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​$2,000 Gold Achieved, What’s Next?

21 June 2019

Precious Metals Commentary

Patience is beginning to pay off for precious metals bulls, as gold has managed to break through a key resistance zone of the past few years. Once the level of $1,350-$1,360 was broken on Thursday it was a quick trip to $1,395 before consolidating down to $1,389 at time of writing. Silver sluggishly followed suit, making ground back above USD$15 per ounce to $15.45, but remains seemingly undervalued with a gold:silver ratio at a whopping 90 to 1.
Gold USD chart 
Our call for AUD$2,000 gold for 2019 was met a bit sooner than even we expected as gold reached highs of $2,017 before pulling back to $2,008 on Friday, with the AUD trading at 0.6919 US cents.

The breakout into multi-year highs can be seen in the above chart and is a very significant development for gold prices moving forward. To put the move into perspective, not even the Brexit shock of 2016 or the surprise election of Donald Trump could see gold move above this level in USD terms. So what has changed?

Regular readers of our market updates will note that we have been consistent in our view that there has been far too much debt build up post-GFC for the Federal Reserve to successfully navigate a rate hike cycle without grinding the US economy into recession. The latest statements coming from the FOMC indicated that indeed the Fed is likely to start backtracking and cut interest rates, again. Roughly half of the FOMC officials are now forecasting 50 basis points of rate cuts between now and the end of 2019, a significant change in sentiment since the May meeting.

Gold’s reaction to the latest FOMC statements is symbolic of a massive dent in the confidence of the Fed, and hence other Central Banks, as the initial plan of unwinding the easy monetary stimulus of the past decade is proving impossible. In a simple metaphorical description, the bus driver appears to be drunk at the wheel, and the passengers are starting to wake up and realise.

This is a significant development, as it appears Keynesian economics is being questioned. Despite all efforts of monetary policy, global economic growth is grinding to a halt and the only thing that central banks have achieved post-GFC is massive asset price inflation, mainly benefiting those at the top of the pyramid (by design or incompetence is the question).

Flashback to February this year, in a market update titled ‘Slow and Steady Wins the Race’ we outlined two possible scenarios that could play out in 2019 when it came to monetary policy and you can see an excerpt below:
  1. Central banks continue down the tightening path regardless of financial markets’ reaction, leading to heightened volatility, particularly in equities, and a global growth slowdown.
  2. We see a pause in this tightening as an answer to the above, and central banks reverse course and turn stimulus taps back on in an attempt to reflate the economy (or bubble).

It’s hard to imagine another scenario where central banks successfully normalise rates, and return their balance sheets to pre-crisis levels whilst the global economy ticks along fine and dandy, as there has been a huge increase in government, corporate and private debt under the recent ultra low interest rate environment.

We mentioned at the time that both possible scenarios would create an environment that is positive for gold prices, and as it turns out, scenario 2 is what we are seeing play out today.

The flood of money into gold is something we continue to expect moving forward, as investors are clearly anticipating a global shift in monetary policy towards lower interest rates and loosening financial conditions. As investors flee to safe-haven assets at a time when there is over US$12 trillion in negatively yielding investment grade corporate and government bonds, it’s no wonder that gold is seeming to attract a lot of attention as a potential better alternative.

Housing Flatlining

A Macquarie Bank chart of Australian dwelling prices shows they have been flatlining recently post-election and interest rate cuts.

Daily Dwelling Prices
That would be welcome with Australia having won a silver medal for biggest after inflation house price fall in 2018, based on the HSBC chart below.
HSBC chart
However, according to Evergreen Consultants established house prices are still more than 20% overvalued, based on the ratio of the median established house price to annualised average weekly earnings (AWE).
Aussie House Price Valuation

The dotted green line takes into account interest rates, which as they fall makes property more affordable. Evergreen Consultants feel that the election and monetary policy changes “have placed a firm floor under the housing market” but “an economy-wide collapse in house prices … would likely require an increase in unemployment and lending rates”.

An increase in lending rates is unlikely, with Westpac seeing the RBA cutting rates 0.25% in August and again in November, based on sluggish below trend growth momentum and a downbeat view on the labour market.

Shane Oliver (AMP) notes that consumers remain cautious, with “paying down debt or bank deposits” continuing to be seen as the wisest place for savings.
Wisest place for savings

Trade War Good for Australia

The trade war continues, with Capital Economics saying that they no longer expect the US and China to strike a deal on trade and “now forecast that the two countries’ dispute will escalate further”.

