Lowering our gold price forecast further and recommending a short COMEX gold position
Gold unfazed by Cyprus, recent slowdown in US recovery
Over the past month, events in Cyprus have triggered a resurgence in Euro
area risk aversion while US economic data has started to disappoint.
Remarkably, gold prices are unchanged over that period, despite US 10-
year TIPS yields back at their lowest level since late 2012, highlighting how
conviction in holding gold is quickly waning. This is particularly visible at
the ETF level with gold holdings continuing to decline quickly. Importantly,
our economists expect that ramifications from Cyprus will be contained
and that the recent US slowdown, so far consistent with their forecast, will
not derail the faster recovery they expect in 2H13. Net, a large rebound in
gold prices is unlikely barring an unexpected sharp turn in the US recovery.
Turn in gold prices accelerating; closing our long gold position
Given gold’s recent lackluster price action and our economists’ expectation
that the acceleration in US growth later this year to above-trend pace will
support US real rates, we are lowering our USD-denominated gold price
forecast once again. Our new forecast is further below the forward curve
with year-end targets of $1,450/toz in 2013 and $1,270/toz in 2014. As a
result, we recommend closing the long COMEX gold position that we first
initiated on October 11, 2010 for a potential gain of $219/toz, with the risk
reversal overlay expired on March 25. Our long-term gold price forecast
(2017+) remains at $1,200/toz: while higher inflation may be the catalyst for
the next gold cycle, this is likely several years away.
Initiating a short COMEX gold position as our ECS Top Trade #8
While there are risks for modest near-term upside to gold prices should US
growth continue to slow down, we see risks to current prices as skewed to
the downside as we move through 2013. In fact, should our expectation for
lower gold prices continue to prove correct, the fall in prices could end up
being faster and larger than our forecast, as aggregate speculative net long
positions across COMEX futures and gold ETFs remain near record highs.
We therefore recommend initiating a short COMEX gold position as our
ECS Top Trade #8, implemented through an S&P GSCI® front-month
rolling index to further benefit from the contango in the COMEX future
curve, targeting a move to $1,450/toz with a stop at $1,650/toz. While we
may be end up too early in entering this trade, we prefer that to being late
given our belief that the skew to current prices is to the downside.
Turn in gold cycle accelerating
Despite resurgence in Euro area risk aversion and disappointing US economic data,
gold prices are unchanged over the past month, highlighting how conviction in
holding gold is quickly waning. With our economists expecting few ramifications
from Cyprus and that the recent US slowdown will not derail the faster recovery they
forecast in 2H13, we believe a sharp rebound in gold prices is unlikely. Given gold’s
recent lackluster price action and our economists’ expectation for higher US real
rates, we are lowering our USD-denominated gold price forecast once again. This
revision further increases our conviction that the turn in the gold cycle is
materializing and our new forecast is further below the forward curve with year-end
targets of $1,450/toz in 2013 and $1,270/toz in 2014. As a result, we recommend
closing the long COMEX gold position that we first initiated on October 11, 2010 for a
potential gain of $219/toz, with the risk reversal overlay expired on March 25. While
there are risks for modest near-term upside to gold prices should US growth continue
to slow down, we see risks to current prices as increasingly skewed to the downside
as we move through 2013. In fact, should our expectation for lower gold prices
continue to prove correct, the fall in prices could end up being faster and larger than
our forecast, as aggregate speculative net long positions across COMEX futures and
gold ETFs remain near record highs. As a result, we recommend initiating a short
COMEX gold position as our ECS Top Trade #8, implemented through an S&P GSCI®
front-month rolling index to benefit from the contango in the COMEX curve.
We entered 2013 expecting that an improving US economic recovery would eventually
offset further Fed easing and trigger a decline in gold prices in the second half of the year.
The decline in gold prices started earlier than we expected, however, on the combination of
better-than-expected US economic data, a more hawkish interpretation of recent Fed
communication and a lower level of US fiscal and European sovereign risks. Net, COMEX
gold prices declined $115/toz between December 5, 2012 when we published our gold
outlook (Gold cycle set to turn on improving US recovery) and mid-March. With this move
lower triggered by the unexpected sharp improvement in the three risks that we initially
thought could support gold prices in 1Q13, events since mid-March have finally offered
potential catalysts for a rebound in gold prices. And yet, gold prices have remained
unfazed by the recent resurgence in Euro area risk aversion and disappointing US
economic data, currently trading at their level from a month ago, $1,585/toz.
