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In December, Goldman Sachs commodity analysts caused quite a bit of chatter when they called the end of the bull market in gold.The bank’s central thesis is that the U.S. economic recovery finally takes off in 2013, and Goldman expects that to drive a selloff in the gold market as investors rotate away from traditional “safe-haven” investments.
At the time, the analysts wrote, “We lower our 3-, 6- and 12-mo gold price forecasts to $1,825/toz, $1,805/toz and $1,800/toz and introduce a $1,750/toz 2014 forecast. While we see potential for higher gold prices in early 2013, we see growing downside risks.”
Now, Goldman has decided to up the ante a bit. Yesterday, its commodity analysts introduced a new call: gold at $1200 per ounce by 2018.
In a note to clients, Goldman analysts Christian Lelong, Max Layton, Damien Courvalin, Jeffrey Currie, and Roger Yuan write, “Assuming a linear increase in US real rates back to 2.0% by 2018, as proxied by the 10-year US TIPS yield, we expect that gold prices will continue to trend lower over the coming five years and introduce our long-term gold price of $1,200/oz from 2018 forward.”
What about monetary demand for gold and inflation, though?
The analysts answer that question:
Beyond real interest rates, fluctuations in the monetary demand for gold also exert an influence on gold prices. Our forecast currently embeds physical gold demand from ETFs and central banks growing in 2013 at the 2009-2012 pace, with ETF purchases slowing in 2014. In our forecast, this steady monetary gold demand helps slow the decline in prices over the coming years. Given the risk around this assumption, we also considered alternative paths for physical gold demand but found that, while not negligible, the impact of gold prices to stronger or weaker monetary demand for gold remains modest compared to the influence exerted by real rates and the Fed’s QE. As a result, it would require a significant further increase in monetary demand for gold to change our outlook for gold prices. While a very significant increase in monetary gold demand by EM investors and central banks could hold the potential for such a large impact, it is also worth noting that a decline in gold prices pushing ETF gold holdings sharply lower would in turn precipitate this fall in gold prices.
Our framework for evaluating gold prices relates the real (inflation-adjusted) price of gold to real interest rates and the monetary demand for gold. As a result, a higher rate of US inflation would inflate our forecasted gold price proportionally. For now, our economists view inflation above the Fed’s target as a low probability risk given: (1) inflation expectations have remained well anchored despite significant expansion of the Fed’s balance sheet, (2) the margin of economic slack will only gradually decline given their expected slow decline in unemployment, and (3) we further forecast that commodity prices will remain more stable than in prior years. Finally, even if higher inflation materialises, 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.
In other words, Goldman expects the effect from higher interest rates to weigh more heavily on gold than the boost it the shiny yellow metal would get from continued monetary easing and inflation.
Still, 2018 is a long way off, so Goldman will have plenty of time to test its hypothesis–and tweak it if need be.