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Markets Awaken: US Stocks Crash 11%

28 February 2020

Precious Metals Commentary

Gold started the week with a bang, jumping on open to reach highs of USD$1,687 before levelling out at $1,640 at time of writing. The US stock market finally woke up and has been a sea of red for the entire week thus far, with the S&P 500 crashing 11.60% in less than a week. We commented over the past few weeks of the bizarre nature of the markets lack of reaction to coronavirus, and sure enough this week the market has finally awakened to the potential impact of the virus on global economic growth, as equity markets have been a complete bloodbath.

Last night alone saw a 1,200 point (4.4%) plunge in the Dow Jones Industrial Average with global markets set to continue the sell off today; ASX futures are trading down 3% before open. Daily moves of the past 24 hours in various equity markets can be seen below.
 
Dow Jones Industrial Average Chart
Those surprised at gold’s apparent lack of performance in retrospect should note that there are a few reasons why we think gold has held up well, all things considered. Given the incredibly sharp decline in the US stock market you will often have participants liquidating everything to come up with enough money for margin calls, including gold positions. Given the amount of leverage in the US stock market today, it is not surprising to see even gold pull back slightly.

Secondly, we can’t ignore the sharp rise we have had since February and the ‘length’ of the market as managed money remains extremely net-long. This adds to the risk of profit taking, as there are a huge amount of speculative longs that will be looking substantial gains and itching to lock in some profits. We will have some dips along the way, but we believe the gold market now has a different mentality and any decent sized dips will be met with strong buying.

Physical demand at ABC remains robust with 71% of all trading volume in 2020 so far being on the buy side, 29% of volume selling.   

Comparing other precious metals, silver fell back this week to USD$17.80, platinum fell sharply to $900, and palladium rose to $2,838 per ounce. Being more of a commodity and reliant on industrial demand, we saw silver suffering on the escalation of the coronavirus as around 18% of annual fabrication demand comes out of China. Silver has not experienced the safe haven demand that gold has over the past 18 months, which has pushed the GOLD:SILVER ratio to a very high 92.

The AUD/USD is ticking through some fresh lows at 65.6 US cents and in a falling knife scenario. Year to date, the AUD is down over 6%.

Back to equities and there are no surprises for us on the level of correction we have seen thus far. In a recent market update from February 7th, we commented on the frothy nature of the US stock market, with valuations at extremely high levels. This only adds to the potential downside when a black swan finally arrives to spook markets. We would argue that there are over 100 big names on the US stock market that could suffer a 50% correction and still look expensive.

Ultra easy monetary policy has pushed valuations to historical extremes and the market has been completely irrational in the past few years, with many companies priced for perfection. The past two days alone has seen $1.7 trillion wiped off the US stock market and many of the names we mentioned in that recent update have since crashed between 10-20%.

Last night there weren’t too many places to hide in US stocks with some notable names below.

US Stocks Chart 
As for gold targets, we noted last week that Citigroup expected gold to hit USD$1,700 in the next 12 months. This week, Goldman Sachs are also readjusting their forecasts, calling gold the "haven of last resort", with a 12 month target of USD$1,800 due to fears of COVID-19 and Bernie Sanders being US President.

Globally ETF demand has been off the charts with the total amount of gold held by exchange-traded funds reaching a record 2,625 tonnes ($210 billion worth) after 25 consecutive days of inflows.
 

Australian Economy Crashes on Corona

Over the past few weeks, we have been remarking that markets have been resilient and somewhat immune to any fears of coronavirus COVID-19.

US fund management firm MFS says that the “virus outbreak is simply a catalyst for the exposure of the misallocation of capital that happens in every late-cycle market” as investors shift their thinking and start looking beyond share buybacks and other return boosting strategies to “companies with truly durable earnings and cash flows”.

While we would agree with this “bug looking for a windscreen” view, the reality is that COVID-19 is currently (and will for months going forward) impacting the Australian economy.

A recent Roy Morgan survey had 15% of Australian businesses reporting that they were being affected by the virus, which comes on top of the bushfires that impacted on 28% of businesses.

