Goldman Sachs Remains Bullish on Gold

Goldman Sachs’ bullish attitude toward gold is undoubtedly based on numerous factors, but interest rates and the state of the US economy are prevailing themes that appear to top the firm’s list of considerations.

An October report from the company noted “a remarkable correlation” between US real rates and gold prices.

“As we expect gold prices will continue to be driven in large measure by the evolution of US real interest rates and with our US economic outlook pointing for continued low levels of US real interest rates in 2012, we continue to recommend our long trading positions in gold and reiterate our 12-mo price target of $1,860/toz,” the firm said.

In November, Goldman Sachs revised its forecast up to $1,930/oz, again pointing to low interest rates and slow growth in the US.

2012 is not the first year that Goldman Sachs has been bullish on gold, nor the first time that the sentiment is heavily based on US interest rates.

In 2010, the company highlighted falling interest rates and expressed an expectation that the rates would move even lower, helping to boost gold prices. The conditions prompted Goldman Sachs to raise its price forecast for gold, and to recommend long December 2011 COMEX gold positions.

It was a good call, as gold did rally in 2011. In November, Goldman Sachs reported a gain of $423.9/oz and announced that it was rolling the gold trade recommendation into a long December 2012 COMEX gold future position.

Interest rates and gold

Interest rates will not only be low throughout the remainder of this year, but for quite some time. In January, Federal Reserve Chairman Ben Bernanke said he expects to keep rates low at least through to the latter part of 2014.

Goldman Sachs is apparently not alone in the belief that these low interest rates are positive for gold. The day after Bernanke’s announcement, the metal rallied, lending support to the firm’s theory of a strong correlation between the two.

However, inflation is a major concern as it erodes the purchasing power of currencies and drives people to options such as gold so that they can protect the value of their money. In an environment of low interest rates, money in the bank earns depositors little more than appreciation for their patronage, so a rallying metal like gold becomes attractive for its returns.

No QE3 announcement

Although Goldman Sachs has issued the same trading recommendation as last year, to date there is a notable difference in the conditions that existed then and those that we are now experiencing: a lack of quantitative easing (QE).

Part of Goldman Sachs’ bullishness going into 2011 was based on expectations of another round of QE, which the firm described as “a strong catalyst to carry gold prices.” The Fed obliged and the metals markets benefited.

While Goldman Sachs recognized the combination of low interest rates and quantitative easing as bullish for gold at that time, the firm also considered tightening monetary policy to a be a downside risk. Goldman Sachs predicted that gold prices would continue to rise until US monetary policy began to tighten.

When the firm revised its gold forecast last November, it wrote, “given our US economists’ cautious economic outlook and the significant downside risks associated with the European turmoil, additional Fed easing might well be needed.”

This statement led some to believe that Goldman Sachs was placing its bets on another round of stimulus, or QE3, to boost the gold markets again.

But that has yet to happen, and the markets were severely disappointed last week when Bernanke failed indicate that it will happen in the future. The Fed Chairman’s failure to announce details about QE3 was a serious blow to precious metals prices, including gold, which again shows that Goldman Sachs was onto something when noting that there was an important link between monetary policy and gold prices.

Further support for the gold market

Goldman Sachs’ bullish outlook for gold this year was also based on predictions that “the level of concern over European sovereign debt will continue to drive gold prices, with the potential for a European financial crisis skewing the balance of risks to the upside.”

The markets are definitely driven by news from Europe; the gold rally that followed the announcement of the latest Greek bailout is just one example.

Furthermore, the firm has reportedly cited “‘extreme’ concerns about demand and dollar funding stresses” as making the metal undervalued relative to the fundamentals.

“The gap between prices and fundamentals remains sufficiently large to lead us to reiterate our recommended long position in the metal,” the firm said when it recently reconfirmed its bullish outlook for the metal.

Takeaway for investors

Goldman Sachs’ reconfirmation of its bullish gold position preceded Bernanke’s failure to announce further stimulus and the blow to the markets that followed.

Although QE may have weighed heavily on Goldman Sachs’ gold outlook for 2012, and still may be a factor, investors should realize that the extent of the troubles in Europe were not well-known until the latter part of the year. Now, market participants are fully cognizant of the potential for a serious crisis in that region, and are aware that there is no immediate solution, so the importance of those two factors may need to be re-evaluated.

Moreover, given that other factors appear to be complementary considerations to US economic conditions, and low interest rates in that nation seem to be a long-term reality, even in absence of QE3, Goldman Sachs’ bullish position may again prove to be a good call.

Securities Disclosure: I, Michelle Smith, hold no direct investment interest in any company mentioned in this article.