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Metals Soft as China and Greece Make Waves

10 July 2015

Precious metal markets have eased this week, despite extreme uncertainty in world markets caused by the latest drama in both Greece and China. Whilst many would have expected ‘safe haven’ demand to push metal prices higher in the face of a plunging Chinese stock market and a potential ‘Grexit’, we actually saw gold re-test the USD $1150oz mark, whilst silver fell below USD $15oz at one point.

We’ve since seen a minor recovery in the metal market, with gold currently sitting at USD $1160oz, whilst silver has moved back toward USD $15.50oz.

For local investors, we’ve actually seen an uptick in the market, as weakness in the AUD has seen the gold price head above $1550AUD, whilst silver has effectively been flat.

When it comes to Greece, despite voting NO in the referendum, there is still clearly no ‘solution’ in place, with it beyond doubt the country will need some kind of debt relief, which effectively means asset write offs for whoever owns that debt.

On that score, Eurocrats will be less worried today than what they were a few years ago when Greece first hit the headlines, as a lot of that debt has been transferred from private sector banks onto the backs of the taxpayer, who ultimately stand behind the various bailout mechanisms the ECB and the like have cooked up.

The broader issue therefore is not so much about financial contagion anymore (which is not to say that’s not an issue), but the politics of this whole process, as ‘debt forgiveness’ for Greece will inevitably lead to other nations asking for the same treatment. Furthermore, the truth that dare not speak its name is the reality that the entire western developed world has (to varying degrees) got the Greek disease, with unpayable sovereign debt hardly limited to our Hellenic cousins.

One final complication with the whole Greek drama is the geopolitical implications of a potential Grexit. As John Browne, writing for Euro Pacific Capital in mid June this year so aptly put it; “Despite Greece's almost complete lack of financial integrity, neither NATO nor the EU can afford the political cost of a Greek exit from the EU.”

You can read Browne’s note in full here

Browne went on to note that should Greece and the EU not reach a deal, then “Greece will likely go searching for other sources of funding. It may find many willing givers, all with strings attached. Russia may offer funding to Greece in return for a naval base. If not Russia, even China might attempt to offer a vast, soft funding rescue package in order to buy entry to the European and NATO landmass. It is no secret that China has a strong interest in taking over operations of the Port of Piraeus, one of the largest ports in the Mediterranean.”

In short, watch this space, as this Greek tragedy has a few more chapters in it.

In China, what has been arguably more remarkable than the stock market sell off itself (which was always going to happen), is the reaction of authorities, and their desperate attempts to provide support. This week we’ve seen

• July 4: 21 brokerages, led by Citic Securities, say they will invest $19.3 billion in a new blue-chip fund to stabilize the market, and vow not to sell any of their own proprietary equity holdings.

• July 5: 28 firms planning IPOs on the Shanghai and Shenzhen market say they will postpone them and start refunding investors’ capital.

• July 5: China’s central bank says it will inject an undisclosed amount of capital into China Securities Finance Corp (CSF)., a state-owned company that makes margin loans to brokers.

• July 6: Executives from mutual funds pledge to support the markets with their own capital.

• July 8: Regulators banned company shareholders with stakes of more than 5% from selling for the next six months. China’s central bank said it would further support the margin lending provider CSF through interbank lending, bond issuance, and collateral backed financing and re-lending. China’s securities regulator also said it would increase purchases of small-cap stocks.

• July 9: China’s banking regulator, the CBRC, said banks can now loan money to companies using stock as collateral, and ease margin requirements for wealth management customers.

Source: Quartz

In the last 24 hours it seems to be ‘working’, with the Chinese market opening up in the green today. We expect that to be very short lived, and whilst we think long-term Chinese stocks will be a great buy – we’d avoid them like the plague right now.

Not surprisingly, with all this volatility, attention of the markets has overwhelmingly been on both China and Greece this past week, with round the clock coverage.

