Market Conditions for Gold

There are many views on the future price of gold, with a strong preponderance for higher prices. It’s tough to parse through them and to decide which to rely upon. This article provides some statistical information about investor views that may help.


On the positive side — central banks are strong net buyers (the U.S. not included).  Some countries are repatriating gold reserves held outside of their borders.  China and some others are diversifying their foreign reserves to include currencies other than the U.S. Dollar and gold bullion. Central banks are debasing currencies around the world with various easy money programs that apparently have no visible signs of being tempered.  We are in a world or negative real interest rates.  Those things suggest gold  may see price gains for a while.

On the negative side — central banks have been net sellers at times — if their appetites are satisfied, a reduction in purchases would change the supply/demand relationship and potentially push gold prices down significantly.  Interest rates will rise some time due to improving economic conditions, at which time the emotional and financial appeal of gold would decline relative to bonds, stocks and real estate.  Just as negative real interest rates supports the price of gold, positive real interest rates create headwinds for gold, which produces no income and has some costs of carry for storage and other costs of holding directly or through funds.  Importantly, it is hard to be fully comfortable with gold when everybody and his brother feels it must be owned — when the radio is saturated with advertisements by gold dealers with suggestions to buy gold coins and to convert IRAs to gold IRAs, and when the web is fully of articles, books and videos about the coming disaster for which owning gold is posed as a solution.  Lastly, if the world was coming apart, gold confiscation by governments (as it was in the 1930’s by President Roosevelt) is a clear risk; and the vaults that hold bullion for gold ETFs could well be looted by criminal bankers or rioters.

Morgan Stanley thinks gold will rise to about 1775 in 2013, and then 1845 in 2014 (it is at about 1650).  It has a trailing 1-year high/low range of approximately 1540 to 1790.

Goldman Sachs thinks gold will rise in the early part of 2013 to about 1825 during US debt ceiling and sequestration debates, but then decline in the second half as the U.S. economy improves, reaching 1750 by 2014.

Felix Zulauf of Zulauf Asset Management in Zurich believes that if gold goes above 1750 to 1800, and negative real interest rates continue, gold will go to 2200 by 2014.


Gold has gone down in the past as well as up, and has only been freely traded in the U.S. for less than 50 years.  It has a history as long as civilization, but the investment alternatives that exist today did not exist over the history of civilization, so ancient data while often cited, is of questionable analytic utility.  Some analysts discuss gold and Roman Empire, or other history, but we think sticking with the modern era is best for finding insights

For the past year, gold has been rather “dead money” and its chart looks like it could be creating a rounding top, instead of waiting to burst upward.

The chart shows price (black line), 1-year moving average price (dash gold line) and 1-year high to low price range (tan shaded area).

It’s nice to have the opinions of big name houses, they generally don’t tell you how they arrive at their views, other than making broad statements about fiscal and monetary policy, and that sort of thing — hardly precise.  Unfortunately, there are no fundamental data such as sales, earnings, dividends, or interest rates to which valuation multiples can be applied.

To complement the gold forecasts of various analysts, not all of whom can be relied upon to be objective or non-conflicted, we think it makes sense to canvas what the bulk of the investor community is forecasting with their risk capital.

To look forward for plausible gold price ranges, we can be assisted by examining:

  1. extrapolation of historical volatility of gold
  2. directional signals from long and short futures positions in gold
  3. extrapolation of options implied volatility for gold

Extrapolation Based On Historical Volatility of Gold

This chart plots statistical price probability ranges for GLD (the gold ETF that is priced at approximately 10% of the price of gold) using historical volatility of GLD.

The green cone projects the 70% price probability range from 02/12/2013 to 02/12/2014 based on 1-year historical volatility of GLD.  The end-point values are 174 and 146 (equivalent to 1740 and 1460 for gold).  The purple cone projects the 90% price probability range, with end-point values of 184 and 139 (equivalent to 1840 to 1390 for gold).

The tan colored line is the 1-year moving average price, and the dashed black line is the linear regression best fit trend line from the beginning of 2007 through 02/12/2013, and extended to 02/12/2014.  Those values are 162 and 200 respectively (equivalent to gold 1620 to 2000).

Directional Signals From Long and Short Gold Futures

The CFTC (Commodity Futures Trading Commission) publishes weekly figures on the number of contracts that different types of investors hold (called Open Interest or OI) for gold and other commodities and financial indexes.  They call that report the “Commitment of Traders”. Their most recent report on gold is shown below.

