With gold soaring above $2000 (for the December future) to a new all time high…
… now is an opportune time to revisit a conference call held by Bank of America’s commodities team (which as a reminder is the most bullish on gold, expecting the yellow metal to hit $3,000 in 18 months) in which the bank discussed its outlook for gold and other precious metals in the context of global asset allocation (Michael Hartnett), interest rates (Mark Cabana), and technicals (Paul Ciana).
The global pandemic is providing a sustained boost to gold due to increased savings, growing inequality, vast capital destruction, declining productivity, rising public debt levels, and, most importantly, falling equilibrium real interest rates. In addition, we believe that a clouded geopolitical chessboard further supports the case for our $3,000/oz forecast over the next 18 months. How does gold fit into the broader macro picture?
With governments around the world boosting their damaged economies with a host of fiscal packages focused on the environment, we also see upside in other precious metals, including silver, platinum and palladium. How high could these metals go?
Some quotable highlights:
“The monetary and the fiscal stimulus in terms of the announcements thus far, it comes to $20 trillion, $8 trillion of monetary stimulus and $12 trillion of fiscal stimulus. And that number is – it’s a little over 20% of global GDP. So it’s just astonishing and breathtaking and you have to sort of pinch yourself sometimes to sort of realize that it’s actually happening.”
– Michael Hartnett, Chief Investment Strategist
“[The Fed] is not going to talk about upside risk to inflation in the next six months. I’m not even sure that they would be talking about that in a meaningful way in the next six years”
– Mark Cabana, Head of US Rates Strategy
“When you’re looking at what [DXY, 10 year real rates] levels we would need to see gold at $2500 per ounce, it is combinations like the DXY at 90 and real rates at minus 2. That will take gold to $2500. The DXY at 85 and real rates at minus 1.75 will also take you to $2500. DXY at 80 and real rates at minus 1.5 also take it to $2500 an ounce.”
– Michael Widmer, Metals Strategist
“There’s a saying in technical: buy smiles and sell frowns. So if you look at a chart and is smiling at you, smile back and be long. Gold is likely going higher”
– Paul Ciana, Chief FICC Technical Strategist
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Where to next for gold? – Below is the full must read transcript of BofA’s call “Where to next for gold?” on 30 July 2020, 9am EST
Francisco Blanch: Thanks everyone for joining us. We have a great call for you today. Obviously gold hit record levels in nominal terms in the past few days and we wanted to have a conference call to discuss this with you and bring in our Chief Investment Strategist, Michael Hartnett to talk about his perspective on a cross asset basis on the gold market. And also we wanted to have Mark Cabana, who’s our US Rates Research Head, talk about how interest rates may behave and how central banks may shift, with the Fed’s balance sheet continuing to expand.
And then we want to talk about also some of the technical targets. So we’ve invited Paul Ciana, our Chief FICC Technical Analyst as well as Michael Widmer our Metals Research Head and myself Francisco Blanch. I run the Commodities and Derivatives Research Team for the bank.
So let me kick off with our view on gold and then I’m going to start with Michael Hartnett and go down the list of our analysts asking them specific questions around the outlook for gold. But importantly I want to lay out the main view. The main view, as many of you know, is we’ve called for $3000 gold as a target in the next 18 months and we put a piece out entitled “The Fed can’t print gold” back in April.
The reason why we put that piece out is because we felt the COVID crisis was leading to such a large increase in central bank balance sheets, such a large expansion of monetary policy, coupled with an enormous fiscal expansion that the value of currencies, not just the dollar, would be hit pretty meaningfully. And so far it seems to be the case that investors have geared their portfolios partially believing the unprecedented fiscal and monetary expansion would lead to a large surge in investor gold buying, with ETF inflows at record levels in recent weeks.
This is an investor led rally so far but we think that we still have a lot of room to grow. Investor demand has gone from about 25% of gold demand to about 45% in the second quarter. So investor demand as a share of gold has almost doubled. But throughout this period we’ve also seen that central banks have reserved their cash for liquidity reasons and have curtailed their [gold] purchases. And we’ve also seen a drop in jewelry demand, very meaningful drop, partially because stores were closed but also because of mobility restrictions.
And then additionally we’ve seen an important shift in the purchases of coins and bars for a number of reasons. So gold has seen a big shift on the demand side but to a large extent the rally has been ETF driven, mostly driven by investor buying. And we see that continue over the course of the next six to 12 months with eventually central banks coming in, with potentially more investors coming in, and with allocations increasing.
Now, why would this happen? Well, mainly we think the pandemic is boosting gold demand from investors because of a large surge in savings, because of the growing inequality, because of the vast capital destruction cycle that we’re seeing, because of declining productivity, because of rising public debt levels and, the most important of all, because equilibrium real interest rates are falling. And that, in itself, is a very, very important reason why we’re seeing gold prices rallying. And then, of course, the US dollar falling partly because the US is the most affected country by COVID-19 so far across G10.