Gold prices unfazed by Cyprus…
While gold prices rallied initially on news of the Cyprus bailout, this move was modest at
only $22.5/toz (1.4%) between the close of Friday, March 15 before the bailout
announcement and the intraday highs of $1,615/toz on Tuesday March 19, with gold prices
range bound after that despite the uncertainty surrounding a revised package. Further, the
EUR declined twice as much as USD gold prices, in sharp contrast to the larger USD gold
moves observed during the last quarter of 2011 when fears that Greece would leave the
Euro area were at their highest (as measured against the two-year standard deviation of
rolling three-day returns).
We believe this price response was warranted: although events in Cyprus have triggered a
resurgence of Euro area risk aversion, our economists believe that ramifications will be
contained. Cyprus is significantly less systemic than Greece and the ECB’s OMT has
substantially reduced the tail risk of crisis escalation into the systemically relevant bond
markets of major EMU countries. And so far, the EUR/$ cross currency basis – a proxy for
Euro area bank funding pressures – has been unaffected by these events. Further, the
progress in containing the Euro area crisis has reduced the risk of financial spillovers from
Europe to other regions, especially the US.
… and shrugging off weakness in US economic releases so far
After selling off on the Cyprus resolution to reach intraday lows of $1,540/toz on April 4,
gold prices finally started to respond to the recent weakness in US economic releases, with
last Friday’s (April 4) much weaker than expected Non-Farm Payroll report bringing gold
back to its month-ago level of $1,585/toz. But while Friday’s rally was as large as past
responses to such large NFP misses, it was short lived, with gold prices back to declining
on Monday, April 8. This extends the pattern of gold prices shrugging off disappointing US
economic data since late March (Exhibit 3).
While US economic data has started to disappoint relative to consensus expectations, this
slowdown has so far been consistent with our economists’ expectations that economic
data will slow over the next few months, due to the reversal of one-off factors boosting Q1
growth – in particular the high rate of inventory accumulation – and the negative impact of
the sequester. And while the ISM Manufacturing and Non-Farm Payroll were weaker than
our economists had expected, they do not see these releases as enough evidence to
significantly downgrade their broader view of near-term manufacturing activity. In
particular, they believe that signs of resilience from the US consumer to the increase in
payroll and income taxes so far in 2013 will likely prevent a sharp slowdown in the US
recovery. As a result, while weaker than expected retail sales this week could support gold
prices near term, we believe that a large recovery in prices is unlikely barring an
unexpected sharp reversal of the US recovery in coming months.
Date GS US Economics Headline MAP
score
1-day gold
return
5-Apr Smaller-than-Expected March Payrolls Gain -10 1.5%
4-Apr Initial Claims Much Higher than Expected, But Seasonal
Distortion Likely -2 -0.1%
3-Apr March ISM Nonmanufacturing Weaker than Expected,
with Soft Details -3 -1.4%
3-Apr March ADP Report Weaker than Expected -3 -1.4%
2-Apr Auto Sales Down Slightly n.a. -1.6%
2-Apr February Factory Orders Report Generally On
Expectations n.a. -1.6%
1-Apr ISM Manufacturing Weaker than Expected, February
Construction Spending In Line -10 0.3%
29-Mar Income and Spending Post Solid Gains in February, U
Mich Consumer Sentiment Revised Up for March 2
28-Mar Chicago PMI Weakens -4 -0.7%
28-Mar Q4 GDP Revision Slightly Less Positive than Expected,
Claims Rise -2 -0.7%
27-Mar Pending Home Sales Tick Down in February 0 0.7%
26-Mar Consumer Confidence Fell Sharply in March, Richmond
Fed and New Home Sales Slightly Weaker -9 -0.6%
Importantly, this recent range bound trading pattern of gold prices stands in stark contrast
to the large decline in US real rates, as measured by 10-year TIPS yields, which are back to
their late-2012 lows. We believe this further highlights the quickly waning conviction in
holding gold and is best illustrated by the sharp and steady decline in ETF gold holdings.
