‘Sell in May and go Away’ is a famous stock market saying, meant to protect investors from seasonal declines in equity markets by encouraging them to lighten up on their holdings by the end of April. This is because May has often heralded a period of weaker market returns, if not outright declines.

Overnight, the message appeared to be directed toward the precious metal market, with gold starting the month of May on the wrong foot, dropping down toward below USD $1180oz at one point.

The silver market was also rocked, plunging below USD $16oz, with the sell off occurring in an incredibly short period of time, as stops were triggered after a US initial jobless claims report which hit 262,000 last week, a 15 year low for the reading.

For some reason this seems to have tipped the market into taking a hawkish interpretation of the latest FOMC statement, despite the appalling Q1 GDP report which showed the US economy slowing to a standstill at the start of 2015, and a lacklustre personal income report.

There are a handful of key data points due to be released in the next 24 hours, including manufacturing reports from Markit and the Institute for Supply Management, as well as construction spending, vehicle sale sand consumer sentiment figures. A series of strong reads could be enough to send gold back below USD $1180oz, and comfortably below AUD $1500oz.

Alternatively, if those numbers come in below market expectations, we could see the market gravitate back toward the all important USD $1200oz level we’ve been oscillating either side of for some time now, with a huge week ahead in terms of economic data which could drive markets.

Ignore the Noise

Whichever way the markets move in the next 24 hours, and no matter the explanation given for it, we think it’s best clients focus on their long-term strategy, and ignore the daily noise.

Earlier in the week, Greg Canavan from The Daily Reckoning penned a piece entitled “Action in the Gold Market”. In it, he made the same point I did above, and that investors should ignore the majority of the explanations about why markets moved the way they did on any given day. Greg’s article pointed to reports on the same day which stated that European stocks were up on hope of good news from Greece, whilst fear of the same situation deteriorating was the catalyst for gold price gains.

As for the volatility we saw late last week and the snap back above USD $1200oz we saw prior to the overnight decline, Greg noted that there had been a $1 billion gold swap that took place between Venezuela and CitiBank, with Citibank potentially needing to hedge its exposure by selling gold futures. That could have been behind last weeks temporary weakness.

You can read Greg’s article here if interested

As an example of the noise we witness in markets everyday, at the very time the Fed interest rate decision and FOMC statement was being released, my inbox was bombarded with at least 15 “news items” to do with markets. All these items are largely useless in the long-term picture, and are of no value to investors whatsoever. The headlines noted that the “the USD trimming losses vs. the YEN and the EUR”, then “the dollar was rallying”, then it was “trading within ranges”.

I was also told the Fed saw moderate growth, that the slowdown in the economy reflected ‘transitory factors’ to a degree, and that they saw inflation rising to 2% in the ‘medium term’. As I say, most of it is noise, which is why it’s not really necessary to be following the market 24 hours a day to be a good investor.

The key things to remember, and which Greg’s article at least partly attested too, are that

• Gold is yet to decisively bottom in USD, though the picture looks encouraging, last night's price action notwithstanding

• Gold looks much better in AUD, as weakness in the local currency props up returns for domestic investors

• Dollar cost averaging is still the most prudent approach to accumulating precious metal holdings as a core holding in your portfolio for the coming years

The pullback in bullion overnight has allowed me to take my own advice, picking up some more silver for my own portfolio.

Will the RBA Cut in May?

The will they, won’t they debate around interest rates will only hot up in the next few days, with the market increasingly expecting the RBA to cut interest rates in May.

Earlier in the week, we actually saw the market start to price out a May cut, and the Australian dollar at one point headed back above USD $0.80. This may have also contributed to the weakness we’ve seen on the ASX this week, though global factors are more likely the issue.

The rising AUD vs. the USD is also probably a result of the increasing realisation by market participants that the Fed won’t be hiking interest rates in 2016, with US GPD for Q1 coming in at just 0.2% this week, way below expectations.

Interestingly enough, RBA Governor Glenn Stevens was in the news this week after a speech he gave, which amongst other things discussed the problems retirees will be facing in the coming years regarding income generation on their assets. The quote below is from Stevens direct.

“How will an adequate flow of income be generated for the retired community in the future, in a world in which long-term nominal returns on low-risk assets are so low. Just about everywhere in the world the price of buying a given annual flow of future income has gone up a lot. Those seeking to make that purchase now – that is, those on the brink of leaving the workforce – are in a much worse position than those who made it a decade ago. They have to accept a lot more risk to generate the expected flow of future income they want.”

His statement about the risks retirees are facing with their investment portfolio is of course one of the major reasons we remain bullish on precious metals, as protection against that risk is something all investors will need to implement in the coming years, and it’s increasingly unlikely bonds and cash will fully play that role, as they have in the past.

Of course, any interest rate cut the RBA makes going forward, either next week or in the coming months will only make the ‘reaching for yield’ problem worse. It’s a game that will continue to be played for many years.

Upping Cash with QE Everywhere

There was a couple of very interesting reads this week, one from Societe Generale’s Albert Edwards, and another one from Magellan Asset Management, the Australian based international equity behemoths. Looking at Magellan first, they’ve decided to increase the cash weighting in their global equity strategy, from 10% to 15% of assets. They are clearly cautious on what the next few months will hold for equity markets, citing further “compression in risk premia’ (i.e. asset prices have continued to rise)”.

What I found most interesting regarding the article (titled “The Great Disagreement”), was the differing expectations between where the market thinks interest rates will by the end of 2017, vs. where the Fed thinks they’ll be.