Now there is another factor that we think is helping the rallying in gold and could actually boost it over the course of the next few months. It is the fact that China’s GDP has been quickly converging to US levels. This is a very important factor because again it brings questions about the US dollar as a reserve currency. And ultimately I think the fact that China could become the largest economy in the world may create a tectonic geopolitical shift. As we’ve seen, [rising tensions] have led to changes in foreign policy behavior, with the US shutting down a Chinese consulate in Houston and then China responding by doing a similar measure in their own territory.
So I think this situation is likely to lead to more gold demand down the road. Now I don’t think the US will lose its currency reserve status anytime soon. But I think it’s important to understand that the fact that China is rising geopolitically as well as economically at a faster rate today because the US is taking a bigger hit from COVID than China. The pandemic could continue to accelerate this transition.
So with that introduction and that constructive view on gold let me turn over to Michael Hartnett to discuss his views in the context of asset allocation. So good morning Michael and I really appreciate you joining us.
Michael Hartnett: Good morning.
Francisco Blanch: Our commodity team is bullish gold. You’ve been bullish gold also for some time. But before we get to that let’s start with the big macro picture here. What are the major side effects, Michael, on various asset classes of the ongoing massive monetary and fiscal easing? And I know you’ve been at the leading front of this. The theme of liquidity supernova that you put back in the day in the financial crisis has come back again, right? So how do you think about this and what’s happening? Thank you.
Michael Hartnett: Well, you cover an interesting subject here with gold because it has finally joined credits and treasuries and equities in enjoying the liquidity supernova. In addition gold also may be telling you something about the fiscal stimulus that we’re seeing this year. But if you put the two together in 2020, the monetary and the fiscal stimulus in terms of the announcements thus far, I mean it comes to $20 trillion, $8 trillion of monetary stimulus and $12 trillion of fiscal stimulus. And that number is – it’s a little over 20% of global GDP.
So it’s just astonishing and breathtaking and, you know, you have to sort of pinch yourself sometimes to sort of realize that it’s actually happening. But the other thing you can do is just look at your screen and see what it’s doing to asset prices. And, you know, I think since the March lows and obviously the March lows followed a, you know, one of the great crashes of all time but since those lows you’ve seen the global equity market capitalization go up by almost $30 trillion. Global stock markets are up more than 40%. Oil as you well know is up 70%, 80%.
Credit markets if you’re looking at the high yielding parts of them are up 25% and gold is also up 25%. And the only asset that really has suffered is the US dollar. And I think what people are trying to scope out is: we know the policy and particularly monetary policy works for Wall Street. I think what people are trying to work out is does monetary and fiscal policy work for Main Street and are you going to see economic growth and inflation pick up on the back of this fiscal stimulus-and is that what gold and the dollar are beginning to tell you. Or have we just dug such an enormous pit in terms of debt that the only way that we’re going to get out of it is either by a default and devaluation-and that’s what the dollar and gold are telling you. And I think that’s really going to determine greatly how people will allocate going forward.
But my own sort of personal view is that while I can see just in the next couple of weeks some of these gains pulling back a little bit, I think that the two drivers of asset price inflation and the bullish view in 2020 are still broadly in place. You’ve got a lot of bears, you’ve got a lot of liquidity and when you put those two things together you tend to get a lot of upside.
Francisco Blanch: Yes thank you Michael. And it is definitely a very complicated picture particularly because we’ve never seen this scale of “GDP backfilling” through fiscal and monetary. So it is hard to know how things will end out here. But let’s shift to a very important question because I think one of the issues that we haven’t addressed is whether inflation is set to rise or set to fall from here.
And you mentioned this is working for Wall Street. We are inflating asset values. But are we going to inflate consumer prices? Are we going to push the economy to a point where people have an incentive to work and invest and bring GDP back to normal…
Michael Hartnett: Yes.
Francisco Blanch: …where we all hope it’s going to be in the next few months?
Michael Hartnett: Yes I think inflation will go up. I mean mathematically it’s almost impossible for it not to go up given that oil prices over the next 12 months are going to be higher than they were over the past 12 months and oil is often a big driver of the overall CPI. I think that you look at maybe the US is, the example here I mean for much of the past ten years, inflation has been somewhere between 1-1/2%, 2%. So I think this year it will be around about 1%. I think next year it will probably rebound into the 1-1/2%, 2% area. And, you know, oil will be a factor there.
I think the more interesting factor will be wages and whether people are always talking about sort of the global supply chains being broken but whether you get these labor market supply chains broken because of the virus and employers end up having to pay their workers more money to get them back to work. I mean that wouldn’t be a surprise to me. So there could be sort of supply side reason why in the next 12 months inflation goes up.
