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Addicted to Lowe’s Love of Low Rates

29 November 2019

Precious Metals Commentary

Yet again we’ve had a quiet week price wise with gold holding firmly above the key $1,446 Fibonacci 38.2% retracement level discussed in our recent technical analysis.

Gold Spot/ US Dollar Chart

The market appears to be bid at this level and while there is some risk it may break down, we have seen trader commentary that there are buyers who would see that as the ideal opportunity to scale into gold as it gets into the low 1,400s ($1,412 is the next support level, being a 50% retracement).

Silver has moved with gold to trade just above $17 as we write with the gold:silver ratio at 86, which has been an area it has gravitated to repeatedly over the past year.

The Aussie dollar continues its long-term downward trend, so AUD gold and silver prices should be supported over the next few months at least. Gold is currently $2,155 and silver $25.15.

Australian Dollar/U.S Dollar FXCM Chart

Addicted to Low(e)

A couple of weeks ago, we noted that RBA governor Philip Lowe would be softening up the markets for quantitative easing (QE) in a speech on the 26th.

The point of QE is to push down longer-term interest rates and the so-called “risk-free rate” that is represented by government debt - sure, no risk it won’t get paid back but let’s just ignore the inflated value of that money you’re getting paid back with.

As most corporate debt is based on the risk-free rate plus a credit risk margin, QE can therefore impact interest rates across the whole economy. The RBA’s current interest rate setting only impacts the shorter end of rates.

The other attraction of QE for the RBA is that as rates approach zero, QE provides a way for them to avoid (for the moment) unpopular negative rates as they hope lowering longer-term rates will be enough to get them to their inflation and employment targets.

By lowering the return on Australian investments, QE should also push down our exchange rate as overseas investors pull out money looking for better opportunities.

Our focus on interest rates is therefore not just because they directly affect the return you earn on your investments but because a weaker exchange rate pushes up AUD metal prices. Every one cent change in the AUD is good for around 1.4% to 1.5% change in AUD gold prices.

Low interest rates also increase gold demand as returns on its competitors decrease. While Australia is a big producer of gold, we aren’t a big consumer, so any increase in local demand due to low rates is unlikely to have any material impact on the gold price, which is globally determined.

But not to worry, the central banks of US, Europe, Japan, England and Sweden are pulling their weight, moving from owning securities equivalent to around 5% of GDP to 30% today.

Central Bank Asset Purchases Chart

Philip Lowe said that Australia wouldn’t be joining this group immediately but he didn’t rule it out either, saying only that he didn’t expect we would reach the threshold to do QE in “the near future”.

He said that threshold is if the cash rate was at 0.25% and their targets of 2-3% inflation and 4.5% unemployment rate were not being achieved.

Westpac thinks “near future” for QE means the second half of 2020, as it expects two rate cuts next year to 0.25% by June 2020.

AMP Capital says that “further RBA monetary easing both in the form of rate cuts and quantitative easing point to more downside for the $A” and they see our dollar falling to 0.65 in the months ahead, which at current prices, would result in an Australia gold price of $2,245.

Lowe must have confidence that QE will work where low interest rates haven’t, as he said that “negative interest rates in Australia are extraordinarily unlikely” because our growth prospects are stronger, our banking system is in much better shape (cough) and have better demographics.

We found it interesting that while Lowe can see QE being required in Australia, he noted the following negatives from “extraordinary measures” like low/negative rates and QE:
  • reduces the incentive for banks to hold adequate buffers, making episodes of stress more likely in the future
  • creates an inaction bias by regulators or government
  • damages bank profitability, leading to less capacity to lend
  • damages a country’s credibility as it is money-financed government spending
  • creates political tensions as asset purchases disproportionally benefit banks and wealthy people
  • encourages households to save more and spend less due to concerns about lower income in retirement
Seems like a compelling list to us, but Lowe just says that when considering QE the RBA would balance these side-effects against the positive effects. So like they balance the lost income to savers against mortgage savings to borrowers from low interest rates – as in they won’t.

The reason for this, market commentators Epsilon Theory say, is that QE creates an addiction to more QE as investors earn less yield on their investments they need continually falling rates to increase the capital value of those investments.

If rates are zero or negative, then an investor like a super fund can’t generate a return and then it won’t be able to pay a pension. Ditto insurers and other businesses that rely on investment returns. So rates have to keep dropping to create that capital appreciation so everyone can show a “return”.

Lowe notes in his speech that central bank “extraordinary measures have continued way past the crisis period” and that is unclear when, or if, they will even be unwound. He doesn’t explain why this is the case and we wonder if he ignorant of the reason or just doesn’t want to acknowledge it.

For an indication of how “extraordinary” those “measures” are, consider this chart of 670 years’ worth of interest rates from Visual Capitalist.

Visualising Interests Rates Throughout History Chart

Another Lowe blind spot comes in what assets the RBA would purchase as part of a QE program. He says that they would only look to purchase government bonds and only in the secondary market and would not be buying private sector assets.

