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Mother of All Melt Ups

17 July 2020

Precious Metals Commentary

Gold continued the battle for the US$1,800 level this week which seems an area of resistance for now. Silver had a breakout above the US$19.00 per ounce level, trading as high as $19.47 before pulling back.

Some US dollar weakness this week sees the AUD over 70c leaving gold for local investors relatively flat and silver higher than this time last week.

Silver is starting to outperform gold, and many will see the US$20 mark as a significant point to breach. The ratio dropped back to its lowest point since February this year at 93:1 and we continue to see very strong demand for the metal by those perhaps betting the actions of central banks will eventually become inflationary (more on that below).

After such a sharp rally we would not be surprised to see a bit of profit taking above $19.00, so the potential for silver to take a bit of a breather in the short term would be high in our opinion. Overall, our call that the $11.50 COVID sell off ws a significant multi-year bottom in the silver market are so far looking good.

silver price chart

The Federal reserve this week bought $22.7 billion in mortgage-backed securities and sold none, up a mere billion from last week’s $21.6 billion. So QE-4ever remains in full swing as the Fed’s balance sheet just tipped over $7 trillion.

With the Fed dishing out the liquidity, the madness in equity markets continued from their bubbly highs of the past few weeks. For anyone wondering why it is that the US economy is grappling with the biggest economic challenge since the great depression and yet we have equity markets marching higher, consider the type of investors that are piling in and you might get an answer.

Retail Rookies

The number of retail trading accounts that have opened since the COVID lockdowns in the US has skyrocketed. Trading platform Robinhood which makes ‘investing’ with ridiculous amounts of leverage easy and simple for first timers, has seen retail trading accounts jump from 4 million to 12 million since the lockdowns took place. Trading platform Charles Schwab reported today that new retail brokerage accounts jumped 1.65 million in the second quarter, which is more than 4 times last year’s 386,000 figure, and daily trading activity rose 126% from a year ago.

It could be a case of bored millennials taking up stock punting for the first time whilst being locked at home, or a general consensus that the Fed will do whatever it takes to keep the equity market afloat (or perhaps a combination of the two).

number of robinhood traders versus S&P 500

Similar to the Crypto Bubble peak in 2018, the explosion in retail trading accounts coincides with a huge run up in the most speculative of US listed companies. The types of stocks that are benefitting the most, and therefore at the highest risk of a spectacular crash, are the ones that appeal to the younger millennial investors that wouldn’t even consider looking at a market cap or traditional valuation metric such as a P/E ratio. Tesla is the new Ethereum.

tesla chart

And this is not just a US markets phenomenon, with this Twitter thread noting that the Davey Day Trader/Robinhood craze is a global mania, spanning Russia, Korea, China and Europe to name a few.

For a new acronym of the week, Ed Yardeni, the president of Yardeni Research calls it ‘’M.A.M.U’ - the Mother of All Melt Ups. In a recent podcast from Grant’s Current Yield, Yardeni describes the situation being primarily driven by the Federal Reserve giving the impression to investors that stocks can only go higher as long as the Fed is there to turn on liquidity taps.

grants current yield podcast

Quite a dangerous period to navigate when you consider the appetite for risk is literally peaking at a time where the overall economy is in the most ‘tumultuous period since the Great Depression’.

Surely it cannot end well.

Financial Repression

Russell Napier, of The Solid Ground investment report, is a high-profile market strategist who has been in the disinflation camp for many years.

He has recently switched to a view that inflation will return over the next decade. Of itself this isn’t news as we have noticed many commentators seeing inflation in our future given the money printing central banks have been busy with.

But what drew our attention was Russell’s belief that we will see 4% inflation in the US and most of the developed world by 2021, which is quite a move in such a short time. Over the next 10 years he is looking for between 4 and 8% inflation.

More concerning is his observation that governments will force interest rates well below these high inflation rates as that is the only way to shrink our currently excessive government (and corporate and personal) debt levels.

Russell says that “control of money supply has moved from central bankers to politicians. Politicians have different goals and incentives than central bankers”.

Interest rates below inflation (negative real rates) fuels gold buying as investors look for protection. Russell also sees capital controls like restrictions on moving money out of the country and super funds being forced to buy government bonds at low interest rates.

Together these measures are called “financial repression” and were identified way back in 2015 by the International Monetary Fund as a likely “toolkit deployed to cope with the most recent surge in public debt in advanced economies”.

Younger investors may consider us indulging in a bit of doom and gloom but those with a few grey hairs will remember the 1970s and know that this has occured before. As Russell notes, financial repression type policies were “all in place for an emergency called World War II. And most countries just didn’t lift them until the 1980s”.

If you want some real doom and gloom we would point out the risk that high-ish inflation along with low interest rates can easily tip into hyper-inflation if confidence is lost in the ability of money to retain its value.

It is a common misperception that hyperinflation is due to money printing. In the initial stages money printing propels mild inflation but a tipping point can be reached where the relationship changes with falling confidence in money causing people to want to get rid of it in exchange for real assets (like gold).

This “hot potato” effect, causing the velocity of money to accelerate, in conjunction with governments printing money to pay for their (inflation driven) increasing costs becomes the force behind hyperinflation.

As Hugh Hendry, global macro hedge fund manager who foresaw the birth of the gold bull market and profited from 2008 GFC, says in his recent The Dawn Of Chaos report: “it’s the mood of society that ultimately unleashes the inflationary genie from the bottle”.

But don’t worry. Former chair of the Federal Reserve, Janet Yellen, said in this interview that while “sometimes central banks lose their independence when the government decides they’ve really got problems” and can be forced to hold interest rates low and buy government debt, resulting in very high or hyperinflation, “I don’t think that’s going to happen in the US”.

It is no surprise that Russell says “gold is obviously a go-to asset for the long term” for investors looking to protect themselves for a future he calls “a very dangerous place for savers”.

Likewise, Hugh is “long gold, I'd be long equities, and I would be long FX volatility... the Saudi peg's not gonna last, Hong Kong's peg's not gonna last...because the world is gonna change”.

When we see an article in the UK Financial Times blog by mainstream portfolio managers arguing that inflation is about to make an unexpected comeback and recommending purchasing commodities and gold in particular, we’d say that is a sign the mood is changing.

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.