As CNBC recently announced, Goldman Sachs, the leading investment bank in the United States, has recently hiked gold price forecasts. The representatives of this financial institution have raised their gold price 3-month forecasts to $1,800. At the same time, the firm set a 6-month XAU/USD target at $1,900 and a 12-month forecast at $2,000.
The investment bank also maintained its long gold trading recommendation, stating that in the short term the price of this precious metal might drop to $1,700, but soon it should recover and reach the above-mentioned targets.
It goes without saying that in response to this news, many traders and investors might wonder, what makes Goldman Sachs so confident about the future rise of gold price. Some commentators suggested that the outbreak of COVID-19 and subsequent economic downturn triggered the risk-off trades, which benefited the precious metals. This is indeed a valid argument and this factor did play some role during the recent price action.
However, it is important to note that this might not be the main reason for the recent move. In fact, it seems there are other forces at play here. In order to illustrate this let us take a look at this daily XAU/USD chart:
As we can see from the diagram above, the gold price mostly moved sideways from June 2017 until May 2019. During this period this precious metal was mostly confined within the $1,150 to $1,350 range. It was only in June 2019, when the price broke decisively above the $1,350 resistance level and made some dramatic gains, currently trading near $1,757 level, by June 2020.
So if the rise of the gold price was just a case of people being scared and restoring to risk-off traders, then this recent uptrend should have started from January or February 2020, rather than 7 months earlier. In fact, during the first half of March 2020, the gold price even dropped sharply and it took some days for it to return to former levels, resuming its uptrend.
Influence of Negative Real Interest Rates
So if the risk of trades was not the main reason for the gold’s recent gains, then what can be the possible cause of this recent uptrend? Well, the recent Goldman Sachs report does mention the influence of negative interest rates on gold prices. So how does this affect the commodity markets?
To answer this question, it is important to mention that nearly all savers and investors have a goal to preserve the value of their capital and also hopefully earn some decent returns in the process. For sake of simplicity let us compare two alternative, fixed-income instruments, and gold. The first one includes savings accounts, Certificates of Deposit (CDs), and bonds. The second category can include physical gold, as well as its ETFs and other related assets.
So back in 2000, when the Federal Funds rate was 6.5%, CDs seemed a lucrative alternative to gold investing for some investors and savers. The reason behind this was the fact that the average long term inflation is at 3%, so in real terms, depositors could earn 3.5% in real terms. This is one of the reasons why the gold price was mostly confined to the $250 to $400 range at that time.
However, as the US Federal Reserve reduced its rates to 1% during the following years, the gold price started to make some steady gains. As Peter Schiff, the Chief Executive Officer of Euro-Pacific capital mentioned in one of his interviews, Alan Greenspan, the Chairman of the Federal Reserve at that time, used the gold price as one of the measures, to find out whether the current monetary policy was too tight or too loose. So if the price of precious metals rose steadily, then it was a sign that the current interest rates were too low and had to be raised to confront the threat of high inflation.
Current Situation with Gold Price
After making those considerations, mentioned above, it is not surprising that the gold price is rising consistently and Goldman Sachs forecasts it to reach $2,000. Nowadays, all major central banks have their interest rates at 0.25% or lower. Some of them, including the Swiss National Bank and Bank of Japan, even resorted to negative nominal rates.
Receiving 0.25% on savings accounts or CDs, when the long term average inflation is running at 3%, means that the hard-earned money of savers and investors is losing its purchasing power. Since the majority of people are not happy with their savings steadily losing their buying power, they look for alternatives. As a result, some of them turn to precious metals, as a hedge against inflation and currency devaluation.
Obviously, if the world’s major economies start to recover from the downturn and return to decent levels of growth, then the central banks might at some point decide to start normalizing the policy. However, as we have seen from the past experience, the policymakers are very quick to drop rates to near zero, when things go wrong, but during booming times, they usually raise rates very gradually. So it might take at least 3-5 years before the central banks can catch up with inflation rates with 0.25% rate hikes.
This suggests that for the next 3 years gold and silver are well-positioned to make some significant gains. Obviously $2,000 does represent a significant psychological resistance level, the move close to $1,900 was rejected by the market in 2011, as a result of which, the gold price fell down significantly.
However, it is helpful to note that by that time, there were high-yielding major currencies. For example, by that time, the Reserve bank of Australia kept its rates at 4.75%. Nowadays, as all major currencies have a yield of 0.25% or less, there are no such opportunities.