I think that the question for the market is how sustained that is and whether there’s something larger afoot. And again I come back to the point about what is gold, what is the dollar, what are these things telling you? And I think that when you look at society and politics and compare what prospectively is ahead of us compared to what we’ve had previously I think that again these themes of a bigger government, a smaller world, fiscal policy access, etc. I think these are all in the air right now.
And, I do think that in time we’ll look back on 2020 we will see a major inflection point for interest rates and inflation. Does that mean that inflation’s going to surge from here? Absolutely not. But I think it’s important that inflation and interest rates stop surprising on the downside. And they’ve done nothing but surprise on the downside for ten years. And if you look at the average bond yield forecast, you know, for the past ten years or so it’s missed by 50, 100 basis points every year.
The outcome has always been much lower than predicted. And guess what at the end of ten years everyone is entrenched in a view that you can only see deflation and disinflation ahead. And so I wonder a little bit if again what you’re seeing in terms of fiscal policy and globalization. Maybe gold and the dollar are hinting that there is a more secular turning point here in terms of inflation. And that’s very meaningful because I think the way people are positioned across asset markets is a very, very deflationary way. Everyone is long credit and short commodities and long growth and short value and long the US and short everything else and long large cap and short small cap.
And that’s all because of one thing interest rates, which in turn is all because of one thing: inflation. And so I see things afoot and I think that again gold and the dollar may be the sort of lead indicators of this. But the deflationary psychology, a little bit like inflationary psychology of the early 80s, may be breaking. And if it does, that’s obviously got some big, big asset allocation implications going forward.
Francisco Blanch: Okay, so based on that thought what are the assets that you like most from a macro perspective heading into year-end and maybe a little longer than that? I mean how do you think about positioning here and looking at macro portfolios, CIOs, asset allocators? What do you think they should be doing? It sounds like you’re worried about bonds selling off if inflation does pick up and you’re worried about a reversal in recent trends, right?
Michael Hartnett: Yes, there’s tactics and there’s strategy for the next 12 to 18 months. I think the strategy for the next 12 to 18 months is you progressively become more conservative and you become progressively more inflationary in your asset allocation. And those relative traits that I spoke about, I want a little bit more value, a little less growth, a little bit more rest of the world, a little less US, a little bit more commodities, a little less credit, a little more small cap and a little less large cap. I think that those are the right allocations to shift into.
You know, you have to shift toward inflation. You don’t have to go whole 1970s inflation. But I think the way the people are positioned, the psychology that people have, the policy environment, the political environment, it certainly tells me that slowly but surely you’ll find inflation expectations turn higher. And if you do I think that you want to be raising your inflation, or your inflation hedges, within your portfolio. And I think gold is clearly at the leading edge of that.
And, just to give you a statistic you can go back to, ETF portfolios back the last time gold was where it was today I think it’s 2011, 2012 you remember we were coming out of the great financial crisis. And there was a little period where people got a little worried about inflation. It’s like, my God where is all this stimulus going to! And gold was extremely popular. And I can tell you that if you look across our private client portfolios and their ETF allocations, precious metals was roughly 10% (the ETF portfolio share I remember publishing at the time). Today that figure is more like one or two.
So again I think people are just not positioned in an inflationary way. And I think that that’s the biggest story afoot here. As for what the market does in the next two or three weeks, if you want me to talk trading squiggles I will. But I think that the broader picture I think is the more important picture. And again I think that that is a shift in the 2010s away from monetary policy and deflationary assets, to monetary policy driving inflation assets higher. I think the 2020s will be one – be one where fiscal policy and politics drive inflationary assets higher.
Francisco Blanch: Thanks Michael and I couldn’t agree with you more. I think the fiscal picture is going to become the most important driver of asset values over the next five years. And the way I think about this is, if you go back to the last ten years, everything has been about following the Fed. So the Fed does this, you follow the Fed and you’re just fine and in the last three, four months it’s been the same thing, right? I mean it’s like a Pavlovian dog. Financial markets have followed the Fed’s lead and it’s worked out.
But in the future we’re going to be facing enormous budget deficits and following that fiscal policy trail is going to be very important for returns because I think two, three even four years now a lot of the money into the market is going to come from government expenditures. Understanding whether expanding or curtailing those weekly paychecks that the government has been sending, how this – how does that affect purchases, how does that flow through the economy? And so clearly we are moving into a bit of a different economy here with some governments even in Europe actively talking about basic income…
Michael Hartnett: Yes.
Francisco Blanch: …and money flowing directly…
Michael Hartnett: Yes.
Francisco Blanch: …through the fiscal channel. So it’s going to be very interesting…
Michael Hartnett: Genie’s out of the bottle in terms of this then. Genie’s out of the bottle.
Francisco Blanch: Genie’s out of the bottle. And so it won’t be anymore “buy the Fed.” It’s going to be “buy the government”, the central governments right? I mean, those budgets are going to be the ones driving the spending and the market behavior. So thank you for all that. It was very insightful.
Michael Hartnett: Yes.
