By Charlie Morris.
See the facts, trade the action and ignore the noise.
In this issue:
- Reiterating bull market – this bull has legs
- Inflation will come – the US embraces negative real yields
- Bullish price target – $7,166 by 2030
- Bitcoin – buy when the bear is done
Reiterating bull market
People tell me they don’t receive Atlas Pulse anymore. If you are reading this, you’re on the list, it’s just that I don’t write it very often. The last issue was a year ago when I upgraded gold to bull market (price $1,239) for the first time since 2012.
Unlike the gold bugs, I’m not a broken record. And unlike the barbarous relic brigade, I recognise gold’s importance in the modern world. Atlas Pulse analyses the gold price and outlines the bull/bear regime with the reasons why. It is an evidence-based approach with an enviable track record. I tell it how I see it and find the air-punching narratives tedious. You won’t find one here.
As I write, the gold price is $1,475, up 15% this year having touched $1,550 (+21%) in September 2019. If the current price holds, this will turn out to be the best year for gold since 2010. And as we move into 2020, I bring further good news; this bull market has legs. In this issue, you will find a bullish target of $7,166 that is logical and plausible. All that needs to happen is the return of inflation. It’s high time. But before I explain how I got to a $7,166 target; I’ll go back to basics first.
An Atlas Pulse Bull Market has three conditions that I came up with more than a decade ago:
- Easy money, defined as US cash real interest rates below 1.8% – TRUE
- The long-term gold trend in non-dollar terms must be positive – TRUE
- Gold must be beating the stockmarket – TRUE!
In 2019, the Fed have stood back from further hikes, and we’ve seen an increase in the balance sheet, as tapering has reversed course. “It’s not QE,” they say, but it doesn’t smell quite right regardless. Whatever it is, the Fed’s balance sheet is growing again and policy is easy.
Gold is rising in all currencies
Historically, it has proved to be important that gold rises in all currencies, and not just in US dollars. This simple test ensures we don’t mistake dollar bear markets for gold bull markets.
Since 2000, the world’s best currencies have been the Swiss Franc and the Thai Baht, and gold recently broke higher in both. That implies that gold is rising everywhere.
Gold challenges equities
As for gold beating the stockmarket, few seem to recall that it is still the best performing mainstream asset of the 21st century. It has smashed global equities, which have been held back by poor performance in Europe and Japan. Gold has also managed to stay ahead of US equities, which have been strong since 2013. Gold even managed to keep up with the emerging markets until 2008, which remain the leading equity region to this day. If only just.
Gold remains in the lead despite a savage bear market between 2011 and 2016 and having no yield to fall back on. It’s a remarkable achievement, that most people probably don’t realise.
Gold remains ahead of equities in the 20th century
Source Bloomberg: Gold (gold), Emerging markets (blue), US equities (red), World equities (black) including dividends in USD 1/1/2000 to 16/12/2019 rebased to 100
But we want to look forward, not back. You can’t escape that equities nudged past after the 2011 peak. The relative position is important because investors need to know that they can allocate large sums of money to gold without missing out on equity performance. If equities are lacklustre or troubled, it’s an easy decision to make. But if they are strong, like they are now, it’s harder.
I can’t promise that US equities will face imminent collapse, but for gold to rally, they don’t need to. The largesse in equities has, in part, come from economic growth, but bigger drivers have been easy money, financial engineering and stimulus. As we step into 2020, with the threat of tightening behind us, there is no reason for gold to lag equities in future. A Goldilocks scenario (just the right amount of inflation) seems to be unlikely, because we’ve already had that. And since late 2018, asset returns seem to have broadened out. It’s no longer just about US equities.
The chart shows gold versus US equities over the past five years. Gold (reading of 80), means it has only lagged by 20% in a roaring equity bull market dating back five years, which isn’t very much at all. And since September 2018, gold has been beating equities, with higher highs and higher lows. A new high above 92 would generate significant confidence in the gold market, as that would bank four years of outperformance. It really wouldn’t take much for that to happen.
