The outlook for gold in 2013 was more mixed than in years prior, but several investment banks maintained bullish price targets. Morgan Stanley, Barclays, Bank of America, and Société Générale all have year-ahead price targets of $1800 or higher. Here’s the thematic outlook from a recent report by the cross-asset team at Soc Gen:
Our commodities team is calling for renewed price strength in gold prices into 2013. They currently forecast gold rising to an average of $1,850/oz in Q2 2013, predicated on inflationary fears and currency volatility. They also expect the US dollar to remain relatively weak on QE3 and the possible use of other monetary tools designed to offset any headwinds from fiscal consolidation. However, they caution that investors are well disposed towards gold and are to some extent already positioned accordingly, so there is unlikely to be sufficient investor buying power to sustain peak prices for long.
Traders with a bearish outlook on gold can rebut each of these points:
- Inflationary fears do not justify gold ownership, either on a fundamental basis or as a question of investor sentiment. Gold is not an inflation hedge on any practical investment horizon. And given that the greatest risks to developed market economies are still deflationary, there is no reason to expect even malinvestment from inflationary fears to drive gold upward.
Fig. 1. CVIX – Major FX 3M IV. Source: Deutsche Bank
- Currency volatility remains at multi-year lows. While there are some pockets of FX volatility (see our coverage of the yen story over the last two months), composite measures are still quiet (fig. 1) and absent some new catalyst, there is no reason to expect currency volatility to push investors toward gold.
- Weak USD: the first half of the year should not bring a trend change for the dollar, but one theory bandied about on some desks this winter has been that a stronger U.S. economy in the second half might actually meet with a positive correlation in the USD. The impact of fiscal problems – which were such a point of concern over the holidays – has, so far, been mild. Moreover, the risk of monetary policy seems to be on the other side of what Soc Gen mentions – that Fed governors will push for tighter policy too soon.
- The final point, that bullish attitudes toward gold are already reflected in the asset price, is well taken. Gold has been the darling for years of wiser-than-thou doomsayers, of more sober-minded risk parity proponents, and even of retail investors. In 2011, as weak ratings pushed his television show off the air, Glenn Beck cashed in on his celebrity by selling gold coins to viewers, allegedly as part of a fraudulent scheme; hyper-inflation fear monger Peter Schiff sent out a similar mass email hawking gold at a steep discount last week. Gold rocks do not produce food, fuel, quarterly earnings, or any other goods or services; while there was room for greater-fool upside at $500, as world economies recover, there are more attractive places to park cash than in a $1600 “store of value”.
Fig. 2. Gold implied volatility at 5-year lows. Source: CBOE, Condor Options
With the implied volatility in gold options at a five-year low (fig. 2), investors can take a long volatility position with an options strangle to profit from a large move in either direction. A 95/105 three-month strangle could be entered recently by buying the GLD May 153 puts for $1.55 and the GLD May 169 calls for $1.83. If the metal loses favor this year, volatility should pick up as complacent longs take profits. If the bearish bias proves wrong, the call side of a strangle can be purchased here at a cheap enough IV rate to offer economical protective upside exposure.