Resilient US consumer to support US economic growth
Beyond the near-term slowdown in the US recovery, our economists expect that the
normalization in the private sector financial balance will progressively overcome the drag
from fiscal retrenchment and push growth from the below-trend pace of the past few years
to an above-trend pace by 2014, above consensus expectations. While their expectation for
the size of QE3 remains larger than consensus, they reduced it recently and as a result
lifted their 10-year Treasury yield forecast by 0.25%, to 2.5% by the end of 2013 and 3.0%
by the end of 2014 (see The Meaning of “Substantial”, March 15, 2013). As they continue to
expect subdued core inflation over the next couple of years, this revision implies a
commensurate upward revision to US real rates (Exhibit 8). This represents a faster
increase in US real rates than we adopted in our last downward revision of our gold price
forecast (see The turn in the gold cycle is likely already underway, February 25, 2013).
Finally, while the US fiscal and policy risk premium has already come down sharply this
year, our economists don’t expect its resurgence in coming months. In particular, the
House passed the spending bill removing the threat of a government shutdown, and
spending cuts under sequestration have already taken effect. This leaves the next potential
issue as the debt ceiling this summer, and while our economists expect this next debt
ceiling increase may be harder than the previous one, it will nonetheless be easier than the
2011 one.
The turn in the gold price cycle is accelerating
Under our updated gold framework, higher real interest rates and a smaller expansion of
the Fed balance sheet accelerate the decline in gold prices that we have been forecasting
through lower COMEX speculative length and lower ETF gold holdings (for details on our
modeling of gold prices please refer to Gold cycle set to turn on improving US recovery,
December 5, 2012). Specifically:
Lower COMEX net speculative length. The decline in net speculative length from
October to March was significant and larger than implied by the observed rise in real
rates. However, our updated modeling showed that COMEX positioning also reflects
changes in the size of the Fed balance sheet, upon announcement of purchases/sales.
And our model suggests that the downward revision to the expected size of QE3, both
by consensus and our economists, helps explain most of the additional decline in
COMEX net speculative positions. Net, while COMEX net speculative length may have
declined slightly too much given their steady level in the face of the recent decline in
US real rates, the magnitude of this undershoot remains modest with our real rate path
pointing to further declines in net speculative length.
A further decline in ETF gold holdings. In our last forecast revision, we shifted to
forecasting that ETF gold holdings would decline as real rates increased but the recent
decline in holdings has been significantly faster than we had expected (see The turn in
the gold cycle is likely already underway, February 25, 2013). While it is harder to
establish whether the level of ETF holdings is fair relative to real rates, our updated
real rate path points to further declines in holdings and at a faster pace than we had
previously expected. Should the month-long decline in gold ETF holdings extend at its
current pace, this would present downside risk to our ETF gold holding path and in
turn our gold price forecast.
Net, we are lowering our COMEX gold price forecast with our 3-, 6- and 12-mo forecast
now $1,530/toz, $1,490/toz and $1,390/toz from $1,615/toz, $1,600/toz, and $1,550/toz
previously. Our 2013 average gold price forecast (including realized first quarter prices)
declines to $1,545/toz from $1,610/toz and for 2014 to $1,350/toz from $1,490/toz (Exhibit 11).
While gold prices have so far declined along the “faster recovery” path set in our
December outlook, our updated forecast remains slightly above this “faster recovery”, as
our economists still expect a slowdown in growth in 2Q-3Q13 and more expansion of the
Fed balance than consensus.
As a result, we recommend closing the long COMEX gold position that we first initiated on
October 11, 2010 for a potential gain of $219.3/toz. We last rolled this trade on December 5,
2012 into a long COMEX Apr-13 position overlaid with a short Apr-13 $1,850/toz call and a
long Apr-13 $1,575/toz put, with the risk reversal overlay expired on March 25.
Positioning for lower gold prices as our ECS Top Trade #8
We see risk to our updated forecast as modestly to the upside in the short-term should US
data continue to disappoint but increasingly to the downside as we move through 2013.