Gold jostling for leadership
Source Bloomberg: Gold relative to (divided by) the S&P 500 capital return 19/12/2014 to 16/12/2019 rebased to 100
The Atlas Pulse conditions for a gold bull market are met. I said that this time last year, and I am reiterating that point now. Equity outperformance could be a little stronger, but at least there’s no material lag. The regime is with us, and next I’ll turn to the one thing that could change everything. This has the power to turn a dreary bull market, driven by falling bond yields, into something you can really sink your teeth into.
Inflation will come
US real interest rates are falling again, which means gold has a tail wind. In my opinion these will keep on falling in what could become a major theme for the decade. I am not saying that the Fed will slash rates to zero like the Europeans. But instead, rates will stay lower for longer, and inflation will rise. We can be relatively sure that the Fed will keep rates low, because they want to keep the party going. We saw that a year ago, as the ten-year bond yield went above 3%. The result? The stockmarket nosedived by 20% and they don’t want to see that repeated.
US real yields are falling
Source Bloomberg: US 10 year yield treasury (black), inflation expectations (red) and real (blue) since 1/1/2000
The real yield is the difference between the US government bond yield and the expected future inflation rate. It tells you how much you could make, after inflation, by investing in government bonds. The current rate is 0.1% which doesn’t sound like much but is much better than what you’d get in Europe.
The missing piece is inflation. Many believe that it won’t rise, because high levels of debt or demographic trends keep it under control. But there’s an external risk, namely the price of oil, and energy is the most important input cost in our lives. For example, food production requires diesel. If the oil price rises, food prices must follow suit. That squeezes the consumer, harms the economy and reduces purchasing power. Even if the green revolution surprises us all, it will take years before it becomes a dominant force. In the meantime, Asia keeps on growing.
According to the OECD, not only is China forecast to fly past the almighty USA by 2030, but India too. The US could be humiliated into third place. President Trump doesn’t like that idea and hence a new cold war with China is underway. Europe might be even more embarrassed as it may not have a single country in the top five. Indonesia, a nation of 300 million people by 2030, might squeeze past Germany. With Japan’s place relatively secure, an Asian decade seems increasingly likely.
While energy consumption has remained flat in the OECD countries, the fast-growing non-OECD countries have seen their consumption nearly double this century. It grows by 3.3% per year and shows no signs of slowing down. The US shale boom came to the rescue post 2006, bringing another 6 million barrels per day (mbpd) to market. That has kept a lid on the oil price since 2014, but if the non-OECD countries carry on at this pace, a future oil shock becomes more probable than possible. Consider that the OECD countries are growing too, and you can see how this Malthusian story mighty play out.
Oil demand growth is still structurally strong
Source Bloomberg: OECD oil demand (red), non-OECD (black) million barrels per day 1/1/1996 to 16/12/2019
And let’s not forget the growing US budget deficit. Deficits are not unique to the US either, as they are coming back into fashion. Japan has a stimulus package; the UK has one while Europe wants one. China will join the party too, and the world wants infrastructure like it’s the industrial revolution all over again. Demand for commodities will soar and the new gold bull market is simply telling you what lies ahead.
Bullish price target
As we approach 2020, it’s worth considering where gold might be by 2030. The 00s saw a 280% increase, and the 10s, a 35% increase. For the 2020s, I am forecasting a 415% return with a price target of $7,166. I’ll explain why.
A six year high for gold’s fair value
Source Bloomberg: Gold and Atlas Pulse fair value model (black) 16/12/1999 to 16/12/2019
Regular readers will know that I value gold using a method which can be found here.
Note that the fair value has made a six-year high; recovering the lost ground since the taper tantrum. Also note that gold has returned to a premium above fair value. With those points in mind, my bullish scenario has three components
- Falling real yields will boost the fair value to $3,386
- The premium will grow to 50% from the current 7%
- Actual inflation for the decade is 48%
The US long-dated real yield fell from 4.3% to 1.4% over the 2000s. That boosted the fair value of gold by 80%. The 10s saw further easing of real yields to 0.1%, which boosted gold by a further 15%. These don’t seem like big numbers and they aren’t. That’s because real yields are made up of the bond yield and expected inflation, but they are not equal in their contribution.
