Gold may be 50% overvalued, but the US fiscal position rules out shorting, while silver has real upside - Icon Economics' Stuart Allsop
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(Kitco News) - Even with gold ETF holdings down and technicals showing the potential for significant losses, the weak fiscal position of the United States means it’s unwise to short the precious metal, according to Stuart Allsop of Icon Economics.
“Over the past few years, I have shifted from being strongly bullish in mid-2021 to strongly bearish at the peak in May this year,” he said. “After the recent correction from this peak, I am no longer short the metal.”
Allsop wrote that even though real bond yields indicate that gold prices should be significantly lower than they are at present, he can’t justify a short position given the “inevitable decline” in real bond yields that must occur to enable the U.S. Treasury to keep funding costs under control. “I, therefore think any dips in the SPDR Gold Trust ETF (GLD) should be bought,” he said.
Allsop noted that the holdings of GLD and other ETFs have declined across the board as gold prices have risen.
“The GLD continues to exhibit a pattern of lower highs and having failed to hold gains above $190, which corresponds to a gold price of $2,000, a triple top pattern is in play,” he said. “The next meaningful level of support comes in at around $170, but a drop to $150 is a growing risk.”
Allsop also noted that gold prices have a strong reverse correlation with real bond yields, and given where yields are currently, the precious metal should be much cheaper. “The last time the iShares TIPS Bond ETF (TIP), which tracks the performance of inflation-linked bonds, was at current levels, gold traded at around $1,000/oz,” he wrote. “Even when we add in the impact of inflation over time, gold should still be trading around $1,500/oz based on the performance of TIP.”
Allsop said that with TIP now yielding 2.6% in real terms, “gold would have to rise by 2.6% per year over the next 7 years in order for the metal to perform in line with inflation-linked bonds.” Adjusted for inflation, this would put the real gold price “back at its 2021 high, significantly higher than its long-term average.”
Allsop said the correlation between 10-year Treasury yields and the ratio of gold prices to industrial metals prices also indicates that the precious metal should be far cheaper than it is. “On this basis, gold's fair value is less than half of current levels,” he wrote.
But even with all the historical and technical evidence of gold’s overvaluation, Allsop believes the fiscal realities facing the United States government mean “the fundamental backdrop for gold prices is set to improve greatly over the coming years,” because “there is no feasible way for the US government to continue running primary fiscal deficits without the Fed driving real bond yields deeply negative.”
When the U.S. needed money to pay for WWII spending, they fixed the 10-year yield at 2.5% even though inflation rose to 20%. “A repeat of such financial repression today would likely drive a collapse in demand for the US dollar as a store of wealth,” Allsop said. “While the gold price was fixed during this period of history, we should assume that the metal would be the main beneficiary of a plunge in real borrowing costs this time around, particularly as the US is not the only country with structural fiscal largesse that will necessitate lower real yields.”
“We have already seen how the price of gold responds when central banks are forced to drive down real bond yields into negative territory to prevent exponentially rising interest payments,” he noted. “The Bank of Japan's yield curve control amid rising inflation expectations has seen real 10-year bond yields fall below zero, leading to a surge in gold prices in yen terms. The metal is up 86% since the brief deflationary episode triggered by the Covid crash.”
Allsop sees the risk of further declines for gold prices in the medium term. “Rate markets are already pricing in aggressive rate cuts in 2024 and speculators remain net long the metal according to CTFC futures data,” he wrote. “If rates remain on hold even slightly longer than consensus expectations, we could easily see gold fall to $1,800.”
But Allsop said he’s no longer shorting gold, and he’ll be looking to buy if the price drops significantly. “Gold deserves a valuation premium to the fact that falling prices would be most likely driven by sustained high real bond yields, which would over time have to reflect strong real GDP growth, and result in high risk-free returns for investors,” he said. “Anyone who is not fully invested, and in particular anyone who has regular salary income should absolutely welcome these things, even if they mean losses on their existing equity and bond portfolios.”
He also sees strong upside potential elsewhere in the metals. “Industrial metal miners have a great track record of outperforming during periods of rising inflation expectations and are trading at undervalued levels,” Allsop wrote. “I also own silver, which is trading at deeply undervalued levels relative to gold and should still perform well in the event of a downward reversal in real bond yields.”