Singapore (7 September 2020) – There are three ways of looking at the value of gold from the financial perspective (versus the traditional demand vs supply view point.) And all three are indicating the value of the precious metal is going no other way, but up.
Spot gold was last traded at 0330 GMT (11.30am Singapore time) at USD1937.50/oz, up from its Friday New York Close at USD1934.80. (Source: kitco.com)
1. Gold versus Real Interest Rates.
In a previous article (“Gold Powers On – What drives it? July 29, 2020), a case was made that real interest rates (in basic terms nominal interest rates minus inflation) are a strong predictor of gold prices. Since then a major development has occurred in that the U.S. Federal Reserve (Fed) had announced a change in their monetary framework. At its annual Jackson Hole meeting of global central bankers in late August, the Fed revealed that they would now adopt a flexible 2% average inflation target (FAIT) and will no longer pre-emptively raise interest rates to counter perceived inflation risk. What this effectively means is nominal inflation will be kept “lower for longer” while inflation will be allowed to run “moderately” above the current inflation target of 2% – two paths that are almost certainly to lead to a further decline in real interest rates. Given the negative correlation that exist between gold and real interest rates, such an outcome will be positive for gold prices. Below is a chart to highlight this correlation. Ceteris paribus, if real interest rate (now hovering around -0.5%) is allowed to decline further to -3% on the back of higher inflation, then gold prices should be around USD2500/USD3000.
2. Gold vs Quantitative Easing
Yet another predictor of gold prices in recent years has been the level of quantitative easing by the Fed, which is measured by the increase in its assets (under the Fed’s Balance Sheet). When plotted together there is a moderate correlation between gold and the increase in such assets (which indicates an increase in the amount of money that is being printed). The chart below highlights this point. From The chart itself we can also see that there were two major spikes in the Fed’s assets – first during the 2009 to 2015 period when the balance sheet expanded from approximately USD800 trillion to USD4400 trillion and another from 2019 to present when the expansion was from USD3800 trillion to USD7200 trillion. In both cases gold rose correspondingly, that is, from 2009 to 2015 it went up from USD400 to USD1200 and from 2019 to present, it went up from USD1200 to USD2000. In other words, every time the balance sheet increases by around USD3.5 trillion, gold prices rise by USD800.
At present, the general consensus in the market is for the Fed’s balance sheet to rise to USD10 trillion, with some even expecting a spike up to USD20 trillion (see “Fed’s balance sheet could top USD20 trillion within a decade – Deutsche Bank” July 28, 2020 https://www.fxstreet.com/news/feds-balance-sheet-could-top-20-trillion-within-a-decade-deutsche-bank-202007280058). Even at USD10 trillion, this would imply an additional increase of USD3 trillion and based on what was seen historical, this would suggest a corresponding gold price of somewhere in between USD2500/USD3000.
3. Gold vs USD
In the article “Gold A Multi-Facet Asset Best Considered As Currency” (https://www.halaluniverse.net/gold/gold-a-multi-facet-asset-best-considered-as-currency/) dated August 4, 2020, we argued that gold is best seen as a de facto currency called USD/GLD rather than just a commodity or an equity or even a mere inflation hedge. The correlation between gold and the USD (represented by the Dollar’s Trade Weighted Index) can be seen in the chart below.
The question is of course then, where is the USD heading? Given the debasing of the currency from the massive printing of money and ultra-low historical interest rates, the USD’s underlying foundation remains weak into the foreseeable future. Couple this with the fact that the USD economy is in need of every help it can get, a weaker USD would compliment on-going efforts from the fiscal and monetary side. Determining the expected level to which the trade weighted US dollar index is going to decline to is tricky. But by inferring from the 16% decline seen over the 2009-2011 period, this would suggest the Trade Weighted USD index could decline another 10% as it has so far only seen a 6% fall from its 2020 peak. Based on our estimates, a 10% further decline in the Trade Weighted USD would boost gold prices by US400-USD600 (to USD2400-USD2600 from its present USD2000 level).
Summary
Based on the above three “valuation” methods, we can see that gold price is forecasted to settle around USD2500/USD3000, which corresponds to a 25% to 50% increase from present prices. Notably, this does not take into account any overshooting that typically accompanies such rallies. However, as in all forecasts, past performance do not necessarily represent future performance. Investors looking to ride the current “bull cycle” must do so with caution given the volatility associated with investing in gold and should always seek the advice of a licensed financial consultant who would be able to determine important factors such as an investors risk tolerance and available cashflow to invest.-/-
Disclaimer: Mr Sani Hamid is a Director (Economy & Market Strategy) with financial advisory firm Financial Alliance and a Certified Financial Planner. He contributes to www.halaluniverse.net on a regular basis. The views, opinions and information expressed in this article are purely Mr Sani’s and are not to be construed as financial advice. Investors should seek advice from a financial adviser before investing.