Francisco Blanch: Let’s take the discussion a little step deeper and talk about the monetary transmission mechanics in more depth with Mark Cabana who heads our US rates strategy. So Mark do you see things similarly to Michael Hartnett? Where do you see nominal rates given this background of unprecedented monetary and fiscal easing? Are we at an inflection point as Michael believes and, if so, where are things going?
Mark Cabana: Sure thanks Francisco. I appreciate you wanting me to join this call. So in terms of the outlook for nominal rates we think that they’re going to stay quite low. We have been arguing that since the Fed cut rates to zero we would likely see 10 year rate stuck between a 50 to 80 basis point range. Now the 10 year is trying. It seems to break to the downside of that. And, you know, I would suggest that given recent news flow on the virus and the US’s inability to contain it and the knock on economic consequences, it’s quite possible that we could see the 10 year break to the downside of these recent ranges and break new all-time lows.
So in the near term again it seems like pessimism remains high and it will take some type of containment or medical breakthrough in order to shock rates to the upside. Now for our Q3 forecast we’ve penciled in 60 basis points at the end of Q3, so obviously we think that this will likely persist in terms of low rates at the backend of the curve. But as Michael was suggesting I am somewhat cautiously optimistic that the virus will eventually get under control and that there will be some type of medical breakthrough.
And we’ve penciled in a sell off for tens in Q4 in the early part of next year back to at around 1% and slightly above. Now again that’s highly contingent on what happens with the virus and what happens with the medical progress but, you know, we’re still comfortable holding at least that option in the near term.
But for the remainder of this quarter and in the near term rates are going to remain low and our preferred expression has been for investors to position long real rates. We’ve been talking about this for quite some time how we think that the Fed is going to engineer setting in monetary policy such that they keep nominal rates at the backend of the curve quite low.
The additional stimulus they’re doing will push real rates lower. That will widen breakeven rates of inflation mechanically and it will result in some upside inflationary, inflation risk premia to be evidenced towards the backend of the curve. We’re still quite comfortable with those views at present and again if you were to tell me where’s my highest conviction view right now in the rates markets is that we will likely continue to see real rates fall further.
Francisco Blanch: Well that’s great because I’m just going straight into this point. Actually that was my next question Mark. As you point out, inflation breakevens have been rising. So real rates are tanking pretty quickly. Where do you see the path for real interest rates? We are now at slightly under minus 1%. Could real rates get a lot more negative than this?
And maybe linked to that is there a chance that the Fed will try to further influence the market or maybe forced (by the market) into going into negative nominal rates. So the first question is: how negative can real rates get and they already are? And the second question is: will nominal rates get negative and therefore further boost that negative real rate? Thank you.
Mark Cabana: Yes, great questions. So let me start with the assumption that the Fed will not take rates negative. We’ll talk in just a moment about the probability or outlook for that. But if we assume the Fed will not take rates negative then it does seem to us that there’s a bit of a floor for how far nominal tens can go.
What we saw back in March and the elevated market volatility and illiquidity was that tens intraday got a little bit below 40 basis points. And so if we assume that that is a reasonable floor as long as the market sends very limited probability to rates going negative, then you can use that as a basis for backing out how low real rates can go.
So let’s just assume that nominal rates we say are somewhat fluid around 40 basis points. In that context, then you can assume that with all of the unprecedented monetary and fiscal policy easing that we have gotten that inflation breakevens at least in the ten year point should be somewhere around 1.6% to 1.75% or so. And then if that’s right, that suggests that real rates could be somewhere on the order of negative 120, negative 130 basis points — somewhere around there.
Now again that assumes that nominal rates have the potential to fall 15 or so basis points further. You would assume that most of that is led by real rates. And then you assume a little bit of breakeven widening on top of that. So there is certainly scope for ten year real rates to continue falling especially if you assume the nominal rates in the near-term are seemingly biased a little bit lower.
So again we’ve been recommending that clients not yet fade this real rate move and would position for a further decline in longer dated real rates. Now this dynamic changes obviously quite significantly if you believe that the Fed will take rates negative. We still believe that the Fed is very, very reluctant to do that. We believe that the Fed has other ways that they’re considering easing monetary policy before they would take rates negative such as through enhanced forward guidance, potentially coupled with yield curve control or some type of distribution in the asset purchases that the Fed has been doing. So we do think that there are things that the Fed will look to employ before negative rates.
But if the thinking of the Fed changed then you have the potential for real interest rates to go significantly further negative. And we don’t know exactly how far the Fed would think about taking rates negative if they were to do that. But I think it’s safe to assume that if the Fed went through all of the effort to change their thinking on negative rates that they wouldn’t be looking to cut rates into negative territory by 10 or 15 basis points. I think that the assumption would be that they would cut more significantly into negative territory.
