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Expert says gold’s run is just getting started

04 June 2021

The Mothership of Banking says Gold is Money

Dear investor,

Settle in folks, we have some ground to cover today.

In fact, think of this edition as a choose-your-own-market-update-adventure.

There’s an interview with a legendary commodities investor. Some titbits from the Reserve Bank of Australia and we have what Opposition Leader Anthony Albanese said about ABC Refinery over here.

Our most important topic for today, is that we start understanding what the new rules for banks mean…and the potential impact on gold.  

Before we get to any of that, let’s check in and see what the yellow metal is doing…

Gold dips on US data…how long will it stay down?

Around this time yesterday, the US dollar gold price looked strong. Hovering around US$1,908, the question I found myself asking, was how much puff is left in this rally?

Initially I thought it might run out of steam around US$1,920. Maybe the yellow metal would spurt higher to US$1,940. But, when the momentum finally left this leg of the rally, I said to some colleagues yesterday that we should look out for US$1,850.

Well, overnight some US jobs data came out and caused the spot price to do a 180-degree turn. Where’d that drive the price down too?

Right down to US$1,858 while we were sleeping…

US dollar gold price - daily chart

Source: Trading View

The reversal in momentum for gold is largely due to private payroll data from a firm called ADP (a different data set to the United States Non Farm Payrolls).

ADP announced 985,000 American jobs were created for May. Coming in well above the expected 645,000.

Essentially the market used this to confirm the view that the US economic recovery is firmly underway. Meaning all the doom and gloom is a 2020 problem.

The thing is, I hold a different view. I’m not the only one either.

Legendary commodities investor Rick Rule and I talked about this on camera last week.

Rick says there are three key factors likely to drive gold prices higher in the long term, and the short term moves are just that. He adds investors shouldn’t worry they’ve missed out on the gold bull market because it’s only just getting started. Click on the thumbnail to watch the interview now.

RBA holds rates but will they increase QE?

Next up in our choose-your-own-adventure series, is what the Reserve Bank of Australia did.

Or in this case, didn’t do. Again.

Unsurprisingly, our mates at the RBA kept the cash rate at 0.10%. Doubling down on their commitment to keep rates low until 2024.

One thing to note about these policy meetings, is how uneventful they’ve become.

Gone are the days where managers would interrupt meeting to announce the RBA’s decision.

Nowadays, the outcome from that first Tuesday in the month barely gets a mention.

Much like the Federal Reserve Bank, our own central bank communicates its intentions to the market so there’s no surprise. Making pretty much every statement feel a bit like a cut and paste job.

One thing worth watching for July though, isn’t the rate decision. Rather it’s the RBA’s stance on the next round of quantitative easing (QE).

The RBA joined their cohorts late last year by introducing QE for the first time.

Our first $100 billion bond buying program quickly turned into a second $100 billion program less than six months later.

As the Australian Financial Review pointed out during the week, this second program may not actually end, rather become a ‘flexible’ QE program going forward. With the AFR suggesting the July meeting may signal this change, writing:

More bond purchases are coming – it’s just a matter of the precise quantities and over what timeframe.
This is where Lowe may be wise to introduce flexibility. As I noted last month and earlier this week, flexibility may have some advantages.
Westpac chief economist Bill Evans on Friday updated his guidance to predict that the RBA may shift to a more flexible QE model.
“The QE program has now matured to allow the board more flexibility,” he said. “We expect the governor to announce an open-ended $5 billion per week purchase program, to be reviewed later in 2021.
“We continue to expect that the ultimate level of additional purchases will reach $150 billion.”
That would equal a total of $350 billion in QE.

What would continuing this QE mean for Aussies? Ongoing QE flags prolonged economic weakness.

The RBA have the wage growth in their crosshairs, and a consumer price index (CPI) rate between 2-3% slightly to the left. Without any meaningful lift in this data set, the QE program is likely to roll on.

We’ll come back to this topic in July.

Until then, we need to look at some of the behind-the-scenes machinations in the gold markets.

Gold gets an upgrade

Today we wrap up with a complex beast.

The mysterious inner workings of the overseer of global banks - The Basel Committee - part of the Bank for International Settlements.

Or at least, we’re going to start exploring what impending changes from this mob mean for those in gold.

This opaque committee is the guardian of what assets banks hold, the risk rating for them and just how much a bank should hold.

When there’s a financial market whoopsie, The Committee sets out to establish new rules to avoid it in future.

As an aside, these rules set out by The Committee don’t have legal force, rather ‘the BCBS relies on it’s members’ commitments, as described in Section 5, to achieve its mandate’ says the BIS website.

Legal standing or not, the guidelines The Committee set out are largely followed.

However, the Basel III changes suggested a few years ago are about to come into play. Some of those may cause a stir in the gold markets.

Now Basel III - as Nick Frappell wrote recently - is the response to one of the biggest market whoopsies in recent memory, the financial crisis of 2008 (or GFC as us Aussies refer to it).

Simply put, the GFC revealed a liquidity crisis when the sudden credit worthiness of certain bonds were rerated (re-valued as junk). A bunch of holders and potential buyers of said bonds wondered why they’d want to own an asset that was likely to default.

What happened next was a plunging in values of these bonds, and whole bunch of institutional traders watching the proverbial hit the fan, looking to ditch the newly defined junk assets.

As the markets ricochet and investors ducked and ran for cover, it became apparent that banks didn’t hold enough riskless asset to weather stormy markets.

Basel III are the reactive guidelines created which determine the ‘core’ capital a bank should have. The goal was to increase Tier 1 capital requirements, would should offset short term market instability.  

In other words, the type of Basel III set out rules about holding assets people want when they’re running for cover in the market.

What’s notable about Basel III, is the rerating gold had.

Under Basel III, gold has been reclassified from a Tier 3 to a Tier 1 asset.

Meaning in The Committees view gold as the least risky asset next to cash.

The framework also stipulates that physical gold must be held in the banks own vault.

In addition, the Basel III wording now speaks of gold as a currency, not a commodity.

This is an important language change to note.

What does this mean for gold?

The short version is, that this reclassification as a ‘currency’ only reenforces my bullishness for the yellow metal.

I’m running out of digital ink space today (and I’m way over my deadline). Come back next week and I’ll show you how it’s going to impact precious metal sector from the inside out.

Until next time,
Shae Russell
Group Communications Manager,
For ABC Bullion