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Look Very Closely at Silver

09 April 2020

Precious Metals Commentary

The recent volatile trading range for gold has tightened this week with spreads on platforms returning to some level of normality. Gold advanced to USD$1,648 this week on US dollar weakness. Silver is currently battling with the USD$15.00 per ounce level after adding around 7% from the start of the week and is quickly becoming our pick moving forward, so a lot more detail on that coming later in the update.

The recent dead cat bounce (or bear market rally) in the S&P500 continued this week. Since Monday, US equities have popped over 10% higher on a combination of short covering, a more optimistic view of the COVID situation in the US, and the stimulus to come. The USD index retreated, putting the AUD back above 62c seeing gold for local investors pull back to $2,648 and Silver $24.25.

Gold looks like it remains in this upward trend for now after breaking out of the recent range. All moving averages remain in a bullish alignment with the next big test to be clearing the recent highs above USD$1,700.

Gold in US dollars

Stressed out and Scared

With many countries in lockdown or “essential” only activity, the economic cost mounts, with the OECD estimating a 20-25% fall in real GDP across advanced economies.

In the US, initial jobless claims rose by more than 10 million in two weeks and requests to delay mortgage payments have skyrocketed in the first week of April from 200,000 requests to more than 700,000 according to the Mortgage Bankers Association, resulting in 2.66% of loans now in “forbearance”.

Not surprisingly, renters are also feeling the stress with the US National Multifamily Housing Council reporting that only 69 percent of households had paid their rent by 5th April. There is now a website called Rent Strike 2020 where 1.5 million renters have signed on to withhold rent as activists urged renters facing hardship to prioritize basic needs.

In Australia, Westpac expects the Australian economy to contract by 8.5% in the June quarter. Martin North of Digital Finance Analytics says that mortgage stress has risen significantly with another 200,000 households falling into stress since February.

Mortgage Stress Trends in Australia
SEEK reported a 65.3% fall in new job ads in the first week of April compared to the same week last year. NAB is forecasting unemployment to reach 12% by mid-year whereas Westpac see 9% but they note that without the JobKeepers Payment the unemployment rate would have reached 17% in the June quarter.

The cost of that $1500 per fortnight per employee (which you still have to pay tax on!) scheme is $130 billion, which along with the other measures results in total stimulus of around $200 billion, or 10% of Australia’s GDP.

On top of that is the RBA’s term loan facility, government loan guarantees for small business and asset purchases by the Australian Office of Financial Management, which could amount up to another $125 billion.

Taxpayers will, of course, be paying for this for years to come as Australia’s return to budget surplus goes bye-bye with Westpac forecasting a deficit of $100 billion in the year to June that blows out to $210 billion in 2020/21 – around 10.5% of GDP and Australia’s largest deficit since World War 2.

Those measures, however, are small fry compared to the response of the US with the Coronavirus Aid, Relief, and Economic Security Act (abbreviated to CARES – seems all Acts these days have to have a catchy name) more than doubling the stimulus act passed in 2009 during the Global Financial Crisis. The diagram below from Visual Capitalist shows where all that money will go.

CARES Act 2 trilion where the money is going
Even though the trend of new cases and deaths seems to be moderating, without widescale testing and contact tracing to isolate cases before the can inflects others, it is unlikely that the economy will be back to normal until a vaccine has been developed and manufactured and distributed in large volumes (estimated at least 12 to 18 months away).

Looking further ahead, the corona virus will leave scars. While many have made fun of the toilet paper shortage, continued empty shelves of key supermarket items does highlight a lack of buffer resources in the wider economy and at the household level.

It would not surprise us to see a permanent change in consumer behaviour with an increase in household savings by reducing personal and mortgage debt levels, bulking up of the pantry, and less spending on non-essential items.

Businesses could also look to rebalance debt to equity ratios and reassess global supply chains with more sourcing and manufacturing happening locally (which would be good for jobs).

The big scar will be public debt. It is not just the one-off impact of the stimulus measures but the risk that once governments see how easy it was (and accepted) to print that money they may well continue to do so at the hint of any future trouble.