Now I want to be clear that’s all sort of theoretical in nature. We think that the Fed is very, very resistant to negative interest rates and for good reason. They’re resistant to negative interest rates because they believe that they are not particularly effective. Certainly the countries that have adopted them have had real challenges implementing them. They’ve created financial market distortions. They’ve been a hit to confidence as it attacks savings and savers. And there are real logistical issues in terms of operational considerations given how large the US money market industry is and this would be a very real challenge for the US money market industry.
So we don’t think that the Fed’s belief in negative interest rates has changed. We don’t expect that it will change in the near future. And I think that you would need to see a more material deceleration in the economy. I think you would need to see great disappointment on any type of medical breakthrough in order to bring that about. And the Fed is going to wait to make that assessment before quite some time and utilizing these other measures before they would consider negative interest rates. So I still think it’s a fairly low probability outcome at this stage.
Francisco Blanch: Okay thanks Mark. And maybe just to wrap up if you can give us a little bit of color as to how you see the Fed’s balance sheet evolving here because I know there’s been revision of balance sheet growth targets. And also in part linked to that do you think there’s a chance the Fed will start acknowledging upside risks to inflation in their statements in the next six months. If so, when do you think it’s most likely that will happen? Thank you.
Mark Cabana: Sure. Let me take the inflation question first just because I think that’s a much easier answer. They’re not going to talk about upside risk to inflation in the next six months. I’m not even sure that they would be talking about that in a meaningful way in the next six years, depending on how the overall evolution of the labor market is concerned. So the upside risks to inflation is not a concern for the Fed whatsoever. They are instead focused much more on downside risks to inflation and I think rightly so given that we have broadly seen economic activity stall to some extent, and given the recent growth of the virus and the inability to contain it, and given some of the very, very significant impacts to businesses, defaults and the services sector and that part of the labor market.
So I think that they are much more concerned about downside risks to inflation as opposed to upside risks. And this is a Fed that we largely believe will begin to shift its communications over the remainder of this year to explicitly acknowledge that it wants to see and overshoot on inflation. It wants to reinforce the symmetric 2% core PCE target. It needs to do that by actually allowing inflation to run hot for a period of time.
And I think we’re going to see the Fed really codify that belief in adjustments to their longer run statements principles that they will make before the end of the year and probably through a shift in the type of forward guidance that they apply, i.e., really over weighting the outlook for inflation and wanting to ensure that inflation can remain above, at or above 2% and perhaps for a period of time maybe six months, 12 months they would think about raising rates. So the upside risk is not a concern for the Fed in the near term.
Now on the balance sheet we have indeed made some revisions to our expectations for the balance sheet. Earlier this year the Fed was rolling out a whole host of programs. And then before we really had details on how they would be structured we assumed that there would be a much more meaningful take up in some of the programs that the Fed were introducing. And we believed that relatively large take up in those programs would likely push the Fed’s balance sheet size to over $10 trillion.
Now the Fed’s balance sheet today is just around $7 trillion. And we have subsequently revised down our expectations for the Fed’s balance sheet because we’re not seeing meaningful take up in many of the programs that the Fed has introduced. Certain programs such as the Main Street Lending Program and muni program are just not well designed. And that’s not really the fault of the Fed. It’s not really well-designed given the limitation that the Fed has in terms of its lending ability. So we’ve taken down those expectations quite meaningfully.
We have also seen much more moderate interest in some of the other extraordinary programs that the Fed put in with regards to the primary credit facility, to the money market facilities. And really the programs that the Fed has put in place and the most heavily utilized have been the FX swaps with other central banks that the Fed has in place. And we have recently seen those swaps mature and not get rolled just to improvements that have been taking place in money markets and in dollar funding markets more broadly. So I think that again it’s really a revision about what the total amount of usage would be on the Fed’s balance sheet.
Now where do we see the balance sheet more explicitly going from here so again we’re right around $7 trillion. We project that the Fed’s balance sheet is going to end the year at around $7.7 trillion. So a further $700 billion growth in the Fed’s balance sheet which is primarily driven by what we think will be more traditional type of treasury purchases, mortgage purchases, CNBS, agency CNBS that the Fed is buying as opposed to any of the other nontraditional programs that the Fed has outstanding.
Now, there are risks to the high side and the low side in our projections just because it’s possible the Fed increases the total amount of asset purchases that they’re doing. But with treasury markets and mortgage markets functioning well and rates so low you can argue that there’s not a real need for that unless there was to be a much larger fiscal stimulus plan than the market is anticipating. But to the downside it’s also possible that if the Fed rolls out more explicit forward guidance saying it won’t raise rates until 2025 and beyond what you could see as the Fed might take some of the treasury buying that they’re doing in that front end to medium part of the curve shift it out the curve a little bit to extract more duration from the market but also reduce the monthly pace that they’re buying. So again I would say that there’s kind of symmetric risks around our 7.7 or so trillion dollar Fed balance sheet estimate by the end of the year. And we really need to see how the Fed adjusts their thinking around more traditional asset purchases to have a clearer sense as to whether or not that’s going to move to the high side or move to the low side.
