While $3,000+ gold has been foretold for many years, is this finally the real deal?
With risk assets retreating on Dec. 15, the gold price suffered mightily amid the bearish liquidation; and with the FOMC’s hawkish hammer shaking the financial markets once again, we warned on Apr. 6 that investors were ignoring the ominous signs at their own peril. We wrote:
Please remember that the Fed needs to slow the U.S. economy to calm inflation, and rising asset prices are mutually exclusive to this goal. Therefore, officials should keep hammering the financial markets until investors finally get the message.
Moreover, with the Fed in inflation-fighting mode and reformed doves warning that the U.S. economy “could teeter” as the drama unfolds, the reality is that there is no easy solution to the Fed’s problem. To calm inflation, it has to kill demand. As that occurs, investors should suffer a severe crisis of confidence.
Thus, while sentiment shifted dramatically on Dec. 15, the fundamentals have been clear for many months. In addition, with nine of the last 10 bouts of rising inflation ending with recessions since 1948, the notion of a soft landing contrasted the calamities that have unfolded throughout history. As a result, while it may take more than a day’s weakness to kill the bulls’ spirit, the PMs’ medium-term outlooks remain highly bearish.
In contrast, some assume that ‘peak hawkishness’ is bullish for the gold price, as rate cuts could commence in 2023. On top of that, Bank of America’s latest Global Fund Manager Survey shows that institutional investors believe gold is materially undervalued.
Please see below:
To explain, the dark blue bars above track the net percentage of respondents that believe gold is overvalued. If you analyze the right side of the chart, you can see that the latest dark blue bar is particularly negative, which signals a degree of optimism about the yellow metal’s future prospects.
Conversely, the dark blue bars have been negative for much of 2021 and 2022, and gold has not rewarded the bulls throughout that period. Also, we’re short the GDXJ ETF, so while the gold price has performed relatively okay, the junior miners’ index has suffered mightily.
Yet, while a stronger USD Index and higher real interest rates have battered financial assets in 2022, Zoltan Pozsar, Global Head of Short-Term Interest Rate Strategy at Credit Suisse, believes the fallout from the Russia-Ukraine war could double the gold price in 2023.
In a nutshell: if Russia responds to the recently introduced $60-a-barrel oil price cap by asking for a gram of gold for two barrels of crude, the yellow metal could benefit immensely. He wrote:
“If the West is looking for a bargain, Russia can give one the West can't refuse: 'a gram for more.' If Russia countered the price peg of $60 with offering two barrels of oil at the peg for a gram of gold, gold prices double.”
He continued:
“Russia won't produce more oil, but would ensure that there is enough demand that production doesn't get shut. And it would also ensure that more oil goes to Europe than to the U.S. through India. And most important, gold going from $1,800 to close to $3,600 would increase the value of Russia's gold reserves and its gold output at home and in a range of countries in Africa.”
But, while he described the prospect as “Crazy? Yes. Improbable? No,” the prediction is more of a ‘what if’ event that falls near the low end of the probability spectrum. Essentially, it’s possible, but it’s more of a wild card that holds less weight in our view than other medium-term factors.
For example, while Russia pegged the ruble to the price of gold in March/April, the gambit only lasted ~two weeks. In addition, the USD/RUB remains well below its pre-pandemic level, so the FX market is not fretting about the EU oil price cap.
Please see below:
To explain, the candlesticks above track the USD/RUB, and if you analyze the right side of the chart, you can see that the ruble is highly valued versus the U.S. dollar relative to its recent history. Furthermore, the large spike on the right side of the chart highlights how the USD/RUB soared when investors assumed the Russia-Ukraine conflict would sink the Russian economy and the ruble.
In contrast, the ruble is far from panicking now, which highlights the lack of concern about potentially lower Russian oil prices.
Overall, it’s possible that a Russian oil-gold peg could push the yellow metal to $3,600 in 2023, but there are many possible, though not highly plausible, scenarios that could unfold. Therefore, we like to position for the most likely outcomes, which means other factors deserve higher priority.
So, while we’re mindful of the prospect, and will react accordingly if the odds increase, we expect gold to hit new lows in 2023.
Alex Demolitor
Precious Metals Strategist