The coronavirus has hit the education, manufacturing and wholesale industries hard. With China pretty much closed down, Australia is affected both in terms of imports as supply lines from China for parts and goods are halted and products delayed as well as on the export side where markets in China are closed.

With 33% of our exports going to China and the Chinese accounting for 38% of our foreign students and 15% of our tourists, Australia is one of the most China-reliant economies in the developed world.

No surprise then that the Australian dollar, used by institutional investors as a proxy for China, has sold off. Our dollar’s weakness has provided a boost for Australian gold and silver prices, demonstrating the hedging aspects of precious metals for local investors.

The education sector has been particularly hard hit, with ABC reporting that the University of Melbourne is “offering cash grants of $7,500 to help Chinese students get around the coronavirus travel ban and resume their studies”. This comes on top of the University of Western Sydney offering $1,500 and Adelaide University $5,000. That is what you do when 38% of your foreign students are Chinese.

University of Sydney has 15,000 Chinese visa holders locked out by Australia’s travel restrictions. This issue isn’t just that there will be a delay in when those students can start their studies - as Bloomberg notes, the “danger is Chinese parents will pull their children out of Australian institutions and instead send them to the U.K. or Canada, where the year begins in August or September” and Australian universities will lose a whole semester or degree of revenue.

One thing that does concern us in the ABC report is that the Australian travel restrictions don’t apply if someone has served a two-week quarantine period in a third country after leaving China. Note that does not mean actually in quarantine, just spending two weeks in another country that the Australian government currently says is not at risk.

With reports of the virus appearing in countries in clusters with no known direct link to China, and many countries just not testing, we are not reassured that the countries where these Chinese students have been staying do not have COVID-19 circulating.

While hardly being experts, we don’t feel comfortable that the “spent 14 days outside mainland China before flying to Australia” rule was or is sufficient to protect Australia, given what we now see with South Korea, Iran and Italy.

The US Centres for Disease Control warned Wednesday that they “expect we will see community spread in this country … not so much a question of if this will happen anymore but rather more a question of exactly when this will happen”. Australia also looks likely to face “community spread” as we seem to be following Philadelphia’s approach during the 1918 Spanish Flu (hat tip to Nucleus Wealth for the chart).

Spanish Flu Chart
It will be interesting to see what happens with consumer confidence this week with COVID-19 really hitting the headlines. ANZ-Roy Morgan Consumer Confidence posted a 0.7% last week and has been at these low levels for the past few months.

Low confidence doesn’t seem to have affected housing, with annual price growth running at over 7% p.a. nationally and the Westpac Housing Consumer Sentiment Index holding at near five year highs. Westpac say that affordability constraints are starting to show through as prices rise.

On the supply side, attached dwelling construction has fallen by 17% over an 18 month period.

Value of Building Work Chart
Overall construction activity fell by 3.0% in the last quarter of 2019, with sizeable falls in all states. With the construction sector representing around 13% of the economy, Westpac say that the 3% drop in work in the December quarter will have a material direct impact on the economy.
 

Cash Handouts

So how to deal with the economic impact of COVID-19? Seems like many are taking a page out of Kevin Rudd’s global financial crisis fighting $950 household cash handouts.

Hong Kong announced this week that any permanent resident aged 18 and above will each receive a cash handout of HK$10,000 (A$2,000) as part of a A$23 billion relief package. While some bloggers have called this “Helicopter Money” this isn’t strictly true as Hong Kong has a fiscal reserve of HK$1.1 trillion. The measure by Hong Kong isn’t unusual as they have done it three times in the past.

Macau, the world’s largest gambling hub with 41 casinos, has also been hit by COVID-19 and will be giving its residents A$420 million worth of vouchers via a card that would be valid for three months.

Singapore, which from what we read is very proactive on tracking all of its COVID-19 cases and transmission, will also be making one-off cash payments between $100 and $300.

As the economic impact builds in Australia, we would not be surprised to see the current government look back to Rudd’s cash handout. Even though only 40% of households reported spending their free GFC cash, it does have the advantage over other stimulus measures of having an immediate and direct impact compared to government spending plans.

As to how much, well we note that back in 2009, $950 would have bought you around 0.8 of an ounce, so to maintain equivalency in “real money”, we should look forward to $2,000 this time.

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 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.