Monday , 2 October 2023

Gold: A Target Of $7,166/ozt Is Logical & Plausible – Here’s Why

As we move into 2020, I bring good news; this bull market has legs. In fact, a bullish target of $7,166 is logical and plausible.

Here’s what a gold bull market looks like:

1. Easy money (i.e., U.S. cash real interest rates below 1.8%)

In 2019, the Federal Reserve stood back from further rate hikes, and we’ve seen an increase in the balance sheet, as tapering has reversed course. “It’s not QE,” they say – but it doesn’t smell quite right regardless. Whatever it is, the Fed’s balance sheet is growing again and policy is easy.

2. The long-term gold trend in non-dollar terms must be positive 

This simple test ensures we don’t mistake dollar bear markets for gold bull markets. Since 2000, the world’s best currencies have been the Swiss franc and the Thai baht, and gold recently broke higher in both. That implies that gold is rising everywhere.

3. Gold must be beating the stock market

Few seem to recall that gold is still the best-performing mainstream asset of the 21st century. It has smashed global equities…in Europe and Japan…and managed to stay ahead of U.S. equities…It’s a remarkable achievement, that most people probably don’t realize…because investors need to know that they can allocate large sums of money to gold without missing out on equity performance…

Can gold start to pull ahead of U.S. equities again as 2020 beckons?

As we step into 2020, with the threat of tightening behind us, there is no reason for gold to lag equities in future…

The chart below shows gold versus U.S. equities over the past five years. Since September 2018, gold has been beating equities, with higher highs and higher lows. A new high above 92 would generate significant confidence in the gold market, as that would bank four years of out-performance. It really wouldn’t take much for that to happen…

Gold price chart

This has the power to turn a dreary bull market, driven by falling bond yields, into something you can really sink your teeth into.

Above, I mentioned that gold is in a bull market, and suggested that a bullish target for $7,166 is both logical and plausible so how did I reach that conclusion? Allow me to talk you through it, step by step below.

Laying the foundations for the epic gold bull market of the 2020s

1. Lower inflation

The real yield is the difference between the US government bond yield and the expected future inflation rate. It tells you how much you could make, after inflation, by investing in government bonds. The current rate is 0.1%. That doesn’t sound like much but is much better than what you’d get in Europe and this means that gold has a tail wind and, in my opinion, real rates will keep on falling in what could become a major theme for the decade.

I am not saying that the Federal Reserve will slash rates to zero like the Europeans but rates will stay lower for longer, and inflation will rise. We can be relatively sure that the Fed will keep rates low, because they want to keep the party going. We saw that a year ago, as the ten-year bond yield went above 3% and the stock market nosedived by 20%. They don’t want to see that repeated…

The missing piece is inflation. Many believe that it won’t rise, because high levels of debt or demographic trends will keep it under control but there’s an external risk – namely the price of oil….For example, food production requires diesel. If the oil price rises, food prices must follow suit. That squeezes the consumer, harms the economy and reduces purchasing power…

It’s worth considering where gold might be by 2030. The ‘00s saw a 280% increase, and the ‘10s, a 35% increase. For the 2020s, I am forecasting a 415% return with a price target of $7,166. I’ll explain why.

Gold price chart

The Atlas Pulse – my occasional free newsletter – fair value model (see chart above) treats gold as a 20-year, zero coupon, inflation-linked bond. Thus falling real rates are bullish and rising real rates are bearish, with historic inflation acting as the long-term tailwind. Note that:

  • the fair value has made a six-year high; recovering the lost ground since the taper tantrum and
  • gold has returned to a premium above fair value.

With those points in mind, my bullish scenario has three components:

  1. Falling real yields will boost the fair value to $3,386.
  2. The premium (to fair value) will grow to 50% from the current 7%.
  3. Actual inflation for the decade is 48%.

The…gold rally of the 21st century has had nothing to do with inflation – it’s been all about the falling bond yield and, by my calculations, falling nominal yields have boosted gold by around 270%. On the other hand, weak inflation has actually held gold back, albeit slightly. I hope this becomes clear on the table below showing future fair value scenarios.

  • The U.S. 20-year bond yield is currently at 2.08% and 20-year inflation expectations are at 1.77%.
  • That puts the fair value at $1,377, which is slightly below the current price, and highlighted in grey.
20-year bond yields

If the real yield was to fall to -2%, different possible scenarios are highlighted in green.

  • Notice how a 0% bond yield with 2% inflation brings us to $2,296.
  • In contrast, a 2% bond yield with 4% inflation gives $3,386. That’s a big difference for the same real yield scenario of -2%.

My 2030 scenario sees a -2% real yield driven by managed rates at 2% and inflation rising to 4%. That results in a $3,386 price target.

Can US real rates move to -2%? They can. UK real rates are currently -2.2%, Swedish are -1.7%, and -1.3% in Germany. All you’d need is a couple of rate cuts to anchor the long bond, while inflation quietly rises towards 4%. With infrastructure spending about to splurge, it’s looking quite likely…

2. A rising gold premium

We should remind ourselves that the last bull market saw the gold price premium rise between 2005 and 2011…[and] bull markets and premiums go hand in hand. Therefore, if my bull market forecast is correct, the premium will be right too…

The current gold premium is 7%. A move to a 50% premium means there is another 43% to be had before we get there. That means the gold price will touch $3,386 x 43% = $4,842 but it doesn’t end there either. Next, we must add actual inflation. That is the inflation that actually happens, as opposed to what is expected.

3. Inflation doesn’t matter in the short term – but it really matters in the long run

In the short-term, inflation doesn’t matter very much but, over longer time frames, inflation is an enormous force. Look at the inflation by decade in the U.S., as per Bloomberg’s CPI figures.

1950s: 24%
1960s: 28%
1970s: 158%
1980s: 64%
1990s: 34%
2000s: 28%
2010s: 19%

At 19%, this past decade has seen low inflation but low inflation won’t last forever. Normally change occurs when the status quo is deeply embedded in group think…

I don’t have a crystal ball for inflation in the 2020s, but the bond market does. It thinks the answer will be 19%; precisely what it was last decade. I am 100% sure that it won’t be 19%. Whether it’s oil, deficits, wages or policy, inflation will rise. I would hazard a guess that it will average 4% per year, resulting in 48% over the next decade and that neatly brings the gold price forecast to $4,842 x 48% = $7,166.

There you have it. A rational case for a gold bull market with a logical outcome of $7,166 by 2030. The margin for error is wide of course, but it makes sense to me…

Editor’s Note:  The above excerpts from the original article and follow up article by Charlie Morris have been edited ([ ]) and abridged (…) for the sake of clarity and brevity.  The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.  Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor. Also note that this complete paragraph must be included in any re-posting to avoid copyright infringement.

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