Goldbugs

Goldbugs

Scores of economists cut their teeth on one of the many editions of Rudi Dornbusch’s textbook: Macroeconomics. While the title may seem perhaps a bit unimaginative – at least to some – the author’s quotes are the stuff of legend. One in particular resonates today: “in economics, things take longer to happen than you think they will, and then they happen faster than you thought they could”. Take gold. It really wasn’t a good run from last summer to this spring. But several technical and fundamental factors, along with various headlines related to competing assets such as bitcoin, are now combining in a way that could be supportive for some time. However, fair-value estimates, which take our forecasts for interest rates and currencies into account, paint a more nuanced picture further out. As is often the case in investing, timing and time horizons do matter.

Reopening and recycling: This coming summer, as economies reopen and restrictions are lifted, both Americans and Europeans should hit the road – they waited long enough to get to their preferred holiday destinations. Higher fuel demand in the context of a tight crude market should lift oil prices. Following the recent inflation spike in the US, this is likely to add to broader inflation concerns. Assuming that the Fed continues to see these dynamics as mostly transitory and, therefore, not warranting any rate hike for the time being, this should be positive for gold. What’s more, rising oil prices – we see Brent at $75 per barrel at year-end – may well prompt oil exporters to ‘recycle’ their petrodollars, possibly flowing into stores of value such as gold. Some of these drivers seem already in motion. They may continue to play out for some time to come.

Bitcoin and China: The value of the stock of bitcoin fell by nearly 30% at one point last Wednesday, a decline of about $225 billion. The headline that appears to have caused such a sharp drop has to do with a statement by China’s central bank basically saying that virtual currencies “should not and cannot be used in the market because they’re not real currencies”. Of course, there’s nothing substantially new in these comments. Several central banks around the world are experimenting with digital currencies, with more or less advanced plans. While we’ve never really seen bitcoin’s popularity as an existential threat to gold’s status as the ‘currency of last resort’, a limited substitution may be occurring for some cohorts of investors. Even though these effects should be relatively small, it’s possible that gold may benefit from this perspective too.

Here’s why this matters:

Short term | Technicals and headlines: After a fairly tough August 2020-March 2021, gold is looking stronger from a technical viewpoint. Last week, the price of gold broke out above its 200-day moving average, which may attract the attention of algorithmic and momentum traders. Also, this rebound is occurring against a macro backdrop that’s typically supportive of gold price appreciation: 10-year Treasury yields in the US seem to have stabilised in the 1.60-1.75% range. This is relevant because gold’s August-March downtrend coincided with a rebound in US bond yields. While it’s early days, it’s quite possible that all this – along with a slightly different and more uncertain narrative on bitcoin, at least in the eyes of some investors – benefits the price of gold for a period of time.

Medium term | Fundamentals and estimates: US inflation has surprised to the upside and the dollar has weakened, both supporting the price of gold. However, we think these more fundamental drivers are unlikely to stay that favourable. Rising real yields – the key driver of our fair-value models – are likely to remain a moderate headwind for gold going forward. While gradually, we expect a further rise as nominal yields grind higher. The trigger for the yield rise should be the Fed eventually announcing that it will taper its asset purchases. Bottlenecks and shortages as demand rebounds, plus rising commodity prices, are leading to a temporary inflation spike. But we don’t see the wage spirals that are typically associated with protracted overshoots.

Meanwhile, markets are likely to continue to focus on central bank policy…

Fed watching: The purchasing managers’ indices last week reached multi-year or record highs in the US, UK and euro area. Reopening and stimulus continue to drive upside data surprises. The German Ifo business climate should rise too. Following April’s US CPI inflation overshoot, core PCE inflation – the Fed’s preferred gauge – should be key. The central bank’s minutes say that part of the committee believes that a discussion on the pace of asset purchases may be appropriate at some point. But that assessment may be stale. After all, it predates the latest payroll miss. We think the Fed is likely to continue to see the inflation spike as mainly driven by the temporary release of pent-up demand meeting supply disruptions, plus base effects and commodity price feedthrough. A discussion on tapering seems probable over the next few months, but we don’t believe that rate hikes are in sight.

Daniele Antonucci | Chief Economist & Macro Strategist