Gold in 2014: Friend or Foe?
Making Sense of Gold's Value
Welcome to the extreme sport of gold trading.
All the standard rules that are supposed to govern gold activity seem to have been tossed out the window last year. Like bonds, gold completely ignored the Federal Reserve's QE3 stimulus program begun near the end of 2012, as it fell all throughout 2012 and 2013 despite the monthly stimulus.
Gold also ignored a falling USD in the second half of both years, choosing to fall with the dollar when it should have climbed against it. And it further ignored relatively flat inflation, which should have kept it stable, and paid no mind to continuing near-zero interest rates, which should have caused gold to rise.
Isn't anyone playing this game by the rules anymore?
Well, maybe the rules we think gold should follow are not really rules at all. History shows that when gold receives the ball, it will sometimes run wherever it wants, like a scene out of the Marx Brothers' classic Horse Feathers.
Given gold's historical unpredictability, should we even bother to get into some predictions for 2014? After all, most analysts a year ago were calling for gold to end 2013 between $1,600 and $1,800. Only a handful nailed the actual yearly close of $1,200, such as the Danish online investment firm Saxo Bank. And they weren't even serious about it, calling $1,200 an "outrageous" extreme prediction.
Since they were so right before, let's compare Saxo's newest predictions for gold against some other banks' guesses, just to get our fill of "expert" prognostication.
Then we'll look at two lessons from history that tell us something very important about gold predictions... No matter how plausible and well-grounded in economic theory the predictions may seem, you can expect as much predictable movement from gold as you can from a chicken with its head cut off.
Gold in 2014
Going up: Erik Swarts of Market Anthropology believes that "gold and silver have tested the panic lows from early summer and look poised for reversal into 2014... Should the Fed more definitively define a timetable of the taper, those assets most closely tied to rising inflation expectations [gold and silver] should once again begin to strongly outperform."
Down then up: Kitco expects that "precious metals will find a bottom during the first quarter of 2014 and rebound strongly into the second half of the year... back towards $1,800 and silver towards $40... Many miners will go under due to the depressed prices of the past year and lack of financing, while best-in-breed mining and royalty stocks [such as RGLD and SLW] will easily double from the current oversold levels."
Up some: Scotia Mocatta, one of the five members of the London Gold Fix, believes "a return to $1,435/oz would not be too surprising, but whether prices could then move up above $1,450/oz might be expecting too much."
Up modestly: Germany's Commerzbank believes gold will end the year around $1,400. As "speculative financial investors have now largely exited the gold market," the bank explains, "the negative market sentiment towards gold and... pessimistic price forecasts" may create "a rapid reversal of the trend."
Up slightly: Merrill Lynch expects gold to average $1,294 in 2014, closing the year near $1,350. It then noted that gold "could trade as high as $2,000 per ounce by 2016."
Up negligibly: Another member of the London Gold Fix, Barclays Bank, expects gold to average $1,350 in the opening months of 2014 but close the year near $1,270.
Ending flat, but choppy: UBS sees gold averaging $1,200, but with large swings, "as it faces the crosscurrents of an improving macro backdrop, the changing landscape of physical demand and, ultimately, the implications on mine production."
Down solidly: Societe General, yet another member of the London Gold Fix, expects to see $1,050 by year's end, citing the end of the Fed's monthly purchases as "the ultraloose stance of monetary policy is gradually unwound."
Down significantly: Goldman Sachs expects a "significant decline" in gold for 2014 by some 15% to around $1,000.
A rout: Credit Suisse predicts, "If the gold price were to continue to retreat along its current trajectory, the metal would be trading close to $900 per ounce by the end of 2014."
And what of Saxo Bank's outrageous prediction for gold in 2014? Remember, they were one of the few who got 2013 right, even if they were joking at the time. Their extreme scenario this time — not their official call, mind you — would send gold skyrocketing.
Deflation and jobs undermine tapering: "Although indicators may suggest that the US economy is stronger, the housing market remains fragile and wage growth remains non-existent," Saxo Bank prefaces. Due to continued budget battles in Congress, "investment, employment and consumer confidence will once again suffer. This will push inflation down, not up, next year, and deflation will again top the FOMC agenda," leading to more stimulus.
More? More Fed soup?: "Quantitative easing in the US has pushed interest expenses down and sent risky assets to the moon, creating an artificial sense of improvement in the economy," Saxo explains. "Grave challenges remain, particularly for the housing market which is effectively on life support. The FOMC will therefore go all-in on mortgages in 2014, transforming QE3 to a 100 percent mortgage bond purchase programme and ... increase the scope of the programme to more than USD 100 billion per month."
But even if such an extreme scenario does not play out, the expected low inflation and stimulus tapering — to be followed by rising interest rates later on — does not necessarily imply lower gold.
In fact, much of what analysts keep telling us about gold's behavior does not hold up nearly half the time. If gold didn't follow that playbook in the past, why would it now?
Gold's Disobedient Past
Let's look at what are considered to be the two biggest movers of gold: interest rates and inflation.
The first rule is that gold moves inverse to interest rates, since rates affect the USD, which determines how much gold you can buy. The second rule is that gold moves with inflation, since inflation erodes the cost of money, which in turn makes gold more expensive.
First, interest rates. While the movement of gold (red and green) — superimposed on a graph of U.S. interest rates below — is not to scale in dollar terms, it does reflect gold's general "up" and "down" trends from 1975 to present.
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According to the interest rate rule, gold should move up when rates fall, since falling rates weaken the dollar. Conversely, gold should move down when rates rise.
The green segments above show all the times, from 1975 to present, when gold did obey that rule, while the red segments show all the times when gold did not follow the rule. Leading up to the 1980 spike, interest rates rose to 20%, and gold rose to $850. That wasn't supposed to happen.
After the spike, both gold and rates fell together. Again, not supposed to have happened.
And look at the last five years since 2009. Rates were flat, and gold just went everywhere. Not supposed to have happened, according to the interest rate rule. Over the past 38 years, as shown above, gold has bucked this rule more than it has followed it.
The lesson? Just because we are entering a period of stimulus tapering to be followed by rising interest rates does not mean gold must fall. History shows gold can climb even when interest rates rise. Supply/demand fundamentals often override interest rates.
And what about the inflation rule, with which gold is supposed to rise and fall in tandem? As seen in the graph below, gold tends to follow that rule more closely, but not completely.
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Again, green shows when gold obeyed the rule, while red shows when gold disobeyed — notably during the mid 1980's, the turn of the millennium when gold bottomed, and again during the 2008 correction — all periods when gold moved opposite inflation.
Do you notice the timing of gold's disobedience? During two critical times: the bottoming of 2001 and the correction of 2008.
And where is gold currently? At a four-year bottom and at the end of a major correction. Gold is at such an extreme that the standard rules of behavior simply do not apply here. The spring is compacted with so much stored energy that it can spring upward even amidst falling inflation, as it did in 2001 and 2008-09.
Lesson? Even if 2014 does not bring inflation, gold can still climb. Remember, the Fed wants inflation, and falling inflation will keep the Fed highly dovish.
If you stick to a sensible allocation, periodically buying on the dips and selling on the climbs, you won't need anyone's predictions to show you the way. Most of these professional guides get lost themselves. Gold simply isn't bound by man-made rules.
Until next time,
Joseph Cafariello for Wealth Daily
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