Francisco Blanch: Thank you Mark. That’s I think very clear. Let me shift over now to Michael Widmer and talk about the outlook for the precious metals market. In particular, Michael is very focused on the micro drivers of gold and, as I pointed out, a huge surge in investor buying has been driving prices higher.
So Michael can you put that in context for us? How sustainable is this upsurge in gold and, when you think about kind of the 4000 plus ton-per-year market for gold how is that kind of demand shifting? And how do you think we’ll move going forward into year-end and into 2021?
Michael Widmer: Thanks, Francisco. So let’s look actually at how gold market rallies normally start and how they have come to an end in the past. When we think about the gold market we usually categorize market participants into four categories. On the supply side we have got the miners and the scrub suppliers, and then on the demand side it’s the jewelers and the investors.
Now the miners tend not to be influenced by prices as much but scrap supply and jewelry demand are actually price takers. And that means that scrap supply normally increases as prices rally. Actually this time around jewelry demand was even more hit because we had relatively no jewelry stores open. And that basically means that investors are the price setters. The higher investors’ prices take or want to take, the more ounces they essentially have to pick up going forward. The moment investors normally start or stop purchasing gold that’s the moment when prices become a little challenged.
If we look at it from a macro angle, we have a macro model that runs in four variables. The two most important variables are in that model are the dollar and ten year real rates. We discuss ten year real rates a lot. When you’re looking at kind of what levels we would need to see to even go at $2500 per ounce again it’s a lot of combinations that you can see that you can come up with but the DXY at 90 real rates at minus 2 will take you to $2500, the DXY at 85 real rates at minus 1.75 will take you to 2500, DXY at 80 real rates at minus 1.5 also take it to $2500 an ounce.
So I would just say from an investor perspective you need to see the real rates moving and you need to see the DXY moving. One question that we always get is that investors are already overexposed. And Mike actually was mentioning some of those figures. We’re looking at equity allocations relative to the overall global equity market and right now investors have allocated just 3% of their assets to gold.
Now if you put that number into perspective allocations, were as high as 6.2% in 1980. But even now when you’re looking at an investors (bonds) optimized the risk return profile of a mixed equity fixed income portfolio they should really hold 4.5% of their assets in gold. So if you take those, the 3% and you compare them to 4-1/2% and 6.2% look that’s actually equates to around 68,000 tons of gold in 49,000 tons of gold relative to a global gold market size of around 3500 tons. So coming back to your question look you need to see real rates, moving you need to see the dollar moving, there is certainly an awful lot of scope still for investors to keep adding to their reserves.
And the last point I would make, we normally don’t classify them as investors, but it’s really the central banks. The central banks have turned gold buyer’s net gold buyers in 2009 and since then prices have just been very, very well supported. And I think devaluation was one theme particularly among the emerging markets central bank that drove those buys. I think concerns over bond valuations also has attracted some central banks.
We continue to see central banks into the market slightly different motives than your pure real rates DXY portfolio. But that’s, but those purchases really in all likelihood continue to come. And if they come and when they come that should also be quite, that should also be quite supportive for the gold price.
Francisco Blanch: Thank you Michael. And finally there’s some discussion of President Trump suggesting a delay to the US election amid fraud claims, so I guess that would also help the case for gold here. Let’s talk a little bit about silver, platinum and palladium. What’s going on there? I mean, can the crazy silver rally continue? And what do you think of platinum and palladium in the context of as I mentioned earlier massive fiscal easing and some of this money being directed towards environmental causes and potentially boosting the amount of precious metals purchases? Thank you Michael.
Michael Widmer: We put out a note back in April actually almost the same time as we put out the gold note and we highlighted that silver is to regain its sparkle. We had thought through the second quarter that silver could rally to $25 by mid-2021. But look I think the rally has been a bit faster and a little bit more furious. So the question is what actually happened? Why did we fall so low? And where are we going to go from here?
I think silver prices dropped sharply during the lock downs for a couple of reasons. One reason in particular I think is that industrial demand is really important for the silver market. It’s about 80% of demand. And I think that’s why gold silver ratio rallied to a record 124 back in March. Investor demand then was already quite strong but it actually did not really offset that weakness in industrial demand. The interesting thing now is that we’re starting to see investors at least stabilize. The macro driven investor demand has already helped to bring the gold silver ratio down. And I think it also helped silver on a standalone basis.
In addition, and I think this is really only played out over the last couple of weeks, you mentioned the US elections. And I take a slightly different viewpoint on that for a second. Silver is a metal that we call a MIFT. So it’s a metal that is important for future technologies. And the metal actually took the leg higher in the past few days when investors or after investors had a good read through the policy outline of Joe Biden who obviously next to Trump is running as candidate for US president.
