle Mines, Barrick Gold, Kinross Gold, Yamana Gold
As for the metal itself, the Swiss bank notes that gold is also at the bottom end of its 10-year range against silver or industrial commodities and 20% below its 2011 peak in real terms.
According to the Credit Suisse model, the price of gold is driven by the TIPS yield and the dollar. Why does this matters?
Recently, the gold price has lagged the fall in TIPS yield (should be 5% higher). Looking at TIPS yields, Garthwaite sees little change; the more investors fear an inflation tail risk as they do on the UoM or FOMC data, the more they will likely want to buy inflation protection and the more expensive the TIPS yield becomes.
As for the dollar, CS remains structural bears. The last time the European current account surplus was this high against the dollar, the euro was 30% higher. Meanwhile, the US current account deficit is not improving with US net debt now at 70% of GDP (anything above 50% according to the IMF, could cause a currency crisis) and globally the world is overweight dollars (60% of FX reserves and 25% of GDP). Speculative positions are at one-year highs.
Combining the two signals, the bank's model suggests 7% upside potential to the gold price.
But while gold may be undervalued in strictly fundamental terms, there is always a risk that central banks will lose control and markets will crash. Gold fixes this, because as Garthwaite writes, "Gold is a hedge against extreme financial deleveraging" and adds:
The level of government debt, deficit and corporate debt is extreme. We continue to believe that if the TIPS yield gets much above zero, that would start to cause the markets to worry about a debt trap and that in turn could lead to a major risk-off trade. This could then prompt a Fed response driving down real yields (and debasing money).
Additionally, gold is also a hedge against the explosive global money supply:
We think this will also cause central banks to buy more gold (as currencies are being debased). Central banks account for 12% of gold demand. If all central banks had a minimum of 10% in gold, then gold demand would increase 1.6x, on our calculations.
What about crypto? If bitcoin is digital gold, is gold then the physical bitcoin? Well, not really: according to Credit Suisse, the disintermediation risk from cryptocurrencies appears to have decreased.
Digging deeper into this, Credit Suisse sees that following constraints on the ability of cryptos to disintermediate gold:
Finally, gold's technicals also hint at a potential upside breakout, with speculative positions neutral, while gold is trading close to its six-month MA.
Of course, none of this matters as long as the BIS strategically lends out paper gold to its member banks who have a net deficit in the thousands of tons, and tactically decides to slam the bid every time there is an even modest breakout to make sure that golden animal spirits never emerge.