Global Real Assets

A bi-weekly discussion of the recent commodity, REIT, and real asset markets and what it may mean for investors.

April 20, 2017

John LaForge, Head of Real Asset Strategy

Why Gold May Climb Higher

  • Real interest rates are historically quite low. Such low rates, in the past, have signaled higher gold prices over the coming year.

What it may mean for investors

  • Even with today’s low real interest rates, we still believe gold will fall into a range of $1,150-$1,250 per troy ounce by year-end 2017.

"Do not allow yourselves to be deceived. Great minds are skeptical.”
—Friedrich Nietzsche

Our gold guidance has been neutral-to-negative for the past few years. Our primary concern for gold has been that pesky commodity bear super-cycle we love to talk about. 2017 is year six of the current bear super-cycle, and as a reminder, the average bear super-cycle has lasted nearly 20 years (using data back to the year 1800). Gold, like many other commodities, is still trying to shake off excess supply built up during the bull super-cycle years, from 1999 through 2011.

At this point in the commodity bear cycle, if history is a good guide, gold should trade in a wide range for the next few years, bouncing between roughly $1,050 and $1,400 per troy ounce. For 2017, we suspect that range will largely be confined between $1,150 and $1,250. At $1,280 per ounce today, gold is above our year-end 2017 target range, but we believe that before the year is over, gold will once again find its way lower.

With that negative viewpoint said, we are realists when it comes to investment calls. We will not always be right. We are always hunting for angles that could prove us wrong, or good arguments that might help us change our minds. As Friedrich Nietzsche once wrote (quote above), “Do not allow yourselves to be deceived. Great minds are skeptical.” As this relates to gold, our primary concern that argues for a higher gold price is the low level of real interest rates, shown in Chart 1. Low real interest rates, historically speaking, tend to be positive for gold prices. The table within Chart 1 highlights the performance of gold at different levels of real interest rates (horizontal dashed lines in the bottom panel). As we can see, the lower the real interest rate, the better gold has tended to perform historically. The reason gold performs best at low real interest rates is that they can sometimes signal coming inflationary concerns.

Real interest rates, as an economic refresher, are a combination of nominal interest rates (such as the 10-year Treasury yield) and inflation. Low real interest rates usually evolve from falling nominal rates, and rising inflation; a combination that drives investors to gold to help with inflation protection. Keep in mind, though, that while gold has been a good inflation hedge historically, it has not been a great one. For more on this topic, please see the March 1, 2017, Global Real Assets Strategy Report, “How Gold Behaves”.

The bottom line is that we remain neutral-negative on gold for 2017, and for the next few years. But, we are investment realists– always looking for angles that could prove us wrong. One angle that has us concerned is the low level of real interest rates. Today’s low real interest rates argue for higher gold prices over the next year.

Chart 1. Gold versus Long-Term Real Interest RatesChart 1. Gold versus Long-Term Real Interest RatesSources: Bloomberg, Ned Davis Research, Wells Fargo Investment Institute. Monthly data: 1/31/1969 – 3/31/2017. Top panel shown in log scale; table statistics are since 1968. Long-Term Real Interest Rates are determined by subtracting the Consumer Price Index (year-over-year percentage) from the 10-year U.S. Treasury yield. Dates were selected to show all available data of full years since gold started trading freely. Past performance is no guarantee of future results.

Risk Factors

There is no assurance that any of the target prices or other forward-looking statements mentioned will be attained.

Investing in commodities is not suitable for all investors. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. The prices of various commodities may fluctuate based on numerous factors including changes in supply and demand relationships, weather and acts of nature, agricultural conditions, international trade conditions, fiscal monetary and exchange control programs, domestic and foreign political and economic events and policies, and changes in interest rates or sectors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks, including futures roll yield risk.

Investments in gold and gold-related investments tend to be more volatile than investments in traditional equity or debt securities. Such investments increase their vulnerability to international economic, monetary and political developments.

Global Investment Strategy (“GIS”) is a division of Wells Fargo Investment Institute, Inc. (“WFII”). WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company.

The information in this report was prepared by the GIS division of WFII. Opinions represent GIS’ opinion as of the date of this report and are for general informational purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon.

Additional information is available upon request. Past performance is not a guide to future performance. The material contained herein has been prepared from sources and data we believe to be reliable but we make no guarantee as to its accuracy or completeness. This material is published solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or investment product. Opinions and estimates are as of a certain date and subject to change without notice.

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