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Go, Aussie Debt, Go!

02 August 2019

Precious Metals Commentary

Just when you think gold prices are going to pull back and have a breather, Trump comes back into the spotlight with some fresh tariffs on Chinese imports, spiking gold to a high of USD$1,449 before pulling back to $1,433, with silver gaining some ground back to $16.23 per ounce.

So the volatility in precious metals prices continues this week and we’ve seen some wild swings so far. In AUD terms, we once again pushed through record highs to $2,105 at time of writing, with silver trading close to $24 per ounce.

Trump slapped a new 10% tariff on $300 billion worth of Chinese goods and for those wondering why this lead to such a spike in gold, one must think of interest rate policy in reaction to the expected impact on economic growth. In a way, Trump is backing the Federal Reserve into a corner, with each new tariff making it more likely for the Fed to have an easing bias when it comes to rates.

We were proven correct in our previous forecast that the Fed cannot normalise rates without catastrophe, so once again it seems that interest rates in the US are going to start moving back down towards zero, and then potentially negative, depending on which central bank is brave or stupid enough to move the cash rate below zero for the first time. The Federal Reserve made a 0.25% cut to their cash rate on Wednesday, which is the first rate cut since 2008.
Gold Price AUD

Central Banks Non-Renew Non-Agreement

Last Friday, the European Central Bank and 21 other central banks that are signatories of the Central Bank Gold Agreement (CBGA) decided not to renew their agreement.

The first agreement was signed in 1999 in response to a market that was very pessimistic about continued central banks sales after the UK’s widely criticised auction of its gold reserves. At the time, the gold price was on its way down to $250 and all expectations were that it would break below that.

The first three agreements set a limit on gold sales across the signatories (shown as dotted bars in the World Gold Council chart below) but the fourth one, which will now lapse, we call a non-agreement because it had no limit.
European gold sales
All the fourth agreement said was that the signatories thought gold was important part of reserves, didn’t currently plan to sell any but if they did they would “coordinate”. Like we said, a non-agreement because it didn’t lock them into not selling (or buying, for that matter).

It may seem a bit farcical but then bureaucracies love precedent, and maybe in 2014 they weren’t brave enough to non-renew so decided not to scare the market by renewing an agreement but do so without a limit.  

So no surprise that the market didn’t react to the non-renewal. If anything, the message sent is that the central banks felt the market was strong enough to handle it. Those of a conspiracist bent might argue that the agreement was binned because one or more central banks had sales planned, as the chart above shows, it is clear that they are still keen on holding on to their gold.

With all the talk about increasing buying by central banks (with Poland the latest), it is worth noting that there are still some central banks selling.

The chart below shows the quarterly buying and selling volume in tonnes, as sourced from the World Gold Council’s Goldhub. The black arrow shows that buying volumes have been on an increasing trend with sales volumes reducing significantly apart from a few sporadic surges.
Qarterly change in global gold reserves

It is also worth noting that by far most central banks just sit tight and neither buy or sell. The chart below shows the number of banks buying or selling out of the 130 that the World Gold Council track.
Number of Central Banks

The switch from net selling to net buying happened just after the global financial crisis. Posibly central banks became more fearful and looked to gold to provide a counterbalance? Or maybe they just like pet rocks? As the chart below tweeted out by Ronnie Stoeferle from Incrementum shows, gold performs better than other go-to safe havens.
Incrementum gold performance chart
It does always amuse us when mainstream commentators disparage gold investing as stupid. If so, then doesn’t that mean that central bankers are also stupid? In which case why do we trust them with controlling interest rates?

Talking about mainstream, we noted last week that gold had attracted the attention of mainstream media but that it hardly indicated any mania phase of a bubble.

The bubble that the smart money is starting to worry about is in stocks and bonds, with Bloomberg reporting Societe Generale recommending that its clients “ride the bull until 2020 - when a U.S. recession and a debased dollar will make gold the perfect doomsday hedge”.

