Fade Goldman's Bearish Gold Call

Dec. 6.12 | About: SPDR Gold (GLD)

The latest research note on gold from investment bank Goldman Sachs - in which they see the gold bull market coming to an end in the months ahead - might be taken much more seriously if not for two factors:

1. The call is based on a vastly improved U.S. economy next year that leads to higher real interest rates and they haven't exactly been knocking the ball out of the park lately in their economic forecasts.

2. The firm has a reputation for telling investors to do one thing and then betting against it, as many (some in Congress) believe was the case with subprime mortgages as the housing bubble peaked.

In a private note that was widely reported at various internet sites, Goldman commodity analyst Damien Courvalin cited the underperformance of gold this year despite a host of positive factors and then offered this forecast for next year:

Improving US growth outlook offsets further Fed easing

Our economists forecast that the US economic recovery will slow early in 2013 before reaccelerating in the second half. They also expect additional expansion of the Fed's balance sheet. Near term, the combination of more easing and weaker growth should prove supportive to gold prices. Medium term however, the gold outlook is caught between the opposing forces of more Fed easing and a gradual increase in US real rates on better US economic growth. Our expanded modeling suggests that the improving US growth outlook will outweigh further Fed balance sheet expansion and that the cycle in gold prices will likely turn in 2013. Risks to our growth outlook remain elevated however, especially given the uncertainty around the fiscal cliff, making calling the peak in gold prices a difficult exercise.

Gold cycle likely to turn in 2013; lowering gold price forecasts

We lower our 3-, 6- and 12-mo gold price forecasts to $1,825/toz, $1,805/toz and $1,800/toz and introduce a $1,750/toz 2014 forecast. While we see potential for higher gold prices in early 2013, we see growing downside risks. As a result, we find that the risk-reward of holding a long gold position is diminishing and recommend rolling our long Dec-12 COMEX gold position into a long Apr-13 position and selling a $1,850/toz call to finance a $1,575/toz put to protect against a decline in gold prices.

To be sure, real interest rates are a key driver for the gold price, perhaps as important as central bank money printing, but, the rationale for lower real rates provided above (i.e., "on better U.S. economic growth") falls well short of being a compelling argument.

In order for real rates to rise next year, either interest rates must go up (something the Fed has promised will not happen) or inflation must fall sharply (something that would scare the Fed silly and only prompt more money printing).

With the progressive decline in the gold price they've forecasted, they are clearly talking about rising real rates next year and that just seems kind of silly when considering how determined the Fed is to spur economic growth and keep monetary policy loose until the recovery has taken firm hold.

Incidentally, this will probably result in higher inflation rates and, hence, lower real interest rates, not higher real rates.

As for the forecast for heady economic growth, it's worth noting that Goldman Chief Economist Jan Hatzius has had a bad run of luck lately, predicting big things in recent years and then having to reverse course later on.

In the summer of 2011 in a note to newsletter subscribers I wrote:

To my knowledge, Goldman Sachs has not yet offered a revised estimate of where they see Q2 growth coming in, however, chief Economist Jan Hatzius came out with something of a confessional last week where he formally backtracked on the rosy outlook published at the beginning of the year.

Hatzius noted that the firm's expectations for 3.5 to 4 percent growth in 2011 (based primarily an increase in "organic" growth rather than government intervention) now looks unobtainable.

Economic growth in 2011 came in at about two percent and, then, in October of last year, a bearish Hatzius predicted gloom for 2012:

Goldman Sachs revised their economic forecasts downward, chief economist Jan Hatzius putting the odds of a recession at 40 percent and predicting that the unemployment rate will rise to 9.5 percent by the middle of next year. Hatzius commented, "The obvious risk with our (non-recession) forecast is that the slowdown in growth and the associated deterioration in the labor market is going to start feeding on itself and pushes the economy into recession via the stall-speed dynamic."

As it turned out, unemployment fell to about 8 percent at mid-year and, so far, the U.S. economy has not come close to a recession.

I don't have a complete history of these forecasts, but the ones that could be found were not very good.

More importantly, to extrapolate rising real interest rates from a bullish economic outlook - given the central bank's penchant for ensuring a recovery takes hold - seems quite a stretch.

Regarding the second item noted above about Goldman betting against there own recommendations, Agustino Fontevecchia over at Forbes put it best when he wrote Selling Gold On Goldman's Call? Take A Page From George Costanza And Do The Opposite.

Recall that Seinfeld's George Constanza had a remarkable run of good luck when he simply did the opposite of what he would otherwise be inclined to do.

Fontevecchia suggests taking the advice of Nomura instead who recommended "buying gold ahead of next week's Federal Reserve meeting where more easing will probably be announced."

It appears that long-term investors are taking the advice of Nomura, not Goldman, today as exchange traded funds such as the SPDR Gold Shares ETF (NYSEARCA:GLD) are rising sharply.

Disclosure: I am long GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I also own gold coins and bars.