The US dollar is now at a level not reached since the aftershock of the financial crisis; this has big consequences for gold (GLD). In just 5 months the US dollar index rose from 80 to 88.5, a 10% increase, notable for any currency in such a short period. Although long gone, the gold standard still holds a strong psychological influence today. This impact shapes policies and trades implemented by banks, and investor perception. When the US dollar is in trouble, global banks and investors like to buy gold. When the US dollar strengthens, more gold can be bought for fewer dollars, thus they shift their focus back into currency, lowering gold prices even farther. The economic crisis was the latest strong trigger for renewed interest in gold as a safe harbor investment.
Most bulls on gold point to the ever increasing demand for gold in Asia, with consumer demand expected to rise by another 50% in 2015. In contradiction, Analyst Jessica Fung wrote "Consumer demand for gold, particularly the 'shift from West to East' makes great headlines, but does not impact the gold price, in BMO Research's view. Since 2000, BMO notes that gold prices increased from US$250/oz to US$1,900/oz while consumer demand has also been wide-ranging and not at all indicative of driving prices either way." This strongly suggests that a very weak correlation between gold price and consumer demand exists, and that currency index movements and changes in the inflation-adjusted Treasury yields play a much larger role.
Goldman Sachs believes that the Ukraine-Russia crisis and economic weakness in Europe and Japan have been supporting gold somewhat, but prices are being pressured by Federal Reserve policy. "Our target at the end of this year is $1,050, really driven by the view that we think that the Fed will ultimately be the dominant force here and put more downward pressure [on prices]," Currie told CNBC's "Squawk Box" on Thursday. "Gold is a hedge against a debasement in the U.S. dollar." He said he'd recommend shorting gold.
Gold is presently down nearly 3% over the past 12 months and is down 37% from its all-time high of $1,923 in September 2011. Even though the yellow metal is reaching oversold territory, Goldman Sachs' prediction remains surprisingly bearish as another 17% decline from these levels would be well under the all in cost of production for gold.
The range of price targets for 2015 is wide. Capital Economics expects gold prices to settle around $1,300 an ounce at the end of 2015. CIBC expects gold prices to average around 1200, same as Commerzbank and close to Citigroup's estimation of $1,220. Natixis is rather bearish with an average price of $1,140. Standard Charted estimates average gold prices around $1,245. TD Securities predict average prices around $1,175. Goldman Sachs forecasts have shown to be more reliable historically, thus their bearish forecast of $1,050 should not be overlooked.
I Know First is a financial services firm that utilizes an advanced self-learning algorithm to analyze, model and predict the stock market. The algorithm predicts the flow of money in almost 2000 markets across a range of time frames (e.g., 3-day, 1-month, 1-year). The algorithm's predictability becomes stronger in the 1-month, 3-month, and 1-year horizons, so it is particularly useful as a long investment tool, albeit that it can also be used for intraday trading.
The sends two separate forecasts for XAU and GLD, because their returns are sometimes different; however, in the long run the two signals can be used to increase the confidence level in the forecast. On November 28th, 2013 I Know First released a gold forecast for 2014 in the article "2014 Market Forecast And Gold Prediction Based On Algorithms". The algorithm was bearish for the 1 month, 3 month, and 1 year time horizons. The 1 year signal of -8.73 and predictability of 0.7 suggested a very strong confidence level in gold prices dropping in 2014. Following the prediction gold prices went up, peaked in mid-march around $1,380/oz and corrected ever since ending the year in the red.
As of December 28th, 2014 with gold prices at $1,195.53/oz the algorithm is bearish in all three time horizons. The signals in the short term are relatively weak, and thus don't represent a strong enough indication to make an investment decision. However, the 1 year horizon has a GLD signal of -35.10, and XAU signal of -1.6, which suggests the algorithm, is more in line with Goldman Sachs estimates of $1,050 than others' $1,200+.
How to Read the Indicators
The signal represents the predicted movement direction or trend, and is not a percentage or specific target price. The signal strength indicates how much the current price deviates from what the system considers an equilibrium or "fair" price. The signal can have a positive (predicted increase) or negative (predicted decline) sign. The heat map is arranged according to the signal strength with strongest up signals at the top, while down signals are at the bottom. The table colors are indicative of the signal. Green corresponds to the positive signal and red indicates a negative signal. A deeper color means a stronger signal and a lighter color equals a weaker signal.
The predictability indicator measures the importance of the signal. The predictability is the historical correlation between the prediction and the actual market movement for that particular asset, which is recalculated daily. Theoretically the predictability ranges from minus one to plus one. The higher this number is the more predictable the particular asset is. If you compare predictability for different time ranges, you'll find that the longer time ranges have higher predictability. This means that longer-range signals are more important and tend to be more accurate.
I Know First Research is the analytic branch of I Know First, a financial startup company that specializes in quantitatively predicting the stock market. This article was written by Daniel Hai, one of our interns. We did not receive compensation for this article, and we have no business relationship with any company whose stock is mentioned in this article.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.