Feeding and Breeding Zombies

Precious Metals Commentary

A poor week for gold, posting five down days in a row in response to market positivity related to COVID vaccines and a belief that economies will turn around, with better than expected data on the US manufacturing sector from the Philadelphia Federal Reserve the most recent figure to support a stock market that is looking for reasons to be bullish.

Gold held up again above the $1,850 level we have mentioned previously, even in the face of ETF outflows. Chris Weston from Pepperstone says that $1,850 is “the line in the sand, and one would expect stops to be lurking under here” and believes it will hold as there has been renewed interest to sell the US dollar and falling returns in the bond market.

At ANZ’s annual gold dinner in Perth, Nick Frappell re-iterated his view that “overall, I'm bullish. There are plenty of reasons to be bullish” with ANZ’s Daniel Hynes saying their modelling indicated gold still has plenty of upside.

The $2,300 target indicated in ANZ’s chart is a level that we have observed consensus building around. Goldman Sachs was reported to see a $2,300 target for gold over the next 12 months, which would be a 24% rally from current levels. Goldman’s forecast is based on inflows into gold by investors concerned about the long-term inflation rate as well as strengthening demand from emerging markets, with Chinese and Indian gold demand "already displays signs of normalization”.

OANDA also sees $2,300 during the first half of 2021 with its three top drivers being rising coronavirus cases, a weaker stock market, and the unemployment situation across the globe. If such a move coincides with an Aussie dollar below 70 cents (which is entirely possible given its performance over the past few years), then that would translate into $3,300 Aussie for gold, a 30% gain from today’s levels.

COVID Stimulus

Regarding COVID, Australia is doing much better than many countries, which are seeing increasing cases and deaths in raw numbers and on a per capita basis.

Just this week the US Centers for Disease Control and Prevention advised against traveling for Thanksgiving given the recent exponential growth in the number of Covid-19 cases, as well as rising hospitalizations and deaths.

While we wait for a vaccine to be fully tested and then manufactured and distributed, governments will have to continue pumping money into their economies. Former New York Federal Reserve President Bill Dudley said that the US economy still needs help from Congress even with the increased probability that widespread vaccine availability is now in sight.

Such stimulus is already at elevated levels relative to GDP for many countries.

Martin Conlon from Schroders says that the key question for investors over the next ten years is whether there are any limits to what government stimulus can do to support economies and markets.

He says that investing has “become a game of trying to predict where money will flow and valuations expand” and that low/zero interest rates do not work as businesses will only borrow when they think demand will justify the additional capacity – and that “remains a problem most businesses would like to have, but rarely exists”.

Zombie Companies

Indeed nearly 20% of the US’s largest publicly-traded companies are now considered zombies (defined as not earning enough to cover their interest expense) and globally we have just over $17 trillion worth of negative yielding debt.

Edward Yardeni (Yardeni Research) says that the US Fed’s easy credit is “feeding the Zombies and breeding more of them” and that such companies are a major source of excess capacity and deflationary pressures.

Central bankers aren’t getting the message that their policies don’t work, with Andy Haldane, the chief economist at the Bank of England, looking favourably on digital currencies as they would eliminate the constraint on charging people to hold cash (i.e. negative interest rates).

What is missed by most is the perverse impact such policies have on the behaviour of entrepreneurs and companies – the true engine of our prosperity. Christopher Cole (Artemis Capital) says that a negative real cost of capital results in entrepreneurs focusing on “narrative perpetuation over value creation” and rather than trying to disrupt monopolies it actually encourages them to be bought out, thereby encouraging concentration of power.

All of the above is not a good sign for stocks. Investment advisors RIA say that the stock market has detached from the underlying profitability of its companies, which is clearly demonstrated in the chart below.

While markets may remain irrational longer than logic would predict, RIA suggests investors may be walking into a trap.

The chart below from Hussman Investment Trust indicates the extent of the depressed interest rates and extreme market valuations trap. It shows that over the next 12 years the estimated average annual return from a conservative portfolio will be -1.56%, the lowest it has been in nearly a century.

Hussman say that the biggest drag on the portfolio are stocks and they “continue to view safety nets and tail-risk hedges as essential” given they “expect the S&P 500 Index to lose two-thirds of its value over the completion of the current market cycle”.

Virtual Gold Conference

Just a reminder that the GAIC virtual gold conference is on next Thursday 26^th November. It is completely free and will have presentations by Jim Rickards and Rick Rule, as well as by ABC Bullion where I will be talking about gold, cryptos and money and specifically why people will run to gold, not cryptos, in a financial crisis.

You can register for the conference here, look forward to seeing there, virtually.

Until next time,

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 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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