Editor's Note: Below is a Hedgeye Guest Contributor research note written by Josh Crumb for Goldmoney Insights. Crumb is a co-founder of Goldmoney Inc. and its Chief Strategy Officer. He was previously an Executive Director at Goldman Sachs - the Senior Metals Strategist in the Global Economics, Commodities and Strategy Research Division in London. This piece does not necessarily reflect the opinion of Hedgeye.
Inverted Asymmetry - Gold Price Outlook
By Josh Crumb
Using our proprietary real rate, energy proof of value- model as a guide, we find that, despite an already impressive year to date performance:
- The USD gold price has less downside risk from current levels than commonly perceived, with skewed upside risk;
- Market participants often wrongly analyze gold as a ‘flow commodity’ and appear overly focused on central bank guidance of nominal rate paths – just one of three important metrics – and therefore still misunderstand the key drivers of this ongoing “money stock” rerating;
- Given current inflation and real interest rate expectations, data and policy surprises present much more upside than downside risk for gold from current levels; and
- For gold to fall back below $1,100/toz again, the market would need a somewhat paradoxical environment of collapsing energy prices yet rising inflation, with the FED hiking interest rates.
In this semi-annual outlook report, we present a hypothesis to explain this bias; we apply our unique price framework to explain price cycle inflection points in support of our alternative thesis; and we analyze the real upside and downside risks when viewing gold as an alternative money stock rather than as a flow commodity.
Ultimately, we believe that the market is still in the midst of an ongoing rerating of gold vs fiat currencies in this age of extraordinary monetary experiments, and that it will become increasingly clear that objective data are becoming detached from the reflexive manipulative-function of central bank forward guidance.
In this environment, gold should be owned and accumulated.
In our view, too many investors have been waiting all year for a ‘$100’ pull back and better entry point, but, in this context, nearly every surprise or shock bringing new information to the market presents a downside risk for fiat currencies relative to gold, especially at the zero-bound where the nominal cost of carrying currency risk is higher than the carry for gold.
However, despite our confidence from the underlying data, a biased consensus outlook still projects downside asymmetry as we approach the elusive point of FED rate normalization. The objective reality is that this asymmetry is inverted, where there is little downside price risk relative to significant upside.
In upcoming reports, we will dive further into the outlook for key variables, including interest rates, inflation expectations, and forward energy prices; however, in this report, we simply present a two-way sensitivity model to show the asymmetry of price risk from current levels.
Upside price risk for gold as a money ‘stock’ is driven by the downside risk in the value of fiat currency; expectations for lower year-over-year gold ‘flow’ are nearly irrelevant to prices.
Market participants often describe the supply and demand outlook for gold as they would for oil or grains, or flow commodities. And with their marginal demand framework, it may appear that a fall in near-term demand for this ‘speculative commodity’ presents a limitless floor to prices. Or as one trader put it:
“Gold has a big door in and little door out when fearful investors and gold bugs are the primary demand for this speculative asset [a ‘useless commodity’ without income or yield], and there is always infinite ETF supply to be dumped onto markets when demand turns and the market goes ‘no bid’”.
And it’s no surprise, having worked as senior commodity analysts at a bulge-bracket Wall Street institution, that this is exactly how the big Wall Street banks and the mainstream financial media therefore analyze and report on the gold price outlook.
This perception is emboldened as gold is relegated to the commodity desks, to be analyzed for year over year changes in supply and (gold bug driven) demand flow, further reinforcing the perception of a perpetual ‘no bid’ risk and unlimited inventories against expanding supply.
This is the perceived asymmetry of gold having unlimited downside and an irrational and uncertain upside, driven only by fear or greed, chasing prices higher as a bubble asset or ‘Giffen Good’ (for which higher prices create more demand).
We believe this consensus analytical framework is wrong and largely irrelevant and can be falsified by both data and logic.
Instead, it is our view that the approximately $8 trillion dollars-worth of global gold inventory is actually being valued and demanded by its holders as an alternative yet permanent money stock with potential advantages to fiat currency-based savings depending on the outlook for real yields in one’s base saving currency. Gold is simply a liquid real-asset with no time decay, no real cost of carry and no counter-party risk, yet it is scarce, has great elemental utility and an energy-intensive replacement cost.
So what if the greater value-volatility in the market price lies in the debt-based measuring systems sitting in the denominator, the far from permanent or standard units of fiat currency value? In our view, this is the major flaw in the consensus analysis of gold, the bias to project fiat currency as a universal, stable, and standard measurement against the uncertain animal spirits of gold commodity demand.
This false starting point is also the primary reason that the Wall Street sell-side analyst consensus has missed basically every major price inflection point of the past decade. It is this misunderstanding and misreporting of gold as a short term flow commodity like oil or grains (useful for consumption, but high cost of storage and carry, so not a store of value like gold) leads consensus to perpetually describe gold as either ‘about fairly priced’, or headed down on an uncertain demand outlook.