This important point is that the gold rally of the 21st century has been nothing to do with inflation, it’s been all about the falling bond yield. By my calculations, falling nominal yields have boosted gold by around 270%. On the other hand, weak inflation has actually held gold back, albeit slighty. I hope this becomes clear on the table below showing future fair value scenarios. The US 20 year bond yield is currently at 2.08% and 20 year inflation expectations are at 1.77%. That puts the fair value at $1,377, which is slightly below the current price, and highlighted in grey.
Source Atlas Pulse: Atlas Pulse fair value model assuming rate scenarios
If the real yield was to fall to -2%, different possible scenarios are highlighted in green. Notice how a 0% bond yield with 2% inflation brings us to $2,296. In contrast, a 2% bond yield with 4% inflation gives $3,386. That’s a big difference for the same real yield scenario of -2%. My 2030 scenario sees a -2% real yield driven by managed rates at 2% and inflation rising to 4%. That results in a $3,386 price target.
Can US real rates move to -2%. They can. UK real rates are currently -2.2%, Swedish are -1.7% and -1.3% in Germany. All you’d need is a couple of rate cuts to anchor the long bond, while inflation quietly rises towards 4%. With infrastructure spending about to splurge, it’s looking quite likely.
But it doesn’t end there as gold bull markets also attract a premium.
A rising gold premium
We should remind ourselves that the last bull market saw the gold price premium rise between 2005 and 2011. It started at a 55% discount and ended at a 51% premium by 2011. The monthly chart hides that, but it happened. Gold also went to a significant premium back in 1980, at the height of the bull market. It must have been at least 50%, but we’ll never know because inflation expectations weren’t known at the time as TIPS hadn’t been invented. Still, there was unquestionably a premium, because the animal spirits were off the record, as the history books remind us.
The gold premium will have a bull market of its own
Source Bloomberg: Gold premium or discount to the fair value model (black) since 1999.
The gold premium tends to be a trending affair. It would be wrong to suggest that just because an asset has a fair value, it must trade there. That’s not how markets work. More likely, the asset will mean-revert around fair value over the course of market cycles. What caught my attention was the new high for fair value on the previous chart, and what looks like a rising trend on this chart. More importantly, bull markets and premiums go hand in hand. Therefore, if my bull market forecast is correct, the premium will be right too.
The current gold premium is 7%. A move to a 50% premium means there is another 43% to be had before we get there. That means the gold price will touch $3,386 x 43% = $4,842.
But it doesn’t end there either. Next, we must add actual inflation. That is the inflation that actually happens, as opposed to what is expected.
In the short-term, inflation doesn’t matter very much. If you are fortunate enough to live in the developed world, you don’t notice rising prices week after week. But over longer time frames, inflation is an enormous force. Look at the inflation by decade in the US.
Source Bloomberg: US CPI by decade
At 19%, this past decade has seen low inflation. Perhaps that is unsurprising as we had a banking crisis. But that was 11 years ago, and low inflation won’t last forever. Normally change occurs when the status quo is deeply embedded in group think. The fiscal programmes come courtesy of a belief, by our masters, that cheap money will continue indefinitely. Those same folks thought the gold price would fall indefinitely in the late 1990s and were heavy sellers as a result. How wrong they were then and how wrong they could be now. If inflation returns, it won’t be the first time our masters got it wrong.
I don’t have a crystal ball for inflation in the 2020s, but the bond market does. It thinks the answer will be 19%; precisely what it was last decade. I am 100% sure that it won’t be 19%. Whether it’s oil, deficits, wages or policy, inflation will rise. I would hazard a guess that it will average 4% per year, resulting in 48% over the next decade.
That neatly brings the gold price forecast to $4,842 x 48% = $7,166
There you have it. A rational case for a gold bull market with a logical outcome of $7,166 by 2030. The margin for error is wide of course, but it makes sense to me. The beauty of having a target is that it makes you think. And the beauty of having a model, is that it enables you to continuously rethink your target. Please allow me to revise it in the next issue.
I am an amateur in bitcoin compared to gold. That’s probably because I started researching gold in 1999, whereas I have only taken bitcoin seriously since 2013. That said, I have, along with my team, built the world’s greatest forecasting tool for bitcoin.
