A Perfect Storm
09 August 2019
Precious Metals Commentary
Well, what a week! After consolidating during July between $1,380 and $1,450, this month gold has made another break going above $1,500 (and holding) on more trade troubles and negative rates. Silver moved in sympathy, breaching $17, although a little weaker than gold pushing the gold:silver ratio back up to the high 80s.
At the same time, the Australian dollar has had a relentless fall, reaching 67 cents but making a small recovery as we write.
Rising US prices and a falling Australian exchange rate have created a perfect storm for Australian precious metal investors, resulting in $A gold up a whopping $350 to crack $2,200 and $A silver reaching the $25 level.
With such a run we should expect some consolidation, but as TD Securities say, “standing in front of this runaway train may still be a fool’s game”. To-date, anyone brave enough to be naked short may be looking at that chart above and see it as a wave about to engulf their speculative boat.
Interest Rates Take a Tumble
While the Reserve Bank of Australia decided to leave interest rates unchanged at 1.00% this month, after two cuts in June and July, fellow central banks in the region have been rattled by the ratcheting trade and currency war with unexpected cuts in rates from:
- New Zealand – cut 0.50% down to 1.00%, double what was expected
- Thailand – cut 0.25% down to 1.50%, first in more than four years
- India – cut 0.35% down to 5.40%, previous three cuts were 0.25%
- Philippines – cut 0.25% down to 4.25%
New Zealand Assistant Governor was reported as saying that the bank’s expectation was that their currency would fall by making a larger cut and the Central Bank of Thailand acted upon its growing worries about serious trade problems.
The weakening currency and “trade problems” comments seem likely to be influenced by China allowing the yuan to breach the 7.00 line against the US dollar following Trump’s 10% tariff.
China said the move was due to “multiple factors, including unilateralism, trade protectionism, and expectations for US tariffs on Chinese goods” and they also halted agricultural imports from the US by state-owned enterprises.
The Renminbi depreciation does offset the impact of tariffs but it shows China’s resolve (or desperation, depending on your viewpoint) as breaking the long established seven level has been considered as triggering accelerated capital outflow. In response, the US named China a currency manipulator.
Regarding international trade, you can see the effect in the chart below from Merk Investments showing declining manufacturing indexes across major countries.
Eight out of the twelve readings are below in contractionary territory with Germany showing a dramatic decline since 2017.
Fidelity International say that the risk of de-globalisation as countries move away from trade liberalisation towards increased trade protectionism is one that investors must consider. In their recommendations, they include a bullet point for “and, just in case, a little bit of gold”.
Bank of America Merrill Lynch agree in respect of gold, naming successive rounds of easing as QF – Quantitative Failure – as they have delivered less bang for each buck. They see central banks easing more aggressively as “making gold an even more attractive asset to hold”.
Negative Rates are Natural?
With interest rates falling, negative rates look more and more likely. Just this week we saw two examples of this upside-down world with Bloomberg reporting a Danish bank looking to sell a 10-year mortgage bond at a negative rate. How long before banks are paying people to borrow money to buy a house?
Reuters also reported that UBS Group will be charging wealthy clients who deposit more than two million Swiss francs a negative interest rate of 0.75%. Banks in Switzerland and the eurozone have been charging corporate clients negative rates, but have so far resisted doing so for individuals.
Is it any surprise that gold has seen increased demand if it may cost less to store physical gold than digital cash? We don’t think it is coincidental that gold bottomed out just as the value of negative yielding bonds started to grow, as the chart below shows.
No doubt some institutional investors are thinking along the lines of precious metal fund manager David Baker who, in response to the 100 year Austrian bond rallying 80%, noted that as gold has zero credit risk and an infinite duration, it should be more leveraged to lower rates than a long duration bond.
Regarding negative rates, fixed income investment manager PIMCO asks whether central banks are being unfairly blamed for low/negative rates. They argue that demographics (rising life expectancies) and capital-saving new technologies work together “to push the ‘natural’ rate of interest lower and lower”.
The problem they see is that central banks keep their interest rates above the “natural” rate or raise it too early and end up being “punished by market forces and have had to reverse course”. If central banks often get it wrong, then we wonder why not just let market forces set the interest rate themselves?
Little chance of that happening with an op-ed in the Wall Street Journal signed by former US Federal Reserve chairs Volcker, Greenspan, Bernanke and Yellen coming to the defence of Jay Powell, saying that the Fed should remain independent (of Trump) and have the “ability to make decisions based on the best interests of the nation, not the interests of a small group of politicians”.
While politicians are hardly saints, we find it interesting that the former Fed chairs’ use of “small group” ignores the fact that the politicians are actually elected by the whole country, whereas the central bankers are not.
Visualising Every Day of the Gold Market
We came across the chart below which shows the daily return of the US stock market over the past 10 years.
It got us thinking about how would gold and silver compare? Below we chart the daily change in the US gold price, using the London PM Fix.
To our eye, US gold looks pretty good risk-wise compared to US stocks, with few days beyond 2% just like stocks. The negative outlier there was the big drop in gold in April 2013 that signalled the start of a brutal bear market down to $1,050 in 2015.
If you are wondering why the x-axis scale is out to 20% on both sides when gold’s worst return is only 9.15% and best 4.95%, it is because we wanted to keep the scale the same as the chart for silver so we can directly compare to the two precious metals.
Not surprisingly, given silver is a lot more volatile than gold, the chart is more “squat” than gold’s. This is the visualisation of the saying that silver is a leveraged version of gold – bigger upside but also bigger on the downside. Most of the outliers occur during silver’s run up to its peak during 2011.
For the moment, price volatility looks like it will remain on the positive side, with two big name US banks seeing upside for gold.
First, we have Goldman Sachs upping its forecasts, seeing $1,600 within six months noting that portfolio managers still continue to under-own gold. Commodity trading firm INTL FCStone also have $1,600 (as an outside chance in August!), noting that fund managers, who have been “long-absent” the precious metals, are starting to come back into the market due to global central bank easing and constructive chart patterns.
Second is the private bank arm of JP Morgan, who believe the dollar could lose its status as the world’s dominant currency and recommend investors should diversify by weighting more to other currencies and gold. They also say that recent central bank accumulation of gold makes sense to them as “gold is a stable source of value with thousands of years of trust among humans supporting it”.
With the US gold price outlook still positive even after this run up, the follow-on question for Australian investors is ‘where to for the Aussie dollar?’ As we noted at the start of this update, the dollar has had a great (for gold and silver investors) run down since mid-July.
If we consider RBA Governor Lowe’s statement to the House of Representatives Standing Committee on Economics today the outlook is for further lows. After observing that the RBA’s easier monetary policy pressures the exchange rate lower, he then says that because inflation is below target and unemployment is above target, it is “reasonable to expect an extended period of low interest rates in Australia” and the “possibility of lower interest rates will remain on the table”.
With a lower dollar on the cards and gold prices on a tear, it is no surprise we at ABC Bullion have been completely run off our feet. We have had more accounts opened last week than any other week this year, and also the highest number of transactions.
The old argument that gold doesn't pay a dividend doesn’t matter when Australian gold prices are up 34% over the past year compared to a 1% annual interest rate. Talking to our existing and new clients, many see their gold and silver investments as allowing them to sit back, relax, and watch the RBA race against other central banks to destroy the purchasing power of our currency in their so-far futile hunt for economic growth and inflation.
Until next time,
John Feeney and Bron Suchecki
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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