With interest rates so low the perceived cost of the debt incurred appears low and encourages looking for any excuse to help the country (and their election chances) along. Ultimately that results in savers getting squeezed between higher inflation and central bank restricted interest rates. Such low or negative real (after inflation) interest rates is historically when gold and silver shine.

High Probability of Silver Going Exponential

The price action in silver has us licking our lips and feeling quite confident that the recent spanking from $18.50 to $11.50 in less than a month will mark a significant multi-year low for the silver market.

It is true that we have been bullish on silver throughout last year based on the ratio to gold, but despite this silver has continued to be an underperformer. Perhaps in the words of Bob Dylan “the slow one now, will later be fast” and we think there is a few key indicators that the silver market has made a very significant low that won’t be retested.

The ratio has been historically high for some time now, but in the last month the complete parabolic spike is something that is nothing short of remarkable and parabolic moves in any asset class are typically unsustainable. A 20-year chart of the ratio puts this into perspective below:

20 year gold silver ratio
Comparing the above ratio to a long-term chart below of the silver price in USD we can see the best and worst times to buy silver in recent years. Going back to December 2008, this was the last major low in the market and excellent buying opportunity with the ratio sitting at a very high 80:1. After the sharp rally and peak in 2011, the ratio bottomed out at 30.1 and theory goes, the lower the ratio the less likely it is for silver to outperform gold moving forward.

silver price peaks and bottoms
Silver investors in 2011 would have seen a 77% decline from the peak to the significant low last month at $11.50, which we think has a very high probability of being looked back on in a few years as one of the best buying opportunities not only in silver but any asset class for the next few years.

At the very recent $11.50 low the ratio peaked at 125:1, which is unheard of. The likelihood of silver outperforming gold is even better than the 2008 low in the market, so moving forward silver is our pick of all precious metals for the next 24 months.

In the short-run silver should get some support on the supply side with Mexico’s one-month shutdown expected to reduce newly mined silver supply (Mexico produces 23% of global silver), following similar lockdowns in South Africa, Peru, Argentina and Quebec.

The economic fundamentals for silver moving forward include both a recovery of industrial demand after the COVID crisis is over, and resurgence in investment demand as a result of inflation fears.

BMO Capital Markets sees a new role for silver in the decade to come with its “use in 5G and photovoltaic related technology will increasingly position it as an infrastructure commodity”.

We expect the actions of Central Banks to the COVID crisis to be inflationary in the future. We think silver could start being viewed as a monetary safe haven, like gold, and could see an influx of demand from investors looking for undervalued assets that maintain purchasing power. We are certainly seeing this demand in spades with physical silver having waiting times despite our refinery running at maximum capacity and overtime.

It will be very interesting to look back on this level of $11.50 and a 125:1 ratio in 12 to 24 months’ time to see we are correct in our call for the 2020 bottom in silver.

It is not just retail investors that see an opportunity in silver. Scott Minerd, chief investment officer for Guggenheim Global, when asked in this Bloomberg interview back in January for his what was his number one conviction trade said, to the surprise of the interviewers, silver. He said it had better relative value compared to gold as it was 65% off its highs and had a high probability of “going exponential”.

Scott Minerd silver conviction trade
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 comms@abcbullion.com.au, or call us during trading hours on 1300 361 261.

Disclaimer
This article has been prepared by Australian Bullion Company (NSW) Pty Limited (ABN 82 002 858 602) (ABC). The information contained in this article or internet related link (collectively, Document) is of a general nature and is provided for information purposes only. It is not intended to constitute advice, nor to influence any person in making a decision in relation to any precious metal or related product. To the extent that any advice is provided in this Document, it is general advice only and has been prepared without taking into account your objectives, financial situation or needs (your Personal Circumstances). Before acting on any such general advice, we recommend that you obtain professional advice and consider the appropriateness of the advice having regard to your Personal Circumstances. If the advice relates to the acquisition, or possible acquisition of any precious metal or related product, you should obtain independent professional advice before making any decision about whether to acquire it.

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