Steve Saville
January 25, 2015
Goldman’s 2015 forecast for gold
Early last year we gave banking behemoth Goldman Sachs (GS) credit for looking in the right direction for clues regarding gold’s likely performance, which is something that most gold bulls were not doing. In November we again gave them credit, because even though we doubted that the US$ gold price would get close to GS’s $1050/oz target their overall analysis had been more right than wrong. It was clear that up to that point the US economy had performed better than we had expected and roughly in line with the GS forecast, which was the main reason that gold had remained under pressure; albeit, not as much pressure as GS had anticipated. But that was last year. This year it’s a different story.
This year, GS’s gold market analysis begins on the right track by stating that stronger US growth should support higher real US interest rates, which would be bearish for gold. Although we expect that the US economy will ‘tread water’ at best and that real US interest rates will be flat-to-lower over the course of this year, GS’s logic is correct. What we mean is that IF the US economy strengthens and IF real US interest rates trend upward in response, there will be irresistible downward pressure on the US$ gold price.
However, the analysis then goes off the rails. After mentioning something that matters (the real interest rate), the authors of the GS gold-market analysis then try to support their bearish case by listing factors that are either irrelevant or wrong. It actually seems as if they’ve taken the worst arguments routinely put forward by gold bulls and tried to use the same hopelessly flawed logic to support a bearish forecast.
For example, they argue that the demand for gold will fall because “inflation” levels are declining along with oil prices. They are therefore unaware, it seems, that “price inflation” has never been an important driver of the gold market and that the latest two multi-year gold rallies began with both “inflation” and inflation expectations low and in declining trends. They also appear to be unaware that the large decline in the oil price is very bullish for the gold-mining industry.
Their analysis then gets even worse, as they imply that the price weakness of the preceding three years is a reason to expect future weakness, whereas the opposite is closer to the truth. They go on to cite outflows from exchange-traded funds (ETFs) and reduced investment in gold coins as bearish influences, apparently unaware that the volume of gold coins traded in a year is always too small to have a noticeable effect on the price and that the change in ETF inventory is a follower, not a driver, of the gold price.
Finally, just when it seems as if their analysis can’t possibly go further off track, it does by asserting that lower jewellery demand and a greater amount of producer hedging will add to the downward pressure on the gold price. The facts are that jewellery demand has always been irrelevant to gold’s price trend and that gold producers are part of the ‘dumb money’ (meaning: they tend to add hedges at low prices and remove hedges at high prices, that is, they tend to do the opposite of what they should be doing based on gold’s intermediate-term risk/reward).
In conclusion, last year the GS analysts were close to being right for roughly the right reasons. This year, however, they cannot possibly be right for the right reasons. They will either be right for the wrong reasons, or they will be wrong.
Our 2015 forecast for gold
Here’s the conclusion of our 2014 gold forecast:
“Based on the small historical sample size, which is all we have to go on, you should ignore the predictions that gold will zoom straight back to its 2011 top. This is particularly so considering that gold’s true fundamentals are mixed at this time (no longer bearish, but not yet bullish). Gold is likely to provide a good return in 2014, but even if a major bottom is in place the gold price is unlikely to trade significantly above $1600 and could have trouble getting beyond the $1400s.”
We were wrong about gold providing a good return in 2014, at least relative to the US$. In US$ terms gold was flat in 2014, although it did provide a good return in terms of every other currency.
In 2014 gold performed roughly as expected in US$ terms during the first half of the year, but then fell to a new bear-market low during the second half. The problems for the US$ gold price during the second half of 2014 were the perceived strength of the US economy (linked to the continuing upward trend in the S&P500 Index), the flattening of the US yield-curve (related to the perceived US economic strength), and the Dollar Index’s upside breakout from a long-term basing pattern.
The gold market has come to ignore the strength in the Dollar Index, because the US dollar’s rise on the foreign exchange market has come to be seen as more of a reflection of declining confidence in the ECB and weakening global growth than a reflection of improving US$ fundamentals. However, there is no evidence, yet, that the S&P500 has peaked. Also, the US yield-curve hasn’t yet signaled a trend reversal from flattening to steepening, and despite the problems in the ‘oil patch’ the general belief is that the US economy will make real progress this year.
There is never a good time to make a 12-month forecast, since forecasting is for the birds. But right now is a particularly bad time to make a gold forecast, the reason being that changes in other markets are needed to turn the gold market higher on a sustained basis and the needed changes may or may not be about to happen. Of primary importance, a sustained turn to the upside in gold almost certainly requires a sustained turn to the downside in US equities. Some long-term indicators are warning that such a change is in the works, but the S&P500’s price action hasn’t yet signaled anything of the sort. The first sign would be a daily S&P500 close below 1970.
If the S&P500 is in the process of rolling over the downside on a long-term basis then it’s highly probable that gold bottomed last November and will generate the sort of performance in 2015 that we originally expected to happen in 2014. That is, gold will probably work its way higher over the course of this year with a top most likely occurring in the $1400s and with an outside chance of making it as high as $1600. The most plausible alternative is that the S&P500 will make some additional headway over the next few months and gold will drop to test its 2014 bottom during the second quarter of this year prior to a long-term reversal.
Current Market Situation
When the Dollar Index was bottoming at around 79 in May of last year, gold was priced at around US$1300/oz. When the Dollar Index was peaking at 95.8 last Friday, gold was priced at around US$1300/oz. Who woulda thunk it?
Gold’s ability over the past 2.5 months to gain ground in US$ terms while the US$ strengthened against all other currencies led to a very sharp rise in the non-US$ gold price. As illustrated by a chart included in the preceding Weekly Update, a result is that the euro-denominated gold price recently reached the top of a moving-average (MA) envelope that has always limited intermediate-term rallies in the past. As illustrated by the chart displayed below, another result is that the gold/UDN ratio, an indicator of gold’s performance in non-US$ terms, is also now at the top of a MA envelope that has always limited intermediate-term rallies in the past.
The implication is that while the gold/UDN ratio could make some additional headway over the next couple of weeks, three months from now it will probably be trading at a lower level.
In non-US$ terms, the gold market is extended to the upside on an intermediate-term basis. In US$ terms, it is extended to the upside on a short-term basis. This is confirmed by the fact that last Tuesday (the date of the latest COT data) the speculative net-long position (and the offsetting commercial net-short position) in COMEX gold futures was at its highest level since January of 2013.
The COT report is a sentiment indicator, with relatively-high levels in the speculative net-long position indicating relatively-high levels of bullish sentiment. Since short-term price highs invariably coincide with short-term extremes in bullish sentiment, an extreme in the speculative net-long position (and the offsetting commercial net-short position) will almost always occur near a short-term price high. The problem is that there is no fixed level that constitutes an extreme in the COT data.
Based on what happened in the gold futures market over the past two years it is reasonable to consider a speculative net-long position in the 160K-180K range to be an extreme, but if a new bull market has begun then the COT level that constitutes an extreme will shift upward over time. For example, in 2010-2011 the extremes were in the 250K-300K range and a level of 170K would have indicated a constructive absence of short-term enthusiasm.
Although a new bull market could be underway, the current level of the speculative net-long position should be viewed as a “caution” sign or a “hold off on new buying for now” sign.
Note that a routine pullback would take the gold price down to around $1250/oz. A decline to $1250 is likely within the next several weeks even if a new bull market has begun and even if the price first rises to around $1350.
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