A Bank of America Merrill Lynch survey of money managers has 56% of them saying trade-war concerns are the top tail risk with the survey allocation implying recessionary conditions. Money manager equity allocations have seen the second-biggest drop on record, while cash holdings jumped by the most since the 2011 debt-ceiling crisis.

According to Moody’s Analytics, this will actually be good for Australia, relatively speaking, with our real GDP unlikely to fall more than -0.5%.
Trade War

The Peterson Institute for International Economics (PIIE) notes that while China has increased its retaliatory tariffs on US exports to an average of 20.7%, it “has begun rolling out the red carpet for the rest of the world” by repeatedly cutting the average tariffs on imports the rest of the world from 8.0% to 6.7%.

This gives countries like Australia an advantage over US companies and should be good for our commodity and agricultural exports. It will also make it hard for the US to regain that lost export ground.

Maybe trade wars aren’t as easy to win as Trump thinks and China is playing a longer game. Investment manager Winton noted Alibaba founder Jack Ma’s warning that the trade war between the USA and China could last as long as 20 years, with previous changes in international trading relationships having dramatic and lasting effects.

It doesn’t look like these risk factors have yet penetrated into the thinking of the average investor. Wealth Manager Tiho Brkan tweeted out the chart below noting that the “public is ALWAYS spectacularly wrong at major turning points”.
US Consumer Confidence Present Situation

The Felder Report chart below, which plots the total value of the stock market against the overall size of the economy, also shows over confidence. Jesse Felder says that this measure indicates “investors are paying such a high price they are likely to receive essentially nothing in return over the coming decade, including dividends”.

10-yr returns

ASX High-Density Pods

The ASX’s announcement of some new “pods” at its co-location data centre just highlights the ascendency of high-frequency trading these days. Due to the massive heat generated by the “Field Programmable Array” platforms used by high-frequency traders, the ASX is “meeting customer demand” for spaces with cold-aisle containment featuring liquid-based in-row chillers.

As to meeting customer demand of retail share traders, well, just place your trades via the NBN on your broker’s website and hope for the best.

Zuck's Bucks

This week Facebook announced it will create its own stablecoin called Libra that will be backed by a basket of bank deposits and “debt from stable governments with low default probability that are unlikely to experience high inflation”.

One may wonder why Facebook decided on creating a new global “currency” for people to get their heads around when there is a globally accepted, country neutral currency already in existence: gold. Interestingly, Libra uses gold as an example of how “to help instill trust in a new currency and gain widespread adoption during its infancy, it was guaranteed that a country’s notes could be traded in for real assets, such as gold”.

No doubt they went with a basket of currencies because backing it by gold would likely have attracted a lot of resistance by governments. Facebook may have thought that saying they are going to buy major country government debt to back Libras would increase the chance they would get a favourable hearing. That does not seem to have worked, with:
  • US Democrat Maxine Waters calling for a moratorium on Facebook's development of Libra
  • US Senate Committee on Banking, Housing, and Urban Affairs scheduling a hearing on "Examining Facebook's Proposed Digital Currency and Data Privacy Considerations"
  • Bank of England governor Mark Carney warning mass adoption would force it "to be subject to the highest standards of regulation"
  • US Federal Reserve Chairman Jerome Powell saying that there were “also risks we're watching, and echo the statement [Bank of England] Governor Carney issued"

It seems the politicians have quickly realised that “Libra is nothing more than a brazen attempt to override national monetary sovereignty by creating a global-scale Federal Reserve equivalent”, as the Financial Times Alphaville blog characterised the project.

While the move away from physical cash towards digital money continues (see Italy’s proposal to tax cash and other valuables locked away in safety deposit boxes), it seems trying to create your own global currency is competition governments aren’t too keen on.

We do not see Libra having any immediate impact on gold but in the long run we feel it is positive as it keeps alive the question that Bitcoin caused people to think about: what is money and what backs it?

Questioning whether one can trust Zuck’s Bucks may lead to questioning digital bank money and subsequently to considering buying physical gold, which doesn’t require any trust.

Until next time,
John Feeney and Bron Suchecki
ABC Bullion
If you have any questions or feedback about this week’s report, we would love to hear from you. You can contact John Feeney (@JohnFeeney10) and Bron Suchecki (@bronsuchecki) directly on Twitter, otherwise please feel free to send us an email at [email protected], or call us during trading hours on 1300 361 261.

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