What Biden actually did is he pledged to achieve fewer emissions from the power sector by 2035. That in turn would likely boost in storage capacity of wind and solar power based on what we have already and if he was elected obviously. If you run the numbers zero demand from the solar industry would potentially increase from around 2285 times this year to an average of 4272 times until 2035.
Now you have to keep in mind that the surplus over the last five years was only 1100 tons, so an increase to that tune would potentially put the market into sustained deficit. The last time that happened was between 2006 and 2011 on a slightly different backdrop. Silver actually rallied to all way to $50. So I think it is certainly an upside risk depending on how these next few weeks or months actually play out.
And then on the platinum group metals, I think it’s been a tricky backdrop for those this year. On the one hand you’ve had South African mine production potentially declining by 30% this year. South Africa is the biggest platinum producer nation and they are already down 20% this year as well. And so the question is which of those two actual wins? I mean we made a call we said look platinum is going to be in deficit and palladium will be in deficit as well.
But then again when you’re looking out medium term it actually starts getting really interesting. We like platinum actually better because it also is a MIFT and actually, has actually quite good demand prospects. Now when you’re looking, when you’re digging a little bit deeper historically, there was always a little bit of a focus on fuels. And arguably that does remains a niche application for now.
Governments actually want to boost the penetration from this combustion system not necessarily in passenger vehicles but more on the commercial side. When you’re running the different figures you get something between 100,000 ounces and 4 million ounces of demand by 2030, so quite a big range. Full market is around 8 million tons so there’s still a little bit of uncertainty on that. The bigger potential impact and I think this is really where it’s focusing because a lot of government policies that we see increasingly around the world are actually quite green. The bigger impact could potentially come from electrolysis and you saw the EU hydrogen strategy link to that.
And what governments basically realize is that there continue to be intermittency issues if you put more renewables on to the ground. And the energy storage that we had discussed in the past like hydro or batteries they all have drawbacks here and there. Hence there is this focus now on actually using hydrogen as an energy carrier. And the technology that has being discussed is environmental change electrolysis which is actually using platinum as a catalyst is very platinum intensive.
It is an extremely flexible technology. You can run it at a very low scale but you can also size it up meaningfully. You can size it up to even out seasonal swings in power generation and demand by generating hydrogen and putting it then for instance into sold current . So it’s a very, very interesting and promising development for the precious metals.
When you run the numbers, you probably need just under 8 million tons of green hydrogen by 2030. If you look into the platinum content that somewhere between 400,000 and 1.4 million ounces. Then when you’re looking at the EU’s Green Deal as a reference point we come up with somewhere between 500,000 ounces and 2.2 million ounces of platinum demand again in a market that is around 8 million ounces. This is all a great development for the market. So look I think precious metals has good prospects going forward. And I think with that I am going to hand it back to you, Francisco.
Francisco Blanch: Thank you, Michael. That was great insight and links to the themes of monetary policy and also fiscal policy that we discussed at the beginning of the call. So let’s finish the discussion on the technical side. And I want to bring in Paul Ciana who has been patiently waiting on the line. And Paul’s been very bullish precious metals but he’s also put out very strong views on rates and on the US dollar.
So first of all, Paul, what targets do you have for precious metals, rates and the (VIX)? And also maybe related to that, if you can tell us where you see the most stretched macro positions across the various assets that you look at and then we’ll probably go and to open up for Q&A. Thank you Paul.
Paul Ciana: Sure. Thank you Francisco and thank you for having me on the call. In the interest of brevity I’ll run through a few thoughts, answer your questions and touch on a couple key things. So with any technical approach we consider multiple time frame trends so there’s long-term charts, medium term and of course the short-term squiggle charts as Michael Hartnett referred to them as.
You know, we have essentially views on all of them so I’d just like to summarize what we see according to the technical advantage. The tide in all of our gold charts is secularly bullish. That is the theme of this call beyond a shadow of a doubt. And overall we do think there is still room for gold prices to gravitate higher.
So over a year ago we opened a major call for gold to hit all-time highs in the next couple of years with upside of around $2100, $2300 an ounce. Should you look at a long-term chart of gold since the 1970s or so which are in some past reports of course you’ll see we’ve labeled the 2014 to 2019 time frame as the end of wave four. What that means is gold prices have moved since the early 70s into that time frame of 2014 to ’19 in four major waves. 2019 represented the start of wave five. There are usually five waves in one direction to new all-time highs. So now we’re at a point where gold has broken out its representing classic LE wave technical theory. And wave five still has room to rally, so it’s still bullish.
As far as sort of the waves in the medium-term trends in the gold market go, the rally over the last year was doing something very technically important. It’s so important rallies occur and then corrections through time follow. That’s really important because markets can correct in two ways, right? They can go sideways, which is a correction through time which represents the strength of the uptrend, and the bullishness in the market because there isn’t excessive selling or they can have corrections through price which are more volatile, harder to hold on to, bigger picture, long positions and essentially shake a lot of people out.
