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Deutsche Bank Says Gold Is Expensive, but You Need Some Insurance

Deutsche Bank Says has thrown in the towel on its call that gold would fall below $1000 Call. Now DB says buy gold for insurance. Here are a few snips of a Deutsche Bank market research report on gold that came my way via email. The title of the report is "It's Expensive, but You Need Some Insurance".

World has Changed in Favour of Gold

The conditions that led us to forecast gold falling below USD1,000/oz have changed. Slowing global growth momentum, the rising risk of a US credit default cycle, and the increasing likelihood of a large one-off RMB devaluation means that the Fed may have to relent from its path of tightening. US rates are now expected to end the year at current levels, and the upward trajectory of the S&P500 is no longer a given in our view. Given the rising core inflation and strong job creation data, the Fed may be compelled to hike in the near term. This combined with seasonal weakness in Q2, may provide investors with a good entry point.

Chipping Away at Growth, Softer US Yield and Year-End Equity Targets

In a world of rising real interest rates, rampant equity markets and strong global growth, gold struggles to perform. However, our Deutsche Bank economists have started chipping away at their US and Euroland GDP forecasts, and we would not be surprised to see consensus global forecasts slip below 3%. Our Fixed income analysts expect 10Y treasury yields to end Q4'16 at 1.75%, which implies that real yields will end the year at current levels. Although, our US equity strategists have only trimmed their year-end S&P500 forecasts modestly, we see risks from US high yield credit defaults which would weigh on the equity markets. The combination of all these changes makes the environment more favourable for gold. Short term price movements have become sensitive to the movements in forward market implied probability of a rate hike. The probability of a rate hike by year end has ticked up modestly after falling to almost zero.

Chinese Buying Presents Further Upside Potential

Chinese physical buying has increased by c.14% CAGR since 2005, mainly in the form of jewellery. However, as in India many of the jewellery items are bought as a store of wealth. Given the depletion of foreign reserves and the flight of capital from China, we think the risk of a one-off RMB devaluation has increased. As these expectations increase, we think physical demand in China will increase. In the near-term however, Chinese buyers remain price sensitive, and trading activity on the Shanghai Gold exchange has been more muted in the recent gold price rally. However, we see buying activity pick up on any small price dips. As result of the change in view, we upgrade our forecasts by an average of 13% over the next three years.

Gold Looks Expensive, but a Premium is Justified

Gold screens as expensive relative to its medium term trading levels, as well as relative to other commodities and economic metrics. A bit like insurance which is often a grudge purchase for many, some investors may balk at the current levels. We would, however, argue that given the plethora of negative deposit rates globally, the holding cost of gold is now negligible in many jurisdictions, and therefore gold deserves to be trading at elevated levels versus many other assets. For instance; the ratio of gold to oil at a multi-year high. We would argue that in this case, oil is simply too cheap. The risk to gold is that although a rally in oil will make gold look less expensive, it eases the pressure on the US high yield credit, which in turn could result in an equity rally.


Report Mistakes

Deutsche Bank compares gold, primarily a financial asset (money to many in the Austrian economic camp), to industrial commodities and concludes "gold looks expensive". This is sort of like saying oatmeal is expensive vs. moon rocks.

Nonetheless, despite some bad logic, Deutsche Bank did manage to put out a buy signal.

In contrast, I suggest gold is cheap. The recent rise in the price of gold foreshadows credit events, competitive currency devaluations, and a justified worry that central banks are not just not in control, but rather the central banks are totally out of control.

 

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