Gold Price Framework: The Next Cycle Unfolds
Based on the findings of our gold price framework, we have long argued that we have entered a new gold cycle. However, until now, there was always the risk that strong economic growth could allow the Fed to raise rates above what the FOMC members themselves expected was possible. As markets and the Fed itself rapidly adjust to the new reality of a slowdown in economic growth, those risks have subsided, bolstering our conviction that the next gold cycle is about to unfold.
In 2018 we published a 3-part series “Gold Price Framework Vol. 2: The Energy Side of the Equation” in which we presented our revised gold price model (part 1), took a deeper dive into the link between longer-dated energy prices and gold by doing an in-depth analysis of the energy exposure of gold mining companies (part 2), and gave an outlook for gold prices (part 3).
For those unfamiliar with our model, we recommend reading at least part 1 to get a better understanding of our findings in this report. In a nutshell, we found that the majority of changes in gold prices can be explained by just three drivers: Central bank policy (more specifically real-interest rate expectations and QE), changes in longer-dated energy prices, and central bank net gold purchases (the least important driver). These three drivers can explain over 80% of the year-over-year changes in the gold price (see Exhibit 1).
Based on the outlook for the main drivers of the gold prices, we reiterate our view that the risk to gold prices is clearly skewed to the upside, a position we are holding since early 2016. While our bullish view on gold remains unchanged, there is a clear change in our conviction level. For the past three years we have held the view that we are in a new up-cycle but we always maintained a somewhat cautious stance as we could see a near-term scenario where the Fed was able to continue to raise rates on the back of an acceleration in economic growth. We now think that this risk has all but vanished, with global economic growth pointing down, the FOMC members themselves cutting their future rate expectations and the market beginning to price in rate cuts rather than further rate hikes. In other words, the next cycle is about to unfold.