So that was happening earlier on people getting shaken out and now it’s more like corrections through time. So it’s a representation of the gradual shift towards a more and more and more accepted bullish trend in gold prices. CPAs are starting to come in more. Eventually we’ll move to the phase of kind of the FOMO buyers coming in. So we’ll get dips undoubtedly and we still think they should be bought.
From a ripples or a shorter term perspective gold is up about 30% from the start of the year to the high this year right? So when gold started trading 2020 to the high this year it’s about a 30% gain. This is about I believe the eighth largest up year in the last 40 years so it’s standing out as one of the bigger up years so far. But the biggest up year gold was up from the start of the year to the high of about 41%. So should we have a year that challenges that year than that does support the idea of gold getting up to about $2150 before year-end.
Otherwise in the short-term we have a variety of momentum signals to consider across our asset classes that suggests that gold is overbought, dollar is oversold, the euro is overbought and, you know, in the interest of brevity I won’t list them all that essentially means take outright risk here to buy gold, sell dollar and buy euro the risk reward for anyone trading they look at that and they say this is unattractive. I can’t really do anything on the spot side right now with how stretched positions are. But what they could do is something like a call or put spread for a one to three month time frame. Maybe even something like sell two buy one type thing to try and finance the position. So that’s what we’re kind of seeing and hearing as well.
Positioning as it relates to CFFC data is definitely long gold. There’s no doubt about it. It should be short dollar by now. When we adjust positioning for open interest we found that the ten week range in gold prices this spring if you remember there was a correction through time that ten week period was very important because it allowed momentum in some of the charts to correct and positioning that was stretched at a record long to essentially correct.
So these corrections were modest but that’s an important ingredient to a sustained trend is dips in momentum and dips and positioning where price action consolidates and then allows for the next surge higher. So what we see from these different perspectives is that people are trading gold, right? And they’re more so turning towards just investing and buying and holding gold. So, you know, still buy dips as you see momentum and a little bit of positioning come off.
In terms of dollar positioning, there was a note on that in the last Bank of America Global Research FX and Rates Sentiment survey. I believe there was a chart that showed significant bearish sentiment for the dollar but a lack of positioning to represent that sentiment. Now that survey was a few weeks ago. The next one is coming up soon. And so over the course of let’s say the last month obviously the dollar has fallen and euro has ripped higher. So I would expect the positioning in the market to be catching up to the sentiment.
It doesn’t necessarily mean it’s stretched. And stretch positioning doesn’t necessarily mean you turn into a contrarian and go the other way because stretch positioning is often held for a while. Euro is a great example of that we consider the time frame of 2017 and into 2018. Frankly if you look at the long-term positioning of gold charts back in say 2000 and 2003 there are periods where gold prices got very stretched long but prices continue to trend as positioning tends to hold.
So in the euro example from late 2017 in into 2018 the euro was stretched long for a period a four month. That’s a long time. And then the euro began to put in a price top in the technical charts and then it began to rollover. So I still think we have time on our side.
Final thought yesterday we did publish a report called Five Major Trend Lines Under Siege. This shows some simple line charts looking at some of these longer term trends that tie back to the inflationary discussion on this call, the interest rate discussion on this call and the position discussions on this call. We we see really three things. One, last week the euro did break out of a secular downtrend marginally so that began in 2009. So we’re looking for a couple of little things to confirm it. It looks like we’re going to get it with the euro trading at 1.18 here.
So the trend in the euro is turning up. It was in a 12 year downtrend it’s turning up into probably medium to long-term uptrend. So there is a technical path into the mid-1.20s. I could even argue for some targets that are above 1.30.
The Bloomberg US Dollar Index where the BBDXY actually broke down through some secular support over the last decade. So decade long support levels and trend lines are broken. So that’s turning in theory to a downtrend so weaker dollar certainly feeds into the comments that Michael Widmer was saying about how a weaker dollar can be extrapolated into higher gold prices.
We’re just mentioning the BBDXY here where he was referencing some level in the DXY. The reason we do that is we look at both, but the Bloomberg Dollar Index is 20% emerging markets so it does show that right now there is actually a little bit risk appetite for some of the EM currencies in this index such as the Mexican peso, the Korean won, CNH as well as the Indian rupee, despite what’s happening in those countries with the virus.
And the last thing and the final note is the line chart of gold which represents a little cheeky I apologize but it essentially represents a smile pattern. And there’s a saying in technical: buy smiles and sell frowns. So if you look at a chart and is smiling at you, smile back and be long. So gold is going higher. We agree with the views on silver too: it looks like it’s a base. Positioning is relatively flat and could actually catch up to the positioning that’s more stretched in gold, so we would be buyers on dips there as well. Thanks for your time I’ll turn it back to you.
Francisco Blanch: All right. So perfect time to wrap it up. We are ten minutes over. Thank you very much.