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​Desperately Seeking Inflation

26 July 2019

Precious Metals Commentary

Gold pulled back to USD$1,417 this week on the back of a stronger US Dollar, with silver shining brightest at present, adding USD 10c since last week and trading at $16.45 at time of writing.
There seems to be some resistance for gold around the $1,440 level as there would be some profit taking from recent longs, so we remain range bound for now, with the Fed meeting next week likely to see a cut of 0.25% to their cash rate.

For those waiting and hoping for a pullback in metals prices to add to a position, you can blame RBA governor Phillip Lowe for ruining the party. Metals were higher in AUD terms this week with gold rising to $2,044 and silver to $23.75 after the governor’s statements on inflation.
Gold Price Chart AUD 
With the country loaded up on housing debt and our savings ratio diminishing, the RBA governor believes the one thing the economy needs most is for our cost of living to go higher.


Desperately Seeking Inflation

At an address to the Anika Foundation yesterday, RBA Governor Philip Lowe talked about the problem of low inflation. Consumers, of course, would not see flat or falling prices as a problem, but the RBA has a target of 2-3% inflation so anything below that is a problem in their eyes.

Lowe does note that their inflation target is not an end in itself but rather as “a means to an end. And that end is the welfare of the society that we serve”, which includes economic and financial stability and steady job creation.

Hard not to agree with these objectives, but we were puzzled when Lowe said that the RBA’s policy “decisions affect borrowing and asset prices and thus financial stability”. Puzzled, because we would argue that the RBA lowering interest rates encourages speculation and asset bubbles, be it in house or stock prices. Hardly conducive to financial stability but then the RBA may have been counting on a “wealth effect” where people (well, at least the ones lucky enough to have assets) would spend more since they feel wealthy.

However, as Mohamed A. El-Erian, Chief Economic Adviser at Allianz, recently wrote, such “wealth effects” and “animal spirits” have proven to be quite feeble, requiring central bankers to double down with “protracted use of unconventional and experimental measures”.

UBS CEO Sergio Ermotti agrees, saying in an interview with Bloomberg that “asset prices went up [due a decade of QE-driven policy] but it’s not really correlated with investor sentiment, which is in my point of view, of course, a very dangerous development” and that central banks risk creating an asset bubble (in our opinion, there already is one).

As to why inflation has been so low for so long, Lowe says it is primarily due to:
  • credibility of the current monetary frameworks
  • spare capacity in parts of the global economy
  • technology and globalisation
Lowe says it will be some time before inflation rises to the target 2-3% and thus it is reasonable to expect an extended period of low interest rates.

Louis-Vincent Gave of independent registered investment advisory Evergreen Gavekal disagrees, based on the correlation of the “capital providers ratio” to interest rates.

The “capital providers ratio” is ratio of the numbers of people who save (usually those aged 35-64 years) relative to the total population. The chart below shows this ratio, in red, compared to interest rates before and after inflation.
Capital providers ratio chart
The fact that this correlation extends back over 60 years is compelling. According to Gave, the rise from 1960 to 1980 and subsequent fall were driven by baby boomers, who were in the first phase of their lives spending (or rather their parents spending on them) rather than saving but after 1980 started to save more than spend, resulting in inflation collapsing along with interest rates.

Going forward, the baby boomers are going back to “dis-saving” as they live off their investments and pensions. Gave says “this phase is likely to be inflationary”.

If true, then Philip Lowe may soon not have to worry about low inflation but the opposite.

Other central banks, it would seem, are more concerned than Mr. Lowe according to a recent World Gold Council survey of central banks.

Eleven percent of emerging market and developing economy central banks surveyed say they intend to increase their gold reserves over the next 12 months due to higher economic risks in reserve currencies and changes in the international monetary system.


Mainstream Media & Manias

With the gold price breaking out, it has attracted the attention of mainstream media sites. We do like to keep an eye on this as it can be an indication of whether a market is getting into that mania phase of a bubble.

No risk of a mania at this stage, especially not if this snide Telegraph UK article is any guide. With a title of “It's now smart to hold some gold” (note the use of “now”, implying it is just a flavour of the month) and references to “people who stockpile tinned goods and Kalashnikovs”, it reads like the author was forced to cover gold by his editor.

We think we can identify the author’s issue with gold when he says that interest in gold rises “when someone you know has made money holding it” – obviously he wasn’t holding it and is jealous of those who made some money.

The other mainstream media article we’d like to highlight is this from CNBC because we are a sucker for a to-da-moon-ish chart.
Bull markets in goldWe would take issue with using December 1969 and a gold standard defined price of $35.30 as the start of the 70s bull market, when it wasn’t legal in the US to own gold until January 1975. Australia was a year later, with restrictions on gold ownership only lifted on 30 January 1976.

The correction in the mid-70s was partly due to the market over playing the effect of legalisation of gold ownership in the US, and the price bottomed at $103.05 in August 1976. The run up to $850 in January 1980 was a more modest 8.2 times increase over 3.5 years rather than the +1755% increase CNBC claims.

The noughties bull took 12 years by comparison but had a similar gain of 7.5 times from $252.80 in July 1999 to London price fixing high of $1,896.50 in September 2011.

Putting a figure to CNBC’s big question mark, if you worked on an average bull market gain of 8 times on top of the December 2015 low of $1049.40 you get $8,395 sometime after 2025.

That may seem crazy, but Erik Lytikainen (Viking Analytics) notes that in both the 1970s and 2000s gold moved through four Fibonacci levels (a common measure used in technical chart analysis).

He says that if this happens again then “the next upward spike could peak in the range between $7,000 and $11,000 per ounce” with a subsequent re-trace of 50% to 70%.

While talking about $8,000 gold might hyperbolic, so would have $1,900 gold in 1999 when everyone was worried about central bank gold sales depressing gold prices for as far as the eye could see.

However, before you think we have turned into a gold pumper, we’ve said many times before that gold should be viewed as an insurance policy and not a get rich quick scheme, to which you should only allocate a modest part of your portfolio to.

Mohamed A. El-Erian recommended back in 2014 that investors should allocate between 3% to 8% to gold and that “only brave investors would omit it from their investment portfolios given the fluid world we live in”.

As to the insurance aspect, the Cor Capital Fund note in their latest Monthly Report that “conservative investors holding ‘insurance’ against their equities and bond holdings in the form of precious metals or cash have done quite well and slept easily”.

Especially so when interest rate manipulations cause capital misallocations, with the resulting low bond yields making Cor Capital “increasingly wonder about the future buying power of currency and value of governments as debtors”.

Surprising then that Bloomberg reported Goldman Sachs saying that the “Yen offers a more attractive hedge than Gold”. Like Cor Capital, we’d rather some honest gold than flighty fiat.

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.

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