As Magellan pointed out, the market is pricing in an interest rate of circa 1.7% by the end of 2017, whilst the Fed median forecast is for 3-3.25%. The Fed forecast is clearly more bullish on the US economy, as they are expecting interest rates to be almost double what the market is in the coming time period.

Magellan’s defensiveness is therefore partly out of a desire to hedge against a decline in equity markets, should the market start to expect higher rates than it currently does (which would dampen demand for equities, all other things being equal).

Whilst Magellan may be right, there is also the potential that even the market itself is being too optimistic, and that rates won’t even make it as high as 1.7%. As we saw this week, US GDP growth was practically non-existent in Q1 this year, with downgrades across the year now likely. Official (and I stress the word official) inflation is also largely non-existent, whilst there is still considerable slack in labour markets.

Add all that together and there’s a chance we don’t see the Fed raise rates at all until 2016, and even then it might be a case of ‘one and done’, with a hike to just 0.50%, then another prolonged period of holding rates steady, hoping markets don't react too violently.

The Magellan article is worth reading for those with 10 minutes to spare.

Whilst Magellan were warning of risks incumbent in markets pricing in tighter monetary policy compared to what they expect now, Albert Edwards warned of low growth and official inflation, leading to more quantitative easing – EVERYWHERE

Whilst he spent the majority of the time focusing on Japan, and why they will ‘win’ the currency war, it’s his second last paragraph worth focusing on, particularly the comment on the inventory build in the USA. Edwards noted, “The Q1 US GDP data was a major disappointment to the market as business investment declined due to the intensifying US profits recession. Only the biggest inventory build in history stopped the economy subsiding into a recessionary quagmire. The US economy is struggling and the Fed will ultimately re-engage the QE spigot. Talk is growing that China will soon be doing the same as local authorities struggle to issue debt.”

Edwards article can be read here via Macrobusiness

Are Central Banks “Odd Lotters”?

Gold market aficionados are well aware that central banks became net gold buyers in the aftermath of the GFC, reversing a circa 20 year trend that saw the divestment of thousands of tonnes of gold reserves from official sector holdings.

The impact of this change is still hotly debated. Logic suggests that a group of market players switching from net sellers to net buyers of the metal should be supportive of higher prices.

The alternative argument to this of course is that central banks are terrible market timers, and their arrival as net buyers should naturally coincide with a market top. Essentially, the argument is that central banks are the ‘dumb money’, chasing markets only after they’ve run too high.

Proponents of this theory often point to the ‘Brown bottom’ in the gold market, named after Gordon Brown, then chancellor of the exchequer in the United Kingdom, who famously sold a large portion of Britain’s gold reserve at almost the exact bottom in the market some 15 years ago.

Didn’t stop him becoming Prime Minister, though that is a whole other story. The ‘central banks are a contrary indicator argument’ was put forward in another article I saw this week, titled “Gold Buying: Why Central Banks are the Ultimate “Odd Lotters.”

You can read the article in full here if you are interested.

For reference, “Odd Lotters” are referred to in the article as people who “live in some place called the Hinterlands and everything they do is wrong. They buy when the smart people sell, and sell when the smart people buy; and they panic at exactly the wrong time."

The article then goes on to state that the central banks of the world are todays “Odd Lotters”, and that their activities in the gold market are evidence of this.

To ‘validate’ the theory, the author includes the following chart, which shows central bank selling up until the end of 2008, then net buying in the years that have followed.

As the graph indicates, the author believes that when central banks turn to trend following, it signals the end of the trend. The author then goes on to state that as long as central banks are buying, there will be no major bottom in the gold market.

Whilst the author is obviously entitled to his opinion, there are a couple of comments worth making. The first is that there is no proven observable correlation, either positive or negative, between central bank activity in the gold market and the movement of gold prices.

Indeed, as I am certain the author knows full well, central banks were net sellers of gold from the mid 80’s all the way through to the onset of the GFC. If they are a definite contrary indicator, then the bull market in gold should be a 30 year old mature adult today, not a 15 year adolescent going through some growing pains. But that is not the case, as gold in fact halved in the 15 year period from the mid 80’s to the turn of the century whilst central banks were selling.

As such, whilst you can make the case that central banks are a contrary indicator using the evidence the author of the article does, you can also make the case that central bank activity perfectly aligns with price movements in the gold market, using the period from 1985 through to 2000 to ‘validate your case’.

Another point worth considering in this argument re central bank activity is this. If they really are ‘odd lotters’, or ‘dumb money’, then heaven help the bond market, which they are investing trillions of dollars into, printing the money required to do so.

For mine, I’ll stick with the logical argument. The fact that central banks are net buyers today provides some support to the precious metal market, though I don’t think it’s the ‘hyper-bullish catalyst’ some claim it will be. I also think rising pro-cyclical demand from China, India and the Middle East will provide a continued support for the market, a source of buying that was largely absent from the last bull-market of the 1970s.

But the big money will be made once mainstream investors in the world develop more fully appreciate, and ‘price in’ the fact there will be no easy recovery from the unresolved challenges the GFC exposed several years ago. When that happens, it will be painstakingly clear that equities and fixed income are exposed to a number of risks, whilst cash itself will be no safe haven.

Getting ahead of that trend by investing in precious metals today still seems the most prudent course of action. That’s in line with what Magellan are doing, it’s just a different form (and far more successful over the long run) of money you’re putting into your portfolio if you stick with the shiny, non-fiat kind.

Until next week

Disclaimer

This publication is for education purposes only and should not be considered either general of 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, 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. This report was produced in conjunction with ABC Bullion NSW.