The reason? Because it would represent “a significant intervention by a public sector entity into private markets … and would insert the Reserve Bank very directly into decisions about resource allocation in the economy”.

Yet he says in his speech that the point of QE is to affect interest rates across all parts of the economy by changing the risk-free rate benchmark. Yes, the RBA would not be choosing one private company’s debt over another, but the buying of government debt is just intervention of a different degree.

The fact is that the act of having to balance the positive and negative effects of QE, or whether it is better that savers lose income and borrowers gain from lowering rates, is a political one. As Epsilon Theory observe:

“Democracies are based on the idea that a country’s citizens should determine a government’s decisions to tax, spend and redistribute wealth. Monetary policy [by a central bank] has no such constraints, yet it has similar consequences for the redistribution of wealth from savers to consumers.”

It suits politicians, of course, for the RBA to hide the fact that it is making political choices behind technocratic speeches. Politicians avoid having to make those choices themselves, and the discipline of the ballot box, by saying that it is out of their hands due to the need for the RBA to be “independent”.

The concept of central bank independence makes sense when the heavy lifting on managing the economy and wealth distribution is done by politicians. Central bank activities can then be said to be trimming the sails of the economy. Independence is also about preventing government from directly engaging in money printing by making the central bank buy its debt.

However, when central banks are buying government debt and engaging in extraordinary measures that push rates to 670-year extremes have they not moved their hand directly on to the rudder? Should they not be held accountable for that by the electorate?

Maybe the answer to why they aren’t is given by Epsilon Theory who say that a central bank is

“a government agency makes the money and sets the price of money and then sells it to a government-selected banking oligopoly that resells it for a profit. Money is a completely rent-controlled market. … And just like all rent-controlled markets, it’s the rich and the well-connected who make out like bandits.”

ABC Refinery an Emerging Force

Respected gold market research firm GFMS released an analysis on the Australian refining market this week. This sort of industry information is not usually made public but GFMS published part of its analysis publicly on LinkedIn here.

In it they note that ABC Refinery is projected to have a total combined refining output of 12.6 million ounces of gold and silver doré, which would give it a 43% share of the Australasian market. They said that in silver, “ABC Refinery is now the market leader in the country”, refining around 70% of available silver in Australia.

Australasian Refining Market Share Chart

The article also came with the chart below, which gives a year-to-date comparison for 2019 against previous years. Our gold exports are up but the destination of it has changed.

Australian Gold Bullion Exports Chart

We covered the long-term picture of Australia’s gold exports a couple of months ago but this chart zooms in and shows that this year, like 2016, has seen most of Australia’s exports going to London.

This aligns with net exports from Switzerland (the location of several major refineries) to the UK of over 316 tonnes in the past four months. We also note that exactly 10 tonnes (so mostly likely kilobars, see here for why) was deposited into JP Morgan’s Comex warehouse a couple of days ago, which may indicate an offloading of excess stock.

These figures speak to current low demand out of Asia, as refineries only ship 400oz gold bars to London if they can’t find buyers for the higher margin kilo bars Asian buyers prefer. This is not surprising as Asian buying can dry up when gold has a run, but demand will return when prices moderate.

Thankfully, Western investors have taken up the slack, adding over 10 million ounces to ETFs and other storage programs this year. So for the moment we see an East to West flow, rather than the usual West to East.

Goldman Sachs sees the overall balance between Western and Eastern demand favouring gold, with a forecast of $1,600 for 2020 (which, if it coincides with AMP’s 0.65 exchange rate forecast, would be $2,460 in local terms), as an investor saving glut will see them continuing to look at alternative investments like precious metals.

A Bet on $4,000 Gold?

We have seen a lot of coverage on Twitter of a Bloomberg report that someone bought 500,000 ounces of gold call options (at a cost of $3.50 an ounce) with a strike price of $4,000 an ounce in June 2021.

Many have been taking this as someone thinking the price will get to $4,000 by June 2021. While that would be a nice outcome, the buyer(s) don’t need the price to get there to make money.

If the gold price rises significantly, the price of the option will also rise above the $3.50 the buyer paid, at which point they can sell the option back.

It is a complex trade, as the price of options are based on time to expiry, volatility and other factors.

So while it isn’t necessarily a bet on $4,000 gold, it is a bullish bet the price of gold will rise significantly well before 2021, and one that someone was willing to stump up $1.75 million for.
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, or call us during trading hours on 1300 361 261.

This publication is for educational purposes only and should not be considered either general or personal advice. It does not consider any particular person’s investment objectives, financial situation or needs. Accordingly, no recommendation (expressed or implied) or other information contained in this report should be acted upon without the appropriateness of that information having regard to those factors. You should assess whether or not the information contained herein is appropriate to your individual financial circumstances and goals before making an investment decision, or seek the help the of a licensed financial adviser. Performance is historical, performance may vary, and past performance is not necessarily indicative of future performance. Any prices, quotes, or statistics included have been obtained from sources deemed to be reliable, but we do not guarantee their accuracy or completeness.