However while Bloomberg says that gold fever is breaking out from London to New York, narrative analysts at Epsilon Theory say that the idea that lowering interest rates further will result in a debt-fuelled market collapse “still isn’t the dominant narrative” and is barely registering “against the tide of ‘Financial Asset Appreciati Strength = National Strength’ memes promoted throughout political and financial media”.

Gold will be the bull to ride once the wider market wakes up.


Fed’s “Insurance” Cut

The US Federal Reserve’s first rate cut in 11 years highlighted how news-driven the markets are these days. We mentioned “farcical” earlier and that seemed to apply to Wednesday’s action.

At first, the market focused on the language that the cut was just a “mid-cycle adjustment to policy” and insurance against outside threats like the trade war. This was read as the Fed not easing up in the future as much as expected. The initial selloff and US dollar strength was then reversed when Powell said that the cut wasn’t the start of a long cutting cycle but that he also didn’t say just one rate cut.

In the end, gold reacted badly as the market felt the Fed still had their (stocks and bonds) back. History, however, shows that when the Fed cuts, stocks decline, as Dohmen Capital Research demonstrate in the chart below.
Fed Funds Rate vs Stock Market

Further confirming the risk to stocks is this chart from Alhambra Investment Partners, showing that “valuations are way, way out of line” with investors betting “that the economy eventually booms”.

Profits & Valuations
After the initial drop, gold kept grinding down getting close to $1,400 but then Trump came to the rescue of gold investors yesterday talking about “putting a small additional Tariff of 10% on the remaining 300 Billion Dollars of goods and products coming from China”.


China Troubles

With China’s manufacturing index for July coming under 50 (indicating contraction), which is the sixth time it has done so in the last eight months, the timing of the additional tariff is likely to apply pressure to China that Trump is after.
China PMI

We note that China stopped accumulating gold in late 2016 when their PMI went above 50 but then restarted in late 2018 when the PMI fell back below 50. The lack of gold buying during 2017 and 2018 led some commentators to argue China was still buying but just not reporting. Maybe their buying is more tactical and dependent on other factors. As the Chinese State Administration of Foreign Exchange was reported as saying, “gold combines the multiple attributes of finance and commodities to help regulate and optimize the overall risk-return features of the international reserve portfolio”.

Retail investors in China are also looking for some shelter against Trump’s tariffs, with the World Gold Council noting a few weeks ago that economic concerns have played a big part in the rise of safe-haven demand for gold in China, as demonstrated in the chart below of the Shanghai Gold Exchange’s margin-traded gold contract.
Gold prive vs investors

Australia Outperforms

We shouldn’t get too smug about US-China dramas down under as University of Sydney adjunct professor Adrian Blundell-Wignall warned that “what is going on in China is extremely dangerous” and a threat to Australia’s future prosperity.

He says that the levels of debt in Australia and China make “Japan's level of bank debt look like a boy scouts picnic in comparison … Just because we dig holes in the ground and we build houses, we think we are a smart country that hasn’t had a recession in 28 years”.

Yes, as this chart from Nucleus Wealth shows, we are real outperformers in the debt game. Go, Aussies, Go!
IMF DataMapper
While we have been building houses and racking up debt to buy them, not surprisingly it seems less and less people are getting close to owning them outright.
Share of households with characteristic

Possibly something to do with stagnant wages over the past ten years? The chart below comes from the Household, Income and Labour Dynamics in Australia Survey.
Median household income

According to the Westpac–Melbourne Institute Consumer Sentiment Index, there has been a sharp loss of confidence around the economy, with the housing correction (the value of which has declined $370 billion since 2017) a key factor as the dent to household balance sheets results in a negative “wealth effect”, crimping consumer demand.

The result is that consumers are still heavily favouring “safe options” like deposits, superannuation or paying down debt as the best place for savings.

We’d suggest it wouldn’t hurt to allocate some of that deposit money into safe haven gold and silver.

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.