Société Générale analysts are quite bearish on gold. Their $1375-per-ounce price target for the end of 2013 puts them well below most of the Street.
Today, the SocGen team, led by Patrick Legland and Michael Haigh, released a new report titled “The End of the Gold Era.”
A $1375 price target implies a 13 per cent decline from today’s levels by the end of the year, but the analysts also examine a “bear case” for the shiny yellow metal that is even worse than their already-bearish call.
It hinges on a “perfect positive macro storm.”
Below are their thoughts on such a “bear case” would play out:
Our central scenario calls for a gentle bear market over the next several years. The question we address here is: what could cause an even greater decline even further than our forecast? Specifically, what would it take to send gold prices dramatically down: 20–30% (a crash) in a much shorter period of time? Simply put, we need the perfect positive macro storm to impact the market which would then influence gold’s ‘fundamentals’ and currently this is a tail risk and is not terribly likely (see our base and bull case scorecard on next page). Nevertheless, we outline what it would take in this report.
Gold is perhaps the most unique ‘commodity’ since its fundamentals are a mixture of non- traditional influences on commodities: real interest rates, expected inflation, dollar moves, fiscal outlook, fed balance sheet (and asset purchases) have a much greater impact on gold than other commodities. The fundamentals – mine supply, scrap supply, central bank buying/selling, bar hoarding, producer hedging, ETF flows, etc. would then react. The price drop will have to come from a macro improvement, not from the fundamental side. Specifically, we need global GDP growth to be quite significant, real interest rates to rise quite significantly (certainly an end to QE), fast US fiscal stabilisation, the dollar to significantly strengthen, inflation expectations to be muted, food inflation to be non-problematic, and then, as a result we would expect to see increased selling of ETFs, significant liquidation on Comex futures, reduced central bank buying, bar dis-hoarding, and a huge revival in producer hedging.
While our base case scenario ($1375/oz by year end) is predicated on our current economic outlook and how the ‘fundamentals’ would react, our extreme bear case (crash) is based on the perfect macro storm. We believe that this crash scenario is less than a 20% probability. While the possibility of this positive macro storm for a crash remains a tail risk, a near positive macro risk could be enough to start the large decline.
The SocGen analysts break down the risks that could create this “perfect positive macro storm” into two categories: “non-fundamental influences on gold” and fundamental factors.
In terms of non-fundamental factors, they say that for the crash to occur, we would have to see U.S. 10-year yields to rise above 3 per cent in 2013, bringing about a much stronger U.S. dollar.
Furthermore, global growth would have to be on the order of 4 to 5 per cent, which the analysts call “a huge headwind for gold.”
The Federal Reserve would also have to begin shrinking its balance sheet this year, driven by a scare in inflation expectations – something most don’t expect until at least 2015.
On the other hand, the analysts say long term inflation expectations falling between 1 and 2 per cent (as proxied by TIPS yields) would be very bearish for gold as well.
The crash scenario also envisions further spending cuts in the U.S. beyond what has already been implemented by the sequester or structural reforms on taxes and entitlement spending.
In terms of fundamental influences on gold, SocGen predicts a 30-megaton increase in gold mine supply in 2013, followed by a 55 mega-ton increase in 2014. Anything above that could help precipitate the crash scenario.
The pace of withdrawals from gold ETFs would have to pick up significantly, central banks would have to start selling, and hedge funds would have to get net short gold.
To top it off, a strong downward trend in gold could cause producers to start hedging more aggressively against a decrease in gold prices, and rising rates could discourage hoarding of gold bars as storage costs increase.
The table below summarizes SocGen’s base and bear cases.
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