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Dead Cat Bounce

03 April 2020

Precious Metals Commentary

A bit of a mixed week for the metals, with gold initially falling to $1,572 but recovering to get back above $1600 by the end of the week. Silver followed suit but traded in a tighter range between $13.81 and $14.56, where it sits currently.

Gold Spot US Dollar Chart
The Aussie dropped this week, down from highs of 0.6214 to 60.5 cents currently. That helped local prices recover with gold putting on $100 from lows of $2,560 to trade around $2,670 as we write and for silver just over $24.

Gold AUD Chart
The gold:silver ratio is still elevated and seems to be consolidating at just above 110. Still way too high historically and it is hard to see it staying at these levels in the long run.

Buy the Market on Government Intervention?

Many investors will be looking at global equity markets with a confused look in recent days as markets have been gyrating up or down over 4% or more each way in single trading sessions. Going from a terrible day one day to a spectacular day the next is not a market which is experiencing a high level of efficiency and really throws the ‘efficient market hypothesis’ school into question.

The truth is, equity markets are trying to work out one thing and one thing only - and that is how far central banks and governments will go in providing stimulus in response to COVID-19 and what exact measures they will take.

With a global pandemic comes a huge amount of economic pain and we could see great depression era numbers across the board later in the year. One argument from stock bulls is that central banks may become buyers of direct shares or exchange-traded-funds (ETFs), similar to the Bank of Japan (BOJ) in recent times.

The BOJ has recently been making purchases of around USD$1 billion worth of shares via ETFs in single trading sessions and their current holding has swollen to over USD$250 billion, with the central bank owning more than 77% of the nation's ETF market. The trouble for the BOJ however, as described by Governor Kurudo last year, is that if the TOPIX index drops below 1,350 the BOJ will be sitting on a very decent sized unrealized loss. Suddenly the plan of gradually unwinding the ETF purchases at higher prices gets thrown out the window and the question then becomes what is the BOJ’s exit strategy?

Right now the index is trading back through this level to the downside so the BOJ is likely to have egg on its face later in the year as what little is left of the free market in Japan is cashing out equities as quickly as possible.

Topix Chart
The interesting thing about the COVID-19 pandemic is that it is going to lead to unprecedented levels of both market manipulation and socialism as governments and central banks are touting that ‘anything is on the table’ in their response to the crisis. Markets no longer function as markets if there is an invisible (or is that visible?) hand with unlimited purchasing power sitting directly underneath the bid. In the long run you end up with a zombie like market with no price discovery.

The current unrealized loss on the BOJ’s balance sheet is apparently no cause for concern in the US as the Federal Reserve announced on Monday that they too will start purchasing ETFs for the first time in history as part of its ‘unlimited quantitative easing’ mandate. We shouldn’t have to explain why unlimited QE is bullish for gold and our readers draw their own conclusions there.

The fresh round of stimulus will involve buying corporate bond ETFs in an attempt to “limit the losses to jobs and incomes and to promote a swift recovery once the disruptions abate”. So, although we have no sign of a Fed announcement to buy S&P500 ETFs, this may be something we see come at a later stage depending on how bad the crisis becomes and how far the market falls.

We do not believe however that this is a sound argument to go out and start buying equities as with the BOJ it could well end up backfiring in the long run. Our belief is that markets are experiencing a dead cat bounce on the back of the recent stimulus announcements, one that will be short lived as the devastating effect of COVID-19 on many businesses starts feeding through to a massive reduction in earnings across the board, which could have lasting effects throughout 2020.

$SPX Chart

Free Float

Last week we discussed the dislocation between the prices of gold in London and New York. The gap has reduced but it is still elevated and will probably remain so until the CME Group’s new “enhanced delivery” futures contract launches of 6th April and traders can arrange more freighting capacity between London and New York.

Mid-week the London Bullion Market Association (LBMA) sent an email saying that “gold stocks in London remain healthy” and that Comex warehouses were “nearing a record high in terms of stock levels”.

The email mentioned that gold held in London amounted to 267 million ounces and New York of 9.2 million ounces. Meant to reassure the market, the mentioning of the gross stock figures doesn’t give the full picture as to the real amount of gold available to the market (otherwise referred to as “free float”).

The term “free float” is used in equity markets to refer to the number of shares of a company that are available to the public for trading compared to shares that are restricted (eg shares held by employees).

Strictly speaking there is no such thing as a free float in gold as there is no centralised gold exchange/market that could apply restrictions on physical gold but the idea is used to distinguish between gold held by short-term traders versus gold held by “strong hands” with a long-term view.