This report will not tell us what price level to expect, but it provides clues as to whether to look to the upper half or lower half of the price probability ranges that we develop using historical and options implied volatility.

The data in this table is extracted from a larger data set in the Commitment of Traders report for February 5.  We highlight three groups; large professional money managers, other large futures traders, and small traders (those whose holdings are not large enough to require reporting to the CFTC).  The first two are considered the smart money, and the small traders are considered the dumb money.

click to enlarge

We see that all three groups have a lot more long gold futures positions (“Long OI”) than short gold futures positions (“Short OI”).  The money managers has a long to short ratio (“L/S Ratio”) of 3.28; the large traders 3.35; and the small traders 2.55.

Perhaps somewhat more revealing is that the money managers have increase their net long positions by 2.61% since last week; the larger traders by 17.32%; while the small traders have decreased their net long positions by 8.1%.  That patterns suggests gold is more likely to rise than fall near-term.

We can’t tell the mix of short-term and long-term futures contracts in these Open Interest figures, but they tend to be more near than far, so this data is not a long-term indicator.

Zooming out to a multi-year view, we see a rather constant number of longs and shorts among large traders and small traders, and not large changes in the ratio of long and short positions.  However, among large money managers we see big changes.  At the end of 2009, the large money managers had 224,030 long positions and only 6,874 short positions (a long/short ration of 35.29).  From there to mid-2012, their longs were substantially reduced and their shorts substantially increased to produce a 3.39 long/short ratio, which is close to where we are today.

So, long still outweigh shorts, but the level of interest in gold has moderated significantly among large money managers since 2009. This is not surprising, given that competing alternatives, particularly stocks have been doing well, and the sense if imminent doom that helps support gold prices is much reduced.

Futures open interest data indicates a reduced focus on gold, but still a positive view on prices — a rosier picture than the price chart would suggest.

Extrapolating Options Implied Volatility for Gold

Based on the January 2014 options for GLD (and assuming a continuing ratio of the price of GLD to gold at 1:10), and using the tools provided by OptionsExpress, the 90%  price probability range is bounded by 1310 and 1950.  The 70% price probability range is 1410 to 1810.

Statistical Views and Morgan Stanley / Goldman Sachs Forecasts

The statistical projections make room for the Morgan Stanley and Goldman forecasts, both of these are for prices in the upper half of the price probability ranges.  The Zulauf price forecast is outside of the statistically projected price ranges.

Mkt price 1650 % From Mkt
Historical Vol. 90% Hi 1840 11.52%
Historical Vol. 70% Hi 1740 5.45%
Options Implied 90% Hi 1950 18.18%
Options Implied 70% Hi 1810 9.70%
Morgan Stanley 2013 Tgt 1775 7.58%
Morgan Stanley 2014 Tgt 1845 11.82%
Goldman Q1 2013 Tgt 1825 10.61%
Goldman Q4 2013 Tgt 1750 6.06%
Zulauf possibility 2200 33.33%
Historical Vol. 90% Lo 1390 -15.76%
Historical Vol. 70% Lo 1460 -11.52%
Options Implied 90% Lo 1310 -20.61%
Options Implied 70% Lo 1410 -14.55%

Events can totally upset all of these data, but for now we go with what we’ve got.

An issue to keep in mind, is that in spite of all the excitement about gold, the percentage price changes in the statistical projections and in the Morgan Stanley and Goldman scenarios are not spectacular.  They are broadly in line with what might be achieved by a selection of stocks as well.

Gold is minimally correlated with stocks and bonds, which makes it a good diversifier to potentially help reduce overall portfolio volatility.  In the near term, however, unless the overall world and national situation changes, gold is not destined to massively outperform, and allocations to gold should not be overly large.

If income is important to the portfolio, then gold might be avoided, or held as GLD while writing short-term, out-of-the-money covered calls on the position.

We hold GLD is some portfolios and write covered calls on GLD in some portfolios.  Our allocation limit is 5%.


Here are a series of 7-year, weekly charts showing the ratio of the price of gold to the total return for different asset categories.  A rising line means gold is doing better.  A falling line means gold is doing worse.

Gold vs S&P 500

Gold vs Dow Jones Select Dividend Index

Gold vs Dow Jones Liquid Investment Grade Corporate Bonds

Gold vs Brent Crude Oil

Gold vs Silver

Gold vs Copper

Gold vs Platinum

Gold vs Gold Miners

Gold vs Corn


Comments are closed.