“Be fearful when others are greedy and greedy when others are fearful.” 

-Warren Buffett

Where are we now?

Oftentimes a well-timed deep breath can be of critical importance. Our brains, wonderful machines that they are, often operate by making snap analogies. This allows us to automate mundane tasks such as putting on a pair of pants, tying our shoes, or brushing our teeth. The brainpower that we would expend in figuring out which pant leg to put on first or where to begin brushing our teeth (Hand up, I’m a top left guy) can thus be saved for more important tasks. This mental efficiency is a key design feature of the most awe-inspiring control center in the natural world — but every system has flaws.

Oftentimes we don’t recognize the need to take that well-timed deep breath because our brains operate so efficiently. We carry on with our activities, building one choice on top on another until we are confronted with the need to reassess the whole chain of decisions, like a man lost in thought who walks without marking where he is going until he realizes he is lost. It seems this type of random walk takes place often in financial markets; I believe we are now seeing a wandering soul in the S&P 500.

We’ve seen the S&P 500 bounce off the COVID-19 lows and rise 7.8% since April 20. Two months of shelter-in-place has left us as a people with a fervent desire to get back to life as we know it, so this optimistic bounce in equities makes sense psychologically.

That same date, however, saw publication of a research report from the Bank of America commodities team titled “Gold to $3,000; 2020-22and LT gold price hikes favorably impact.” Yet the price of gold has increased to a much smaller extent versus that S&P 500 rally, only gaining 2.5% to $1,743/oz. So far, the wandering man has been in control. Can the price movement in the S&P 500 persist and Bank of America’s gold price target be accurate? Can both make sense simultaneously from a fair value perspective?

The Price is Right?

Let’s dive into Bank of America’s report to better understand the rationale that drives a price target almost 50% above the previous gold high:

“Due to the Covid-19 lockdowns, US GDP could go down by 30% YoY in 2Q20, the steepest drop in modern history. Other countries like Japan will likely experience a 21.8% decline in output in 2Q20, while China just reported a contraction of 6.8% in 1Q20. As central banks rush to expand their balance sheets and backstop asset values and consumer prices, a lot of risks could end up being socialized. The size of major central bank balance sheets has been stable at around 25% of GDP for the last decade or so, just like the gold price. As economic output contracts sharply, fiscal outlays surge, and central bank balance sheets double, fiat currencies could come under pressure.” – BoA Global Research Report, 4/20/2020

The warning of a possible 30% drop in second-quarter gross domestic product is one echoed by the Congressional Budget Office, which predicts a 40% second-quarter GDP drop year-over-year and a -5.6% change in GDP over the entire year. The economic effects of COVID-19 are not to be lightly dismissed. Another key point: this economic pain is not only localized to the U.S. All developed countries will be negatively affected by this. Even more than the Great Recession that preceded it, the COVID-19 Recession is a global recession. A global recession traditionally results in a huge run-up in gold.

Not only does the research note call for a high target price point, but it predicts 2021 gold spot price to average $2,012. Not known for aggressive forecasts in recent years, Bank of America nonetheless predicts an average price of gold in the entire year of 2021 at a price of the historical high. It’s one thing to anticipate a high price at some point; it’s an even greater testament to the research team’s comfort with this forecast for them to raise their data point, which is more conservative by nature, to a level 15% more than the current spot price.

The report highlights the relationship of central bank balance sheets to gold prices, linking them with high correlation. A lot of things don’t make sense these days, but this does: more national debt is being piled onto the dollar. If we trust this correlation and trust the Congressional Budget Office’s prediction of $3.7 trillion deficit this year (this will comfortably more than double our worst annual deficit to date), the Keynesian economic system of thought would indeed call for huge downward pressure on the U.S. dollar.

The U.S. dollar has enjoyed an unrivaled power against other major currencies through the last decade. Retaining status as the world reserve currency, the USD gets bought up during good times and bad alike. Several sources attest to the continued place at the top for the greenback, but also hint at some apparent weaknesses to. It isn’t simply the ballooning balance sheet of the Fed, or the massive federal deficit that are concerns: foreign interests have strong reasons for collaborating to weaken King Dollar.

Many of us have never experienced what it is to live in a country with a weak currency, a country where economic activity within the country ebbs and flows as foreign investment rushes in when times are good and rushes out even more quickly when risks are apparent. Venezuela or Argentina are models for this state: a hotbed of hyperinflation, corruption, and unrest. Can the United States stave off her enemies at home (rising debt, unemployment, and financial gravity for the dollar) and abroad (divergent foreign interests)?

The research report thus makes sense in its predictions and assumptions.

Recalibrating

Here we take a well-timed deep breath to reassess where we are and ensure the vision of the future aligns logically with reality. In this author’s article “The Bull Case for Gold,” published April 1, we explored together the critical reason why gold was on the cusp of the traditionally recessionary bull market but had not yet risen: Fear in an environment of hyper-expanded money supply. The reasoning was that COVID-19 would almost certainly lead to a recession and complementary rise in the price of gold, but that there is always a lag historically, and moreover the Great Recession had expanded the money supply to such an extent that this lag could well last longer than is traditional. After seeing gold prices drop by .56% in March, we have seen them rise 6.43% since.

This price action puts reality in line with expectations and gives credence to Bank of America’s price target and average spot price forecasts. The most likely event is not that we have a V-shaped, quick economic recovery, but more of a U-shaped, prolonged bottoming out before we rebound. As restlessness grows and impatience for the “old days” swells, distrust in the financial system and flight to safe-haven assets will inevitably follow.

Don’t let the stock market rally fool you: real fear has re-entered the marketplace. Protests and riots are taking place with increasing frequency. People are restless after the shelter-in-place restrictions. Unemployment figures are expected to mark the national figure from 15%-20%. This figure is higher than at the worst point in the Great Depression — and it happened in only three months. Our own government agency tasked with budgeting predicts our worst-ever GDP decrease this year.

 It is entirely your choice how you will navigate these times financially. A man who walks without thought may possibly reach his goal; but how much more quickly will a man reach his goal who keeps his head and walks deliberately and confidently.

Matthew Worley is a seasoned financial writer with published work on equities, commodities, currencies, and macro and geopolitical concerns in publications such as Forbes (as a ghostwriter), Motley Fool, and Investopedia amongst others.