For example, speculative traders are more likely to sell/supply their gold on a big price move up whereas few expect the US to sell its 8,000 or so tonnes of gold in Fort Knox, which hasn’t moved in over 40 years.

John Read from the World Gold Council estimates that only 48 million of London’s 267 million ounces is free float. This is because most of the gold in London is held by central banks (in the vaults of the Bank of England) and by ETFs.

It is a bit of a rubbery calculation because some central banks are active in the gold market (particularly with leasing metal, which can help bullion banks plug temporary liquidity mismatches in their gold flows) and ETFs also have a mix of speculative and safe haven holders.

Globally, gold ETFs have added around 3 million ounces in the past month to sit just over 100 million ounces. At that rate John’s free float would only last 15 months – ignoring any additional flows out of London to meet demand in New York.

Since the LBMA’s email, US futures warehouses have added 1.2 million ounces to bring total warehouse stocks to 10.5 million ounces. However, not all of this is available to the market, with only 4.1 million being registered for delivery into futures contracts.

Even with the embarrassing price dislocation between New York futures and London spot prompting the CME Group to add the new “enhanced delivery” futures contract that can accept London market sized 400oz bars, they were not willing to relax the requirement that gold has to be in a warehouse “within a 150-mile radius of New York City” to be deliverable against a futures contract.

In contrast, Reuters reported that the five major bullion banks that clear gold transactions in London were considering accepting gold held in other countries, including vaults operated by secure logistics companies as well as refineries.

The fact that the market is considering breaking away from its long-standing requirement that a trade for gold specifies its location – undermining the whole concept of location premiums and discounts – speaks to how unprecedented the COVID-19 induced problems are.

Gold is a Giffen Good

One may think that a simple solution to the gold market’s problems is simply to increase the price! In normal markets price rises result in increased supply and reduced demand.

In the case of gold, one would think that if the price rose above $2,000 it would result in a rush of gold into the market. However gold is not a normal commodity and can be considered a Giffen Good – one where demand rises when the price rises due to its safe haven nature.

That safe haven demand is currently being driven by fears of a rapid increase in inflation when COVID-19 stimulus packages increases in money meets decreased amounts of goods and services from COVID-19 restrictions.

An increase in the gold price due to those fears is a signal to others sitting on the sidelines that others think something is wrong and that induces more demand. We believe this feedback loop is beginning to build based on the number of new accounts and existing clients “topping up” that we have seen at ABC Bullion (and talking to other dealers).

At the moment the picture is mixed for gold. We have weak demand out of Asia due to COVID-19 restrictions and high local prices due to a strong US dollar (and in some markets, net cash for gold type selling), in addition to reduced jewellery demand worldwide.

We will also be watching central bank gold buying, which has been supportive of gold in the past few years, closely. Russia's central bank said it would be suspending domestic gold purchases from 1st April as it draws down on its official reserves to defend its currency from falling oil prices and the coronavirus, and other central banks may do the same.

On the positive side, 133 mines globally have been temporarily shut down due COVID-19, over half of which are precious metal operations (although Australian gold mining has not been significantly impacted at this time) and new and old investors are buying gold at levels exceeding those in the 2008 global financial crisis.

Our view is that safe haven demand will continue to build and eventually swamp any demand destruction in the gold market. Increasing numbers of analysts also see a favourable longer-term picture for precious metals.

United Overseas Bank sees gold rebounding significantly to $1,650 in the 2nd quarter of 2020, then to $1,700 in Q3 and $1,800 in early 2021 due to the inflationary risks of governmental responses to COVID-19. TD Securities is also projecting a move to $1,800 an ounce and then a jump to $2,000 near year-end.

It wasn’t long ago that talk of US$2,000 gold would have been considered crazy by professional market analysts – in these times such figures are now a lot more respectable.

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 article has been prepared by Australian Bullion Company (NSW) Pty Limited (ABN 82 002 858 602) (ABC). The information contained in this article or internet related link (collectively, Document) is of a general nature and is provided for information purposes only. It is not intended to constitute advice, nor to influence any person in making a decision in relation to any precious metal or related product. To the extent that any advice is provided in this Document, it is general advice only and has been prepared without taking into account your objectives, financial situation or needs (your Personal Circumstances). Before acting on any such general advice, we recommend that you obtain professional advice and consider the appropriateness of the advice having regard to your Personal Circumstances. If the advice relates to the acquisition, or possible acquisition of any precious metal or related product, you should obtain independent professional advice before making any decision about whether to acquire it.

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