Gold Gains on Powell Pronouncements
12 July 2019
Precious Metals Commentary
Gold spent most of the week under $1,400 even though China added 10 tonnes to its reserves and Poland reported a large acquisition of 100 tonnes.
Wednesday gold moved decisively up to $1,426 on the back of Federal Reserve chair Jerome Powell's dovish comments at his semi-annual monetary policy testimony but then moderated with US inflation coming in above expectations overnight, although it has held above $1,400.
Gold is still very reactive to daily news but it is forming a trading channel of $1,380 to $1,440 and the longer this continues the better - the market needs to consolidate before attempting another leg higher, which we feel is the more likely outcome than it breaking back down.
While ABC Bullion has seen a strong increase in volumes recently, this is not universal across retail bullion dealers according to our sources domestically and internationally, so the move is still primarily supported by institutional/smart money. The trading range since June 20th suggests accumulation on dips below $1,400.
Unfortunately, silver has not formed a strong floor, with its downward sloping trading range since gold’s breakout suggesting continued underperformance relative to gold.
The longer this situation continues, however, the increasing likelihood that traders see silver as undervalued and will shift to silver for more upside as it catches up to gold, bringing the gold:silver ratio back to more historically reasonable levels (see here for an extensive coverage of the gold:silver ratio trade).
The Aussie dollar remained under 70 cents this week, dropping to a low of 0.6910 but has ended the week even at just under 0.6990. That action gave a boost to Australian precious metal prices, pushing gold to nearly A$2,050 and silver just under A$22. Both are holding nicely above $2,010 and $21.65 respectively as we write.
In last week’s update we noted RBA Governor Philip Lowe’s comments that there were downsides to lower interest rates as not everyone (i.e. savers) benefited.
This week, Tracey McNaughton (Wilsons Advisory) published an insightful article that discussed another downside to lower rates: it widens the gap between high and low income groups.
Tracey says that by lowering interest rates, central banks aim to increase asset prices. The theory is that the resulting increase in wealth would “spill over into the real economy via higher consumption spending, production, business investment and employment”.
The problem is that only high-income earners own assets but their spending does not have as greater an effect on the economy as low income groups. The result is not that much spill over impact on the economy, yet we are left with record amounts of debt.
That debt overhang, as we have discussed in previous updates, puts pressure on central banks to lower rates further as people become more sensitive to rate increases.
As Tracey says, we have now moved from a situation where “the goal was to lower interest rates to pull the economy out of recession. Today, central banks primary purpose is to extend the cycle”.
The impact of this wealth gap effect appeared in the Westpac-Melbourne Institute Index of Consumer Sentiment, which fell 4.1% to 96.5 in July. Westpac said that the fall was “troubling” as they considered the Federal government’s tax package and RBA interest rate cut as a “supportive backdrop for confidence”.
They specifically noted that the sentiment of the groups that should benefit the most from policy easing – mortgage holders and middle-income earners – actually fell 3.3% and 5.5% respectively.
We would suggest Westpac consider Tracey’s analysis as the reason why there are “deepening concerns about the outlook for the Australian economy and prospects for family finances” from the survey respondents.
Meanwhile, Westpac have revised their 2019 year-end price forecast for gold from $1,330 to $1,440. Combined with their 0.66 call by year-end (which we covered here) that would translate to AUD$2,182 by 31 December, a gain of over 8% from where we are today.
Longest Expansion Ever
The US is now into the longest economic expansion it has ever had but as the chart from Strategas below shows, it is also an outlier in being the weakest on record.
The problem with reaching a “longest” record is the natural follow on question is how much longer can it go on? While Merk Research feel that the “the longer term outlook remains negative as we are likely in the late part of this economic expansion” they do note that the economic signals are mixed. This allows for those with a more optimistic bent to find reasons to believe it will continue.
David Rosenberg (Gluskin Sheff + Associates) is not one of the optimists, noting that the New York Federal Reserves’ “model now pegs recession risk at 32.9%, a 12-year high. History shows there's no turning back at this level”.
Well-known economist George Magnus agrees, saying that “the longevity of the expansion, the high valuations of assets and the accumulation of debt” is conveying a “fragile: handle with care” warning.
We would argue that the shift into gold since June 20th reflects increasing fear by market participants that a recession may soon be upon us. Of course, gold will get a boost if we do tip into a recession, but it seems at this time that only the smart money is moving into gold in advance of that risk.
Federal Reserve chair Jerome Powell is doing his best to avoid that outcome, with comments at his twice-yearly monetary policy testimony before the House Financial Services Committee supporting market expectations of a rate cut.
Given our earlier comments about debt overhang, we note Powell said that he remains “concerned about the longer-term effects of high and rising federal debt, which can restrain private investment and, in turn, reduce productivity and overall economic growth”.
Billionaire investor and Elliott Management founder, Paul Singer, also recently warned that the global economy is heading toward a "significant market downturn" due to all-time high levels of global debt and derivatives.
Powell Dismisses Gold
The last few weeks we have been observing how governments don’t like currency competition: first with Facebook’s Libra stablecoin and then in respect of gold standard sympathetic Judy Shelton’s nomination for the US Federal Reserve Board.
No surprise then that Jerome Powel dismissed gold when asked about it, claiming that “there have been plenty of times in fairly recent history where the price of gold has sent a signal that would be quite negative” for the goals of maximum employment and stable prices.
George Mason University economics professor Larry White, however, argues that a gold standard:
- provides a stable international reserve currency that is disconnected from individual nations
- when combined with free banking would have restrained the boom and the bust
- historically has exhibited lower price level uncertainty at medium to long horizons
- without bailouts provides greater fiscal discipline, restraining government over-indebtedness
Maybe the issue is that Powell is worried about his job, as historically many gold standard countries had no central bank at all, yet somehow everything seemed to get along just fine.
We were also surprised to see President Trump tweet on crypto currencies and Libra, saying that he was not a fan as their “value is highly volatile and based on thin air .... similarly, Facebook Libra’s ‘virtual currency’ will have little standing or dependability”. For the President to comment on Libra means the politicians must really be concerned about currency competition.
Big Trader Bets on Bullion
A couple of weeks ago we noted that the probabilities favour a weighting towards silver at this time.
Legendary investor Jim Rogers agrees, saying that if he “had to buy one, silver or gold, I’d rather buy silver. Silver is more depressed on a historic basis than gold” although he is not in the market for additional gold or silver at this time.
Jim Rogers is maintaining his gold holdings and would only look to sell if a bubble develops as “you’d be crazy to hold any asset through a bubble”.
Veteran fund manager Mark Mobius says investors should have at least a 10% allocation to gold as it is uncorrelated to other assets such as bonds and equities, and “provides a foundation stone in an investor's portfolio”.
Mark also asked what was the “sense of holding euro when you get a negative rate? You might as well put it into gold because gold is a much better currency” and it would seem European banks agree to some extent, with their holdings of physical cash moving up significantly since interest rates turned negative.
At some point, they may swap that physical cash for physical gold, as cash is bulky and would have a higher storage cost compared to value-compact gold.
Maybe they also need to consider the forecast of David Roche from Independent Strategy, who is predicting gold to reach $2,000 by the end of year as he believes “financial markets are now poised to crumble like a sand pile” as they are underestimating how far reaching the trade conflict with the United States will be.
Until next time,
John Feeney and Bron Suchecki
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 [email protected], or call us during trading hours on 1300 361 261.
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