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Gold Tests Positive for Vaccine Euphoria

27 November 2020

Precious Metals Commentary

Gold broke down past previous lows and rapidly tested the 38.20 Fibonacci support level for before breaking down further to test key support at the 200 day Moving Average, which has held so far.

The drivers for this drop in price included continuing euphoria created by positive news on vaccines and – finally – what looks like a resolution to the US Presidential election outcome, where the incumbent has lost over thirty legal challenges so far. Expectations for a Biden presidency include marginally higher fiscal relief, as pushed for by the Federal Reserve, although we caution that without control of the Senate, fiscal policy will be moderated by the likely Republican majority. (The possibility that the Georgia run-off results in more Senatorial gains for the Democrats is a not out of the question, but repeated modelling suggest that Republican David Perdue will win the contest 57 times out of a 100…)
Additionally, US Flash Manufacturing PMI data was positive, at 56.70 as against an expected 52.50. German and UK Flash manufacturing and Services PMI also came in ahead of expectations, feeding the narrative that economies are improving and that the worst is behind them.
There are severe caveats to this optimistic view.  Firstly, Coronavirus cases rage out of control in the United States, with 264,000 deaths and almost 13 million cases. This is likely to feed through into slower growth in H1 in the world’s largest economy. Although US Jobs data show that the economy has regained 54 % of the 22 million jobs lost between February and April of this year, the pace of progress has slowed considerably, according to JP Morgan Asset Management.
Although earnings growth has been ahead of admittedly extremely pessimistic estimates, the likely impact of coronavirus on earnings is negative, and given the post-election bounce in equities, that may leave valuations looking very stretched going into 2021, which may make the recent rotation away from gold look overdone.
Also interacting with the above is the recent decision by US Secretary of the Treasury, Steve Mnuchin, to terminate around 455 billion US$ of funds set aside, principally under the CARES Act to support business and employment. This risks a ‘fiscal cliff’ that removes support for businesses from January the 1st onwards and coupled with the spread of Coronavirus cases discussed above, has the potential to cause serious harm to the recovery.  The outward reason for this decision is the sense that  it is ‘mission accomplished’ in terms of economic support, but that does not really square with the facts.

Additionally, the tremendous and well-signalled monetary and fiscal stimulus may feed into an inflation jolt as supply chains remain tight and more companies explore ‘onshoring’ to de-risk those supply chains. Given that the Fed and other leading Central banks would be less aggressive in controlling inflation initially, this suggests that short to medium term real yields would remain lower or indeed lower, and this would benefit gold and other hard assets.
(This does assume that inflation doesn’t rise so quickly that there is a sudden re-appraisal of bond valuations in general, as that could make markets take fright, with volatility surging and gold going in three directions at once in the initial phase.)

Overview of gold ETF flows
Significant outflows have taken place as investors look elsewhere for return..

What of silver?

Silver is still trading in ‘gold’ mode at the moment, rather than ‘copper’ or industrial mode. In other words, we don’t see evidence of silver picking up a bullish cue from a post-vaccine world, unlike other industrial metals or Brent. That could yet happen, as silver can be bi-polar in the nicest sense of the word, choosing a narrative that can be quite sticky with investors deciding that silver is ‘high beta gold’ or ‘white copper’. For now, its still high beta gold.
Although silver took a violent dip below the 38.20 % Fibonacci retracement of the March – August move in late September, the market closed more or less art that level (around US$22.91) therefore we think this retracement still has importance, and that is where silver made a low so far on this week’s decline.

The RBA and the AUD

The Australian Dollar continues to perform, supported by a recovery in China, continued demand for Australian commodities and subdued demand for imports. The cloud on the horizon may be the impact of the RBA’s Quantitative Easing program. RBA Deputy Governor Guy Debelle stated that the RBA is wary of removing monetary stimulus ‘too early’, a lesson learned from observing policy decisions in other countries post-GFC, so expect cautious and a long-term commitment to monetary stimulus from the RBA.
Targets for the AUD are for strengthening to go to 0.7530-0.7540, before the currency engages with a long-term downtrend resistance area, where it is possible to envisage the AUD cycling lower again.  

The USD (via the US Dollar Index Chart, DXY)

The USD weakened this year, that much we know, but the reality is that the Dollar Index is still hanging on to a very persistent uptrend despite the weakness seen so far. Could this all end soon? Economists and currency forecasters say ‘yes’ – the twin deficits and the inability of the Fed to defend the Dollar, should it wish to of course, spell Dollar weakness in 2021.
Looking at the monthly chart of the DXY, you can see that the index is hitting support at the base of the monthly chart and the trend line which extends back to 2011, almost a decade ago.
What is notable is that the Dollar, which held every intrusion below the Monthly cloud bar a month or two in mid-2014, is right on that support level. A break below 91.78 could open the door to a move lower.
The counter argument – a thin one – is that currency forecasters have it wrong and that having hit the 92.176 target the Dollar Index rebounds higher. It did do that initially but quickly sagged again in a downvote on the US economy in 2021.