Investment Banks Suddenly Bullish On Gold

Written by Jason Simpkins
Posted October 14, 2016

Investment banks are suddenly bullish on gold.

It's about time.

For the past couple of years, and even the past month, gold has been been bludgeoned by the Fed.

More precisely, it's been bludgeoned by fears that the Fed would raise rates higher.

But now, more and more analysts are coming to realize that the Fed can't really do that — not in any meaningful way. The U.S. economy is simply too weak. Furthermore, every other major economy in the world is going in the opposite direction.

England, Japan, China, Australia... you name it. They're all cutting rates, in some cases into negative territory. And they're quantitative easing, buying their own bonds.

The Bank of England has cut borrowing costs, boosted its QE, and doled out an extra £100 billion ($131 billion) to encourage banks to lend.

The Bank of Japan has pledged to nearly double its purchases of equity-traded funds, from 3.3 trillion yen ($33 billion) to 6 trillion yen ($60 billion).

Australia has cut its benchmark interest rate to a record-low 1.5%, citing the Australian dollar's recent strength against the pound, euro, and yen. South Korea and China are in the same boat, with the latter announcing a huge devaluation to the yuan, which it'd previously been trying to stabilize.

And most importantly, Japan, the ECB, Great Britain, Denmark, Sweden, and Switzerland have all deployed negative interest rates.

This is the backdrop against which the Fed is supposed to tighten its monetary policy?

That's a tough draw.

Now, to be clear, I'm not saying it won't happen. It will... Just not as quickly or dramatically as the market once anticipated.

Earlier this week the Fed said a rate hike would be needed “relatively soon.” (Exactly what relatively soon is I don't know.) However, the committee decided to wait for further evidence of continued progress on employment and a faster pace of inflation. I'm not holding my breath for either of those to materialize anytime soon.

Nor do I expect a significant or timely rate hike.

Remember, many analysts actually predicted a rate hike in September. Yet, here we are in October and there's been nothing. Now they're saying December.

Maybe that will be it, I don't know.

But here's what I do know...

Waaayyyy back in December 2012 the Fed said it would start raising interest rates when unemployment reached a level of 6.5%. Well, that finally happened in April 2014, when the unemployment level fell to 6.2%.

And when did the Fed actually increase the rate? December 2015, a year and a half later.

The increase? Up from a range of 0%-0.25% to a range of 0.25%-0.5%. And that's where we've stayed for the past 10 months.

My point is the Fed tends to drag its feet on these things. It over-promises to prime the market and then under-delivers.

Take a look at this scatter plot from 2014...

Fed Rate Forecast

This is the Fed's own forecast for interest rates. Each dot represents a member of the FOMC, and its position shows where each one believes the benchmark interest rate will be over the next three years.

As you can see, all but one FOMC member thought rates would be over 1% by 2016. Most were huddled between 2-3%. And two thought we'd have interest rates of 4% or higher by now!

It's laughable, considering we'll be lucky to have a new range of 0.5%-0.75% by the end of the year. We won't get to 1% until at least 2017. And 4%? Like I said, I'm not holding my breath.

So, getting back to gold, the beating hardly seems justified. That's why the metal is up some 25% this year.

But still, the market keeps reflexively flinching like the hammer is going to come crashing down any second.

It's nonsensical.

That's what investment banks have come to realize. They overdid it.

UBS now sees gold prices climbing to $1,350 per ounce over the next year, up 7% from its current level. And that's after what the bank believes will be a brief retrenchment in December when the Fed will supposedly raise rates.

I tend to agree.

Gold saw a nice rebound early in the year, as the Fed repeatedly balked at raising rates further. Only when the calendar year began to draw to a close did it falter. Investors and Janet Yellen seem to sense the last grains of sand trickling through the Fed's hourglass.

I'd expect a similar pattern in 2017. Gold will languish through December until the Fed finally decides to raise rates. Then, it'll be another year of rising gold prices as the Fed plays “wait-and-see” with any further interest rate bumps.

Or, in a different scenario, the U.S. economy stalls and the Fed can't raise interest rates at all. In that case, gold really blows its top.

In either case, there are more gains ahead for gold.

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Jason Simpkins

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Jason Simpkins is a seven-year veteran of the financial publishing industry, where he's served as a reporter, analyst, investment strategist and prognosticator. He's written more than 1,000 articles pertaining to personal finance and macroeconomics. Simpkins also served as the chief investment analyst for a trading service that focused exclusively on high-flying energy stocks. For more on Jason, check out his editor's page. 

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