Agustino Fontevecchia, Forbes Staff
Bringing You The Bull And Bear Case From The Markets Desk
Markets | 3/19/2012 @ 4:18PM
Gold suffered what appears to be long-lasting damage since the onset of March, with prices falling nearly 7% from 2012 highs. As Treasury yields surge, markets have entered a new phase marked by generalized optimism, where fears over economic weakness and of an implosion in the Eurozone have receded. These are ominous signs for safe havens, and gold has gotten clobbered, forcing UBS’ Edel Tully to lower her one-year price target to $1,550 an ounce, a 12.7% downgrade.
Still, the yellow metal could once again look attractive if any of the major risk scenarios play out, or if the Fed signals it has no intention to begin “normalizing” policy. QE3-or any form of additional easing-, rising inflation, or a major oil price shock should add fuel to gold’s decade-long rally once again.
Gold was trading up 0.4% to $1,625.80 an ounce by 4:18 PM in New York. Only two weeks ago, the yellow metal was up above $1,700. On the flip side, 10-year Treasury yields, which were as low as 1.8% in early February, are now up to 2.38% and promise to move higher (Nomura’s short-to-medium term outlook is 2.4%, possibly overshooting to 2.5%).
Last week’s violent Treasury sell-off marked the shifting of a market paradigm. Forcing the Fed to acknowledge the improving economic landscape, February’s jobs report signaled a strengthening recovery. Greece’s widely expected default has momentarily taken Europe’s sovereign debt crisis off investors’ radar screen, while the economic outlook for the Eurozone looks less bleak, with UBS’ 2012 GDP estimates now between -0.4% and -0.7%, suggesting a milder recession than expected.
What does this mean for gold? It means investors have lost their appetite for a macro tail risk hedge, according to Tully. Concerns over sovereign credit and inflation have eased, and investors have begun to question the Fed’s intention to maintain ultra-loose monetary policy. Expectations for QE3 have pared back, with some market players expecting rate hikes to begin before the Fed’s pledged late-2014 time-frame. UBS’ macro analysts expect policy normalization to begin in mid-2013.
Thus, Tully has cut her one year target to $1,550 an ounce; UBS’ 3-month target was axed from $1,950 to $1,600.
In terms of market fundamentals, both physical and speculative buyers have failed to step up. China has lowered its growth outlook and India has recently raised its import duties on gold, which, coupled with a weakening rupee, is structurally bullish for the yellow metal.
With physical demand failing to step in to help put a floor under gold, the investment community has taken the opportunity to short the yellow metal, rather than buy cheap, Tully explains.
Does this mean game over for gold’s multi-year bull run? No, says Tully. The Fed, along with other major central banks, have seen their balance sheets explode as they inject liquidity into the system, while central banks in emerging markets are beginning to ease in the face of a global slowdown. There are no indications the Fed will begin to hike rates any time soon, particularly given the dire state of U.S. housing markets, and real interest rates in many regions are still negative.
The elephant in the room, though, is the rising price of crude oil. WTI was trading around $107.7 per barrel while international crude benchmark Brent recently hit all-time highs in euro terms. An Israeli-Iranian conflict still threatens to disrupt flow through the Strait of Hormuz, while the structural supply-demand balance remains tight.