BofA Merrill Lynch Global Research maintains it’s 18-month $1500/oz target on gold in recent report, titled, “BofA ML Commodities – Global Metals Weekly”.
As it was discussed in October 2008 Metals Strategist issue, BofA Merrill Lynch still expects gold prices to hit $1500/oz over the next 18 months. More recently, they revised their average gold price forecasts in line with the target.
BofA Merrill Lynch analysis still suggests that three variables alone explain the fluctuations in the price of gold: risk, currency and commodity prices. Departing from this framework, they argued back in 2008 that gold prices would rise in three steps. The outburst of the credit crisis in August 2007 marked the beginning of the first stage where gold started to reflect a rising risk premia. Gold moved up from $650/oz to about $950/oz within six months. The second stage has been primarily about USD weakness and a lack of confidence in fiat currencies generally. The third stage will be driven, in BofA Merrill Lynch’s view, by a cyclical upswing in energy and commodity prices, as expansionary monetary and fiscal policies around the world finally yield the desired results.
What are the risks of holding gold?
While a clear case is to be made for higher gold prices, BofA Merrill Lynch view is not without risk. That positive view was challenged in June as central banks and investors sold gold in favour of USD or EUR denominated bonds. A fiscal retrenchment in the Eurozone in May and June and higher bond yields drove investors back into peripheral Euro bonds. In the US, the federal government still faces a USD 1.4trn deficit this year, with no visible budgetary balance to 2020. Should a consensus emerge in Washington on the need to tackle this deficit or should US GDP growth surprise to the upside, gold prices could fall. Equally, an increasingly stable and more certain global economic environment could prove negative for gold.
When to exit a long gold position?
While sovereign debt fears, inflation or an economic catastrophe could drive gold well above our $1500/oz target, prices could prove to be very volatile if this happens. For instance, if the US government decides to wait for higher borrowing costs to start fiscal retrenchment, it is conceivable that gold prices could rally initially only to collapse at a later stage. Thus, while BofA Merrill Lynch retains a positive view of gold over the next 18 months and still expects a rally to $1500/oz, investors should be prepared to sell gold if either increased inflation expectations or doubts around debt sustainability force a sharp increase in US Treasury yields. Simply put, in an environment of high real interest rates, the allure of gold could disappear as quickly as it did in the early 1980s when Paul Volker took control of the Federal Reserve. But in BofA Merrill Lynch’s view, this scenario is far from imminent.