We’ve noticed it personally, not only through our interactions with our direct clients at ABC Bullion, but also the media, with invitations to discuss our thoughts on the latest developments in both countries on Channel Ten and the ABC, as well as other print media and radio.

As we discussed via those mediums – our view is that Greece is still unlikely to leave the Eurozone, and that, from an Australian perspective, what is happening in China is the more relevant event. And on that note, whilst we see a major slowdown in Chinese growth eventuating, and even lower prices for our key commodity exports, we don’t see the Chinese stock bubble in and of itself as a major problem for the average Chinese citizen.

The reason we don’t believe it’s a major issue (which is not to say it’s not a problem for those unfortunate enough to leverage in near the top of the market) is that the average Chinese citizen has minimal wealth tied up in the stock market, as this chart from HSBC indicates.

HSBC

As you can see, the average Chinese citizen still has over 60% of their wealth in cash and deposits, though this number is down from nearly 80% back in 2008. Circa 15% maximum is in stocks today, with some other money in bonds, and of course we know precious metal investment has also soared there in the last decade.

As such, we see what’s happening in the Chinese stock market as more akin to the NASDAQ bubble that engulfed western investors over 15 years ago. The real risk to the Chinese (and Australian economy) is a property bubble and bust, for that goes to the heart of most household balance sheets.

The scarier news for Australia re what is happening in China right now is the iron ore price, which has crashed in the past few weeks, at one point hitting $44.59 a tonne (Qingdao), whilst 12m swap fell to $41.50. These numbers are way below the Australian governments own forecasts (which they’d revised down), which effectively had iron ore sitting at $54.

The bottom line to this is that national income and tax receipts are going to take a bigger hit than forecast, which either ups our debt levels or will require spending cuts or tax increases elsewhere.

Either way, it’s not good news for the Australian economy, and portends lower cash rates and a lower AUD for years to come. Both of those likely outcomes support maintaining core positions in physical bullion.

On that note, alongside my colleague John Feeney, lets get technical.

A Technical Look at the Gold Market

The chart for US gold is somewhat weak, with a final major sell off to end this cyclical bear market still possible in the months ahead. Whilst we think the market has held up OK this week, many watching the gold market will be discouraged that it hasn’t responded to the crisis in Greece and China more. Many of these people will now be expecting a drop to around the $1,080 US mark where next support is.

We’ve mentioned over the past few months on the Investor Centre section of the website that we may continue to see weakness in US dollar gold short-term, but expect Aussie dollar gold to perform quite well. This is indeed what has happened of late.

If we take a look at some technical indicators on the US gold and Aussie dollar charts, the indicators seem to agree with this. It’s a guessing game as to where the US gold price will finally bottom, with next major support shown in the charts at $1,082. The moving averages are still in a bearish alignment, MACD and RSI are neutral, though the Williams % oscillator is closer to signaling a buy sign than a sell sign, which might see a short term rally.

Gold

The more interesting chart of late has been the AUD chart. A few weeks ago we mentioned there is a good chance of the Aussie breaking south of major support at USD 0.75 cents and indeed it has done so.

Latest weakness in China and the collapsing iron ore price, plus tepid consumer and business confidence could see further pressure on the currency, as the market more fully prices in the RBA’s next rate cut, which we see at least one more of before Christmas at a minimum.

The AUD got as low as 0.737 on Tuesday and you can see on the charts we have a fair way south before next major support around 0.713 US cents. We’ve circled the MACD momentum indicator as it’s looking to signal a sell sign very soon.

AUD

Potential weakness in the AUD is why we still believe now is a good time to be accumulating physical gold and silver, as we expect any final wash out in precious metal prices themselves buffered by a fall in the currency.

As such, we’re still happy with our call that it’s unlikely gold in AUD will fall below $1400oz

We also think it’s worth mention that the Chinese stock market volatility of the past week, rather than supporting gold as most people would expect, may actually have contributed to the weakness in prices, as some gold selling will undoubtedly have been linked to those receiving margin calls on their equity positions.

