$502 an ounce ?: from PVE's Favorite Forecaster...Dr. Murenbeeld's gold price forecast for the coming year
October 14, 2005
I got to hear Dr. Martin Murenbeeld at the Denver Gold Forum earlier this month, and, as I said last year after attending his talk, he is hands down the best gold analyst I have ever come across.
At last year’s Denver Gold Forum, Dr. Murenbeeld forecasted three possible gold prices: a low price, a most likely price and a high price. He assigned a probability to each and then calculated the weighted average gold price as his forecast for the average gold price in the year ahead. His probability weighted average gold price forecast last year was $431 an ounce.
Dr. Murenbeeld always starts his presentations by reviewing his previous forecast to see if reality had the good manners to obey him, so it was impressive to see that from the date of last year’s conference to this year’s conference the average gold price was exactly $431 an ounce.
I’m going to skip to the end of his presentation and tell you that his probability weighted average gold price forecast for the next twelve months is $502 an ounce. Now, before you dismiss this number as too low, here is what it means.
Dr. Murenbeeld always includes three possible prices with the minimum probability assigned to any price being 10%. For the next year, an average gold price of $381 an ounce was assigned a 10% probability, $470 an ounce was assigned a 47% probability, and an average gold price of $565 an ounce was assigned a 43% probability.
Assigning such a low probability to a decline in the gold price and such a high probability to a substantially higher gold price is a very bullish forecast indeed. Keep in mind that this forecast is for the average gold price over the next twelve months, so by this time next year the gold price could be substantially higher than $502 an ounce and Dr. Murenbeeld’s prediction could still be spot on.
Why is he so bullish?
Devaluation of the US dollar
Trade data suggests that the US dollar is overvalued and uncompetitive. It shows that international trade is out of equilibrium -- the result of a distortion of the dollar’s exchange rate. Since markets always try to reach equilibrium, there is pressure on the dollar to decline.
The US trade deficit with China is growing particularly ugly; it is now over $180 billion annually. In 1993 China devalued its currency relative to the dollar by about 34%. Dr. Murenbeeld argues that the renminbi now has to appreciate by at least that much against the dollar. Given that anti-China sentiment is growing in Washington with talk of protectionist duties on Chinese imports, there is no doubt the dollar will fall against the renminbi.
The US also runs a record trade deficit with Europe, to the tune of $120 billion annually. I am no fan of the euro -- it is the ultimate fiat currency -- but the trade data clearly shows that the US dollar is overvalued even against the euro.
It follows from the large trade deficits that the US should also have a current account deficit. At the moment the current account deficit is a whopping 6% of GDP and a nominal $800 billion. This implies that nearly $4 billion is pushed onto foreign exchange markets each day. Will the world continue to absorb increasing amounts of US dollars? Dr. Murenbeeld thinks not.
To date more than 50% of the capital flows required to finance the current account deficit come from (mostly Asian) central banks that buy dollars in foreign exchange markets to prevent the dollar from falling, thereby keeping their own currencies and economies competitive in the US consumer market.
As interest rates have risen, private capital flows into the US have picked up, and these are particularly important in financing the creative real estate mortgage market in the US.
In 1987 the US current account deficit reached almost 3.5% of GDP and caused the dollar to fall by more than 40%. If history is a guide, the dollar could easily fall another 15% to 25% according to Dr. Murenbeeld. I think he’s optimistic, and that the dollar could actually fall much more.
US monetary inflation
It is well understood that a decline in the US dollar will lead to higher US dollar-gold prices. But we also have to consider US monetary inflation.
The US budget deteriorated from a surplus of $255 billion in 2000 to a deficit of $430 billion last year. Larger tax receipts subsequently reduced the deficit, but Katrina et al. will most likely absorb any increase in Treasury revenues and push the deficit further into negative territory.
But that is only part of the story. Total US debt (government debt, corporate debt and household debt) is now in excess of 200% of GDP. Last time the US had this much debt relative to GDP was during the Great Depression and the result was a sharp contraction of debt.
During past economic cycles both higher oil prices and rising short-term interest rates (relative to long-term rates) played critical roles in pushing the US economy into recession. Both these factors are now present while household debt is at record levels, the debt service burden is at a record high level and the US savings rate is negative.
Demographics now come into play as the first major wave of baby-boomer retirements is coming up. Dr. Murenbeeld estimates that the US government’s net financial liabilities (gross liabilities less assets) could double in the next 25 years, and that is assuming the budget deficit comes under control.
What is the government likely to do? It has, essentially, four choices: renege on promises, cut services, raise taxes and create more money. The first three options shift the financial burden to households and that means less consumption and slower economic growth. The last option (creating more money) reduces the real value of debt. Last year Alan Greenspan suggested that the pressure of rising budget deficits could force the central bank to create more money.
Creating more money increases prices, including the price of gold. Dr. Murenbeeld has a chart showing the correlation between the gold price and money supply of the G-7 nations. There is no question in my mind that the gold price in any currency is primarily a function of the differential inflation rate of that currency versus the inflation rate of gold.
Increased gold holdings as foreign exchange reserves
According to Dr. Murenbeeld’s figures, Asian foreign exchange reserves now exceed $2.2 trillion. In total these countries have 1,932 tonnes of gold, representing only about 1.68% of their foreign exchange reserves at a gold price of $450 an ounce. The Asian central banks have not publicly shown any willingness to add to their gold reserves yet.
Should they decide to diversify into gold the impact would be staggering. If only China and Japan adopted the same 15% of reserve policy of the European Union, then they would need to buy 17,000 tonnes between the two of them. That is more gold than the Bank for International Settlements, the IMF and all the signatories to the Washington agreement own in aggregate, and it would still amount to only petty cash for Japan and China.
Turning to OPEC nations: In 1970 it took 30 barrels of oil to buy an ounce of gold, and we know that gold was undervalued in 1970. Today it takes less than 8 barrels of oil to buy an ounce of gold. OPEC countries have not publicized any desire for gold, but when OPEC foreign reserves increased from 1973 to 1981 they added 270 tonnes of gold to their reserves. If OPEC were to bring their gold reserves up to 15% of their foreign exchange reserves they would need to buy more than 1,500 tonnes of gold and, again, it would be pocket change for them.
Gold is not only inexpensive relative to oil. When the gold price is compared to the S&P500 we see that there were three stock market bubbles during the past 100 years. In all three cases the S&P500 rose dramatically relative to gold and in all cases the ratio collapsed back to unity again. It is impossible to predict at what gold price, or what level for the S&P, the two will be at unity, but history does suggest they could again reach unity. If the S&P were to stay where it is then the gold price would have to rise to $6,000 an ounce. That is not very likely, since the same conditions that would cause the gold price to rise would probably bring stock prices down, so you can pick your own favorite number between $500 an ounce and $6,000 an ounce.
@:
http://www.kitco.com/weekly/paulvaneeden/oct142005.html
. Let me point you to another website that I like to visit, to get the gist of where I am coming from:
