Nitesh Shah (Wisdom Tree) | After staging a recovery for most of Q2 2021, drawdowns in June and August 2021 have set the metal back. Based on our modelling framework, gold looks severely under-priced. Red-hot inflation – currently above 5% – should point to a gold price above US$2000/oz, yet we are currently languishing around the $1785/oz handle. As Figure 1 below shows, our model indicates that in July 2021, gold prices should have risen close to 12% year-on-year, when in reality it fell 8% year-on-year.
We believe that if gold regains its traditional behaviour, it should rise from today’s levels and counter the headwinds of moderately rising Treasury yields and inflation cooling a little. Gold’s odd behaviour of late is also highlighted in its departure from Real Rates in recent months (Figure 2). However, as we have seen in the past, these short-term departures are often corrected (e.g., in November 2019 and November 2020).
Wisdom tree’s gold framework
Using our model framework, explained in our blog “Gold: how we value the precious metal”, we provide an outlook for gold prices until Q2 2022. This outlook incorporates a consensus view on the macroeconomic inputs to our model based on survey of economists by Bloomberg in July 2021.
What is the economic consensus driving the results?
Consensus opinion is for inflation to fall from 5.4% in July 2021 to 2.6% in Q2 2022. It appears consensus is broadly following central bank guidance that elevated inflation is transitory and largely driven by base effects.
Consensus also expects Treasury yields to rise, reversing most of the decline in yields that we have seen over the last three months by the end of the year and then driving higher to a level we haven’t seen since 2019.
US dollar remains quite flat over the forecast horizon, declining slightly from 92.6 at the time of writing (16 August 2021) to 91.0 at the end of the forecast.
To be consistent with the scenario of easing inflation concerns and rising Treasury yields, we expect speculative positioning would decline from current level of 200k contracts net long to 130k net long.
Factoring these assumptions into our model, we get to a gold price of US$1890/oz by Q2 2022 but could peak out at US$1970/oz by the end of the year. Despite the headwinds of moderating inflation and rising Treasury yields, gold in this scenario is still correcting on the upside after having been under-priced.
We ascribe a 40% probability to the consensus scenario. We also explore some other scenarios [details can be found here:]. In a bull scenario, stubbornly high inflation and a central bank that doesn’t stand in its way, should drive gold to an all-time high of US$2190/oz. In the Bear case scenario, a hawkish move by the Federal Reserve could lead to gold prices falling to US$1550/oz.
Gold is currently under-priced relative to our model forecast. If gold’s behaviour snaps back, there is upside potential for the metal. Even in our consensus scenario where there are headwinds of inflation moderating and Treasury yields rising, gold prices should head higher from today’s levels.