Gold is set to hit $3,000 an ounce in the next 18 months. That’s about 50% more than its all-time high, set back in 2011. (It’s at about $1,700 an ounce just now).
You might be tempted to dismiss this as yet another hopeful-yet-hallucinatory outburst from the bulletin boards of one of the internet’s dedicated gold websites. But it’s not. This is a call from a major investment bank – Bank of America.
Are they right? And what does it say about where we are in gold’s current bull market?
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A punchy call on gold prices
Earlier this week, a team of commodity analysts at Bank of America, led by Francisco Blanch and Michael Widmer, put out a 15-page report discussing the reasons why they think that gold is set to hit $3,000 an ounce in the next 18 months.
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The headline of the report sums up their rationale: “The Fed can’t print gold”. But let’s elaborate on that a bit.
First things first, the global economy has taken a massive hit from Covid-19 and the measures to contain it. Most countries with any sort of statistical competence or honesty are going to register double-digit collapses in GDP for one or more quarters.
That’s an extraordinary collapse, which requires an extraordinary response. And mostly, that’s what we’ve seen.
Governments and central banks are largely operating in tandem now. Governments are spending a lot of money to try to keep the economy in suspended animation, rather than in total collapse – you can’t force economies to close down without offering some sort of compensation for the people most affected by that.
(The efficacy of the measures and the question of whether the money is getting to where it needs to go is a separate issue, worth looking at, but it’s not relevant to today, so we’ll open that can of worms another day.)
With spending exploding at a time when tax revenues are going to collapse, someone’s going to need to pay for that. That’s what central banks are doing.
We can scamper merrily around the idea of whether this is “true” debt monetisation or temporary liquidity provision (which does matter, but only to an extent, and again we’ll park it for another day) – but in practice, central banks are pulling money out of nowhere to give to governments to spend.
So the straightforward argument is this: central banks will print money. Their currencies will be devalued as a result (the more you print, the less each bit is worth). But no one can print gold. That’s your bull case.
What might ruin gold’s party?
I’m not going to lie, when I see big, bold calls like this, I instinctively want to take the other side of the trade.
Gold has already done very well this year. As the BoA team points out, despite a sharp drop in March, in the year to mid-April, gold had returned more than 10%, a return only beaten by 30-year US government bonds and the highest-quality tech stocks.
So while I agree with the arguments for higher gold, what might ruin the bullish argument? The BoA report nods to the strong US dollar, a plunge in jewellery demand in India and China, and also “reduced financial market volatility”.
It’s this latter that I’d be paying the most attention to right now. Gold is a “risk-off” asset. Ultimately, investors buy it when they’re worried that nothing else is going to hang on to its value.
That can happen when the financial system is at risk of collapse, which has been driven mostly by deflationary pressures in recent decades. And it could also happen if and when inflation takes off to the point where financial assets are at risk of losing their “real” (after-inflation) value rapidly and painfully.
But between those two extremes, there’s quite possibly a period in which it looks as though everything is getting back under control. At that point, do investors want to own gold or do they want to pile into equities?
I’m not saying for a minute that you should sell out of gold (we view it as a core holding in any portfolio). And in any case, I’m not sure we’ll get the “Goldilocks” moment in this recovery.
This pandemic is going to have a lot of unanticipated consequences so regardless of how big a cushion central banks are trying to create, volatility is going to be higher than it has been in the past. (For more on this, listen to Merryn’s latest podcast with the excellent Alexander Chartres of Ruffer, right here.)
And in the longer run, there is one key factor that the BoA team also highlights, one that I just don’t think can be avoided. That’s the need for “financial repression”.
Why financial repression will drive gold higher
What’s "financial repression"? It’s when governments across the globe try to hold real interest rates at as negative a level as they can get away with.
If you have cash savings in almost any bank account right now, you’ve already been experiencing it for a long time. Even if you’re earning 1% interest, that’s lower than the inflation rate. So the real value of your savings is being eroded, to the benefit of the person or entity that owes you this money (yes, savings in a bank account are basically a debt that the bank owes you).
Financial repression is all about paying off debt with devalued currency. In other words, it’s about a transfer of wealth from creditors to debtors. Or if you want to put it in a way that implies an entirely different power dynamic, it’s about taking money from savers to give to spenders.
So at the end of the day, I’m bullish on gold. I’m just trying to point out to the over-excitable that these things never go up in a straight line, and that there are plenty of good reasons why gold’s bullish run might be derailed for a short or even a lengthy period of time.
But if you don’t own any, I would aim to rectify that (yes, even if you’re a sterling investor). You can buy physical gold or you can buy exchange-traded funds (ETFs). You can also invest in gold miners, but just remember that’s not the same thing – gold is gold; miners are equities that should (but may not) benefit from a rising gold price.
You can find out more about how to buy gold here.
And if you’re not already a subscriber to MoneyWeek, sign up now. We’re going to be writing about gold miners again soon, so make sure you don’t miss it – you can get your first six issues free (so there’s no risk to you at all) and you also get my latest ebook, looking at what we can learn from previous booms and busts, completely free. Subscribe here today.