With investor conviction in holding gold waning and aggregate net long positions across
COMEX futures and physically backed ETFs near record highs, we suspect that if our
forecast for lower gold prices proves correct, the fall in prices could end up being faster
and larger than we expect (Exhibit 12). In addition, a break through the $1,535/toz base to
gold prices over the past eighteen months could further accelerate such a decline in prices.
Given our forecast for lower gold prices and the downside risks to our forecast later in 2013,
we recommend initiating a short COMEX gold position as our ECS Top Trade #8,
implemented through an S&P GSCI® front-month rolling index to further benefit from the
contango in the COMEX future curve (1% per year). We are targeting a move to $1,450/toz
compared to the current price of $1,585/toz with a stop at $1,650/toz. While we may be end
up too early in entering this trade, we prefer that to being late given our belief that the
skew to prices is to the downside.
Gold prices to decline despite stronger central bank purchases and
further Fed balance sheet expansion
Importantly, our lower gold price forecast accounts for continued central bank gold
purchases. In fact, while we had adopted a 2009-12 trend pace for purchases, we are
increasing this pace in light of strong central bank buying over the past three months
(Exhibit 13). While this assumption may prove too high should central banks slow their
gold purchases if our price forecast materializes, we prefer to be conservative. Such an
upward revision to the expected pace of central bank purchases only slows the decline in
gold prices implied by our real rates and the Fed’s QE3 forecasts by $10/toz per annum.
This is consistent with our view that central bank gold purchases would have to be
significantly stronger to stabilize gold prices.
In addition, our forecast for gold prices to decline during QE3 continues to stand in sharp
contrast with the pattern since 2009 of gold prices increasing in line with the size of the Fed
balance sheet (Exhibit 14). This view is based on our expectations that: (1) real rates will
increase despite further asset purchases, and that (2) it is upon announcement that future
expansion of the Fed balance sheet supports gold prices, with the rally in the fall of 2012
already fully accounting for QE3 (see Additional Fed balance sheet expansion already
priced in by gold prices, December 12, 2012). As a result, we expect the divergence
observed since October 2012 to continue.
Subdued inflation to keep next gold cycle several years away
Finally, our long-term gold price forecast (2017 and beyond) remains at $1,200/toz (Exhibit
15). Over that horizon forecast, we expect US real rates to stabilize and see risks to US
inflation as more symmetrical. And while higher inflation may be the catalyst for the next
cycle in gold prices, this is likely several years away: inflation expectations remain well
anchored and our economists expect subdued inflationary pressures in coming years
(Exhibit 16). Finally, even if higher inflation materializes, its impact on gold prices could be
offset by: (1) US real interest rates rising more quickly than we anticipate if the economic
recovery is accelerating, or (2) an end to the Fed’s aggressive balance sheet expansion if
inflation expectations become unhinged.
Hedging and trading recommendations
Hedging recommendations
Consumers: We expect that gold prices will continue to decline in 2013. We see risk to our
updated forecast as modestly to the upside in the short-term but increasingly to the
downside as we move through 2013. This outlook suggests that gold consumers looking to
hedge purchase call spreads, a low cost hedge that further takes advantage of the low gold
implied volatility levels and positive call skew.
Producers: Given our forecast for lower gold prices over our forecast horizon, we
recommend producers lock in current gold prices for 2013 and beyond. With our long-term
gold price forecast at $1,200/toz, we believe that put-spread hedges are compelling, a
hedge that further takes advantage of the low gold implied volatility levels and positive put
skew.
Trading recommendations
We recommend closing our long COMEX gold position, first recommended on October 11,
2010, for a potential gain of $219.3/toz. We last rolled this trade on December 5, 2012 into a
long COMEX Apr-13 position overlaid with a short Apr-13 $1,850/toz call and a long Apr-13
$1,575/toz put, with the risk reversal overlay expired on March 25. As we forecast lower
gold prices, we recommend initiating a short COMEX gold position, implemented through
an S&P GSCI® front-month rolling index to further benefit from the contango in the
COMEX gold forward curve (c.1% per year).
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