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Peddling Stimulus Poison

25 September 2020

Precious Metals Commentary

A big week for precious metals with gold failing to hold a key technical level and a sharp correction to US$1,866. Silver longs bailed in a hurry after silver failed to hold $26.00, with many stop losses likely exacerbating the sell-off down to $23.20 at time of writing. In USD terms gold is 4% lower than this time last week with silver down 13% for the week.

Those wondering why should note that the metals had done a lot since the March lows, so profit taking on the back of some short-term USD strength was enough to give us the correction. We were not surprised to see this take place, as we noted in last week’s market update that one possible catalyst for a pullback in the metals next week is the chance of a relief rally in the US Dollar, as we can see the USD is oversold and looks at risk of a bounce higher next week.”

For some areas of support in the short term, we have the 61.8% retracement of the recent June-August move sitting at $1,826 for gold.
US gold price chart
Silver remains above trendline support for now after recovering from the oversold lows of $21.65.
US silver price chart
On a more longer-term perspective, both metals remain +20% year to date, so we see this as a healthy correction from short-term overbought levels in August, where the market may have gotten a bit ahead of itself to say the least.

We note overnight that metals analysts seem to be converging on a view that this correction does not invalidate the bull market, saying that “gold and silver prices are now oversold” (Commerzbank), “silver’s seven years of bad luck is over” (Bloomberg Intelligence) and “current pullback is unlikely to turn into a rout” (TD Securities).

Aussie Dollar Effect

When gold is being driven in large part due to US dollar moves, as it is currently, there is often a corresponding effect on our exchange rate which helps mute price changes. A strong US dollar means a weak gold price but also a weak Aussie dollar – and a lower Aussie pushes up AUD gold, everything else being equal.

So for Australian investors the sell-off was mitigated with gold in AUD trading slightly lower at $2,640. Since AUD gold’s peak at $2873.68 on 6th August, it is down 8.1% compared to a 10.1% drop for USD gold.

While 8.1% may seem like a big drop in the space of 50 days, it is not out of the ordinary for a market to experience corrections within an overall bull market.

In the case of the last gold bull market, there were a number a plus 10% corrections in short periods of time. Below we chart the Australian gold price during the 2000s with the major short-term corrections marked.
AUD gold price chart 2000s
As you can see, brutal corrections of 10% to 20% were not uncommon during the last bull market with an overall gain of 374%. Interestingly, the average duration of the seven corrections marked on the chart is 50 days – the same as our current correction from the $2873 high.

Our view is that the precious metals are having the breather they need in order to form the next base to rally off, and we would say dollar-cost-averaging into the metals remains our preferred approach, with further AUD weakness having a high probability from here.

Speaking of AUD weakness, anyone who thought rates couldn’t get any lower than 0.25% may get a surprise in the near future with RBA deputy governor Guy Belle saying more rate cuts aren’t completely out of the question: Given the outlook for inflation and employment is not consistent with the Bank's objectives over the period ahead, the Board continues to assess other policy options”.

Of those options the obvious one would be some home-grown Aussie QE, and another would be to take the plunge into negative interest rate policy.

We not only consider this a possibility, but a certainty, as the flawed economic policies of central banks for the last 20 years has created an area of no return. Central Banks cannot normalise rates without a complete collapse, so their next ‘solution’ will be to experiment with negative interest rate policy to prevent the overly indebted system of grinding to a halt.

Responding to the RBA’s words, Westpac’s chief economist is calling for an October cut to the cash rate of 15 basis points, down to 0.10% statingthe prospect of the RBA “sitting back” to assess the Budget, which has been seen as the “norm” in previous years, is not appropriate for these unique times.” If we know the inevitable is coming, they may as well get it over with and throw down negative -0.25%. At least they’d be seen as heroes by their bureaucratic peers.

Stimulus Is Actually Poison

Chris Leithner, from the Australian private wealth manager Leithner & Company, says that lower (or negative) rates and other so-called “stimulus” measures are at best just short-term “sugar hits” that in the long-term are actually poison to an economy (and central bankers are the peddlers of it).

He says that rates which are divorced from reality result in more sub-standard business projects being entered into and drags forward future consumption. However, when the lower future activity that their previous policy has induced arrives, central banks have to do another round of “stimulus” to keep the game going. These repeated rounds of stimulus create “sky-high and rising debt, implausibly expensive stocks, real estate”.

To pay for all the stimulus a government’s only options are taxation, borrowing or inflation, thus begetting “some combination of higher taxes, bigger debts and deficits and an even more inflated supply of money”.

Shane Oliver, from AMP Capital, projects the Federal Government’s budget deficit to peak at around 12% of GDP, which as you can see from the chart below is similar to what was experienced in World War 1.
Australian budget deficit chart
That will result in Federal gross public debt peaking at 70% around 2032.
Australian overnment debt chart
Shane does not think that this will necessarily cause a problem, noting that our post-World War 2 debt as a percentage of GDP fell by Australia growing and inflating its way out of the debt burden. While growth is not an option this time, Shane think that we will be OK because:
  1. Our debt level is low relative to other countries like Japan and the US who are over 100% of GDP and they haven’t had a major problem
  2. Our net public debt will also be low relative to other countries
  3. Interest rates significantly lower than the post-war period so our debt in GDP terms should fall faster
  4. Australia borrows in Australian dollars and is not dependent on foreign creditors
We, however, are not encouraged by these arguments. The first two are just “best house in worst neighbourhood” and we would just say that they have not had a major problem – yet.

As to the third, yes this will help the government but at the expense of investors who earn nothing on their savings and are forced into risker investments to earn a return, as well as at the expense of our long-term productivity as sub-standard business continue to operate per Chris Leithner’s point.

On the fourth, we note that half of Australian banks funding is from offshore bonds. How long will they be willing to lend to us in Aussie dollars at close to zero return?

We find ourselves agreeing with Jerome Lander from Australian private wealth advisor and fund manager Lucerne Investment Partners who said that “we are in the biggest bubble of all time” due to the expectation that rates will go lower and more stimulus will be provided.

His response – reduce exposure to the market and look for “idiosyncratic returns, more active management and other things which clearly have a much better chance of being protective or going up if things are adverse, such as gold”.

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, or call us during trading hours on 1300 361 261.

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