Gold’s ‘SemiRational’ Run Gives Wall Street Vertigo

Shuli Ren, Bloomberg

Wall Street has finally capitulated to gold’s record-breaking run.

JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon’s reluctant endorsement was the inflection point. “This is one of the few times in my life it’s semi-rational to have some in your portfolio,” said Dimon, adding that he was not a buyer, because “it costs 4% to own it,” referring what he could have earned in money markets instead.

Gold’s relentless rise this year has caught a lot of professionals off guard. According to the latest Bank of America Merrill Lynch money manager survey, a whopping 39% have no holdings, thereby missing out on the bull market.

It’s difficult for fund managers to justify a sizable allocation in their portfolios. The precious metal doesn’t generate any income or have a clear measure of fair value. Its all-in cost of production is around $1,500 per ounce, according to Alpine Macro, a research outlet. This benchmark gives us little guidance, however, as to why the precious metal should be trading at $4,200, or even by some estimates hitting $5,000 next year.

But with gold prices showing no slowdown and the so-called “debasement trade” — a bet that central banks will keep interest rates low and major currencies will lose their value — being the talk of the town, money managers have no choice but to adapt to the new normal. Wall Street’s commodities analysts, for one, have been racing to upgrade their forecasts as the metal hit new highs.

Wall Street has to chase, because the world’s most powerful liquidity train has arrived. The gold bug, which began three years ago as China’s central bank and its thrifty households bulked up their holdings, has spread to the US. Retail investors are now participating in the rally, with passive funds such as SPDR Gold Shares seeing large inflows and trading volumes in recent weeks.

With gold, narratives matter more than anything. If American households start to see that it’s an essential hedge against inflation and devaluation of the greenback, then sky is the limit. Conveniently for its advocates, the physical gold ETF market is tiny relative to Treasury bonds. If only 1% of the privately owned US Treasuries were to flow into gold, its price would rise to nearly $5,000, according to Goldman Sachs Group Inc. This perhaps explains why Dimon said the metal “could easily go to $5,000, $10,000 in environments like this.”

What China will do is another wild card. The People’s Bank of China has increased its reserve for 11 consecutive months, a major catalyst for this year’s rally. But with the price above $4,200, will officials in Beijing slow down their purchases?

Again, storytelling is filling the void. One theory is that Beijing now fully appreciates the beauty of commodity dominance, having successfully used rare-earth export controls as leverage in trade negotiations with the Trump administration. As a result, why wouldn’t the PBOC keep on buying gold? Plus, with exports and current account surplus surging, the government has plenty of dollars to invest.

Don’t stand in front of a liquidity train. Gold’s meteoric rise may be giving Wall Street vertigo, but its adaptive executives are keen to keep pace with the time — to entertain their clients and get business flowing if nothing else. But they are also putting their own credibility on the line. After all, the bull case for gold is built upon shifting sands. [Abridged]

Courtesy Bloomberg/Shuli Ren