The investment process is similar to my approach to gold, in that it is evidence-based. The difference is that external macro-economic factors don’t feature with bitcoin. Other than the supply side dynamics, bitcoin and gold have seemingly little in common, despite “bitcoin is the new gold” being a popular narrative.
My research has led me to conclude that bitcoin behaves like a tech stock. After all, it shouldn’t come as a huge surprise that internet money behaves like internet stocks. The main driver of bitcoin’s price is the size of the underlying network. I therefore built a system that measures bitcoin’s network.
I am currently writing a detailed note on my bitcoin models that you are welcome to read. The main model looks at “market health” and is not dissimilar to the Atlas Pulse gold process. Generally speaking, I am long-term bullish on bitcoin, just as I am on gold, but recognise there are prolonged, and painful, setbacks when it is best to sit on the side-lines.
The market health model comprises six independent models that are calculated using live data from the blockchain. They include long and short-term network activity, the behaviour of the miners, network velocity (a non-price measure) as well as valuation and the competitive pressures in bitcoin mining. The aim is to find weaknesses in the network that would be associated with significant falls in price. Thereafter, don’t sweat the small stuff and remain long during bull markets.
Source ByteTree.com: Market health strategy (red), bitcoin (black) simulated results from $100 invested on 1/7/2015 to 10/12/2019
The last signal came in late August which was bearish. The bitcoin price was significantly ahead of events in late June and the network wasn’t active enough to support such high expectations. The sell signal came just below $10,000. With a current fair value of $5,776 and a current price of around $7,000, I expect it to break lower. Atlas Pulse readers, who are interested in bitcoins, are welcome to visit the site at https://bytetree.com/bitcoin
If you sign up to the weekly market health report, you’ll not only be contacted when I have finished writing my market health piece in the coming weeks, but you’ll also hear from me when the next buy signal is given. Good deal I’d say. The last time I last called a buy signal on bitcoin was back in March 2015 when the price was $256. I know several of you acted, because I have grateful emails to prove it.
A warm thank you to the team at Glint for their help in the production and distribution of Atlas Pulse. Disclosure: I am upaid and am neither an investor nor adviser to Glint.
A price of $7,166 per ounce would value the world’s above ground gold supply at approximately $50 trillion. The world’s stockmarkets are currently valued at $80 trillion, which we know are pricey. A burst of inflation would see the value of equities fall, and gold worth roughly the same as the global stockmarket. Impossible? It happened back in 1980 and it could happen again.
What’s more, I haven’t even touched on gold’s friends. Silver currently trades cheaply, as do the miners and platinum. If gold touches $7,166 per ounce, you can’t expect silver to stand still. Back in 2011, the gold to silver ratio collapsed to 32. With silver trading at $17, a comparable move would see silver touch $140. Silver’s all-time high hit $50 per ounce back in 1980. It tried again in 2011. Third time lucky after four decades?
I wish you all a very Happy Christmas and a prosperous New Year. Here’s to 2020 and thank you for reading Atlas Pulse.
Charlie Morris Bio
Charlie Morris is Chief Investment Officer at Newscape Group and editor of the Fleet Street Letter and Atlas Pulse. A former Grenadier Guard, Charlie Morris entered finance via HSBC, heading up their absolute return offering during a 17 year stint notable for having a global economic meltdown bang in the middle of it. In 2012 he started Atlas Pulse, a regular report looking into the gold price and the validity of holding gold in your portfolio. Two years later, on leaving banking, he began editing the Fleet Street Letter investment round-up and took on the role of Chief Investment Officer at Newscape Group, a St James’s based investment fund, in 2016. Charlie is known and respected for his knowledge in multi-asset investing, absolute return, factors, gold and more recently, digital assets. His primary role is the Head of Multi-Asset at Atlantic House Fund Management, where he recently launched the Total Return Fund.
The information and materials in this document are an expression of opinion and do not constitute financial or other professional advice. You should consult your professional adviser if you require financial advice. We try to ensure that the information in this document is correct, but we do not give any express or implied warranty as to its accuracy. We do not accept any liability for error or omission or for any damages arising in contract, tort or otherwise from the use of the information provided.