A snap back rally in the metals can’t be ruled out. Giving further encouragement to that line of thinking is the current speculative positioning in the gold market, with short bets on gold (bets that prices will fall) at their highest level in years.

The following chart, which I saw in an update from Greg Canavan at Sound Money Sound Investments highlights this neatly, with record shorts highlighted in the yellow circle.

Shorts

According to Saxo Bank, which complied the data, the net long position is the lowest since October 2006. As Greg pointed out in his update, given the recent price action, the net long position is likely to be even smaller now compared to where it was on the 30th June 2015, with the outlook towards precious metals arguably as pessimistic now as it was at the turn of the century, when gold was nearly USD $1000oz lower than it is today.

PIMCO Says Buy Gold

Actually PIMCO didn’t really say that. But Rob Mead, the Australian head of portfolio management for the $1.6 Trillion global investment manager, sure did help make a case for including gold in a portfolio, when he penned an excellent note titled: “Kitchen closed for Australian depositors”, which you can read here.

In this note, Mead stated that; “Since the global financial crisis, Australian investors have earned very healthy real returns of about 2 per cent to 4 per cent for taking essentially no risk by holding term deposits. This kitchen is now closed -- permanently. This is a massive adjustment.”

Mead went on to note that investors need to recognise at least four things going forward

1. Explicitly acknowledge that the real risk-free rate of return is now negative

2. Be mindful of additional risk in instruments used for income generation

3. Focus more on expected capital price volatility of portfolio holdings

4. Ensure there is sufficient risk-factor and geographic diversification in portfolios

Personally, I couldn’t agree with these statements more, and all of them are supportive of including physical bullion in a portfolio. The fact that the real risk free rate on cash will be negative supports the notion investors should minimise cash holdings and hold a non-FIAT currency alternative, of which gold remains the number one choice.

The argument behind holding gold is boosted by the final three points Mead makes, as those mindful of concentrating too much risk in the chase for yield would benefit from holding a zero interest non-financial assets like bullion.

As gold is uncorrelated to equity markets, especially in periods where stocks decline, it will also help balance overall portfolio volatility, providing superior risk adjusted returns.

For those interested in what PIMCO have written about gold specifically in the past, we highly recommend the following read, “Demystifying Gold Prices”, which looks at the performance of bullion and its correlation to real yields.

But no one else is talking about Gold

Despite PIMCO writing about gold in the past, and despite their recent warnings of the challenging outlook that investors face, gold is still very much out of sight and mind for the average investor and asset manager.

One of the enduring challenges that gold market participants have is actually having gold recognised as a viable investment option, alongside more traditional assets.

This is an area of particular focus for ABC Bullion, and for myself personally, who’ve always taken the view that gold should compliment and be part of a well diversified portfolio, rather than seen as an investment you hold because you are ‘anti-stocks’, ‘anti-bonds’ or ‘anti-cash’.

We were reminded of the challenge again this week when we read Russell Investments 2015 Long Term Investing Report. It’s a worthy read, and can be found here for those interested in taking a look.

Our major disappointment with the report was that it does not mention gold even once, despite the fact that gold in AUD was up 9% in 2014, and has returned over 10% per annum for the past decade, outperforming every other asset class the report does mention.

This is not to take a dig at Russell Investments – as this is something that is standard across a large number of asset managers, research houses and the like. Chant West for example, who produce excellent reports looking at the returns on some of the largest superannuation funds in Australia, across a range of risk profiles and asset classes, also don’t include the return on gold in their regular updates.

One the one hand – the fact gold is still continually overlooked as an investment in and of its own right is somewhat frustrating, but there is also a silver lining to it. And that silver lining is that the lack of attention paid to bullion is a sure sign of how much further upside remains in the physical bullion market.

When it really does become time to sell, or at least lighten holdings, we’re certain the gold market will not be ignored.

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.

JE