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Slow and Steady Wins the Race

01 February 2019

Gold in USD terms has managed to crack through the $1,300 resistance level this week, trading at USD$1,320, with silver rallying up through USD$16.00 per ounce at time of writing.
This week saw a big jump in the AUD to 0.725c, so in local currency terms we trade close to $1,817 per ounce and $22.20 for silver. The moves came on the back of flip-flopping Fed chair Powell having an epiphany and deciding to keep rates on hold, stating ‘the case for raising rates has weakened somewhat’.
We’ve been stating the obvious for months now that there is too much debt built up in the US economy for the Fed to be able to raise interest rates and reduce their balance sheet without a disaster in either the equity markets or the broader economy. The usually more hawkish Fed chair may turn out to be just like the last few after all, as he stated the Fed will take a ‘patient’ approach to further hikes.
A ‘risk-on’ reaction followed the statements with the Dow up 1.7%, AUD/USD spiking 1.3% and gold rose 0.52%.
Gold US dollar chart
 Source: Kitco
So gold prices are ticking slowly and steadily towards all time highs in AUD, whilst Bitcoin and other cryptocurrencies are languishing around 52-week lows. So the get rich quick approach to buying assets that have run up over 1,000% gains in 12 months has turned out to be a failing strategy, but who would have guessed?
Bitcoin chart
The psychological urge to make money fast is the reason for the influx of mainstream investors into the crypto market, but often the slow and steady approach to investing wins in the long term. Many investors that lost a tonne of money in crypto last year probably didn’t even know what they were investing in, and mainstream media certainly didn’t help at all, embracing the bubble and legitimising it with few warnings to investors.
A recent podcast with economist and head of Euro Pacific Capital, Peter Schiff, covers this and more, in arguably one of the most entertaining podcast series in financial media, the “Quoth the Raven Podcast”, here. Well worth a listen.

Worst Since GFC

In other news this week, Australian business conditions and profitability collapsed at the end of 2018, tumbling by the most since the GFC. The NAB Business conditions index (see below) is showing a sharp fall to end the year in both business conditions and confidence that looks eerily similar to the 2007 move.
Price fall in September
Business Conditions Components
Conditions by state
Source: Business insider
The move is all the more concerning when considering the broad-based nature of the deterioration, occurring across all states and most sectors. The excessive housing debt and misallocation of resources into this one sector of the economy in recent years will weigh on growth moving forward, and it’s no mystery why Australian retail is plummeting when any disposable income is surely being put towards mortgages. Financial markets already see the prospect of a 25 basis point rate cut by the end of this year at around 60%.
Household debt/ disposable income 2018


Can Gold Go Even Higher?

Yes. Well, (jokes aside) the answer is a little more complex than that, but we will touch on a long-term perspective in light of gold’s recent stellar run, as many of those who tend to sit on the fence at times may be feeling like they’ve missed the boat.
Gold  price chart 
Despite the sharp rally since late last year, gold trades at only +24% above the lows of the last decade in US Dollar terms. So although gold is technically in a new bull market (>20% gains), it appears things are only just getting started.
The weekly gold price in the USD chart above zooms out to put the latest rally into perspective and we haven’t even broken out of the trading range of the last few years. We can feel comfortable now that the bear market from 2011 to 2015 is over and a new trend is developing, but as to how high gold can go – well, that depends.
What may be puzzling to gold perma-bulls (or ‘gold bugs’) is that since the all time high in USD terms in 2011, the M2 money supply in the US has increased by over 50%, whilst conversely gold in USD terms has moved 30% lower in that time.
Gold chart USD 
Despite the huge amount of new money creation, many may be scratching their heads as to gold’s weak performance of the past few years in USD terms, but the answer is relatively simple.
The newly created money of recent years flooded straight into the financial sector, so we saw a huge amount of inflation in financial asset prices, but just not as measured by the conventional CPI definition. New money flowed into government bond markets due to QE and into equity markets, pushing valuations to historically high levels. So when not enough of the new money creation trickled down into the real economy, consumer spending wasn’t boosted enough to move the CPI in any meaningful way. Due to the concentration of money in financial markets VS the broader economy, we failed to see a significant shift in the velocity of the money supply.
When investors began to realise that ‘inflation’ wasn’t spiralling out of control as many predicted, gold prices stumbled and gave back a decent percent of the gains of the previous years.
After a return of over 300% from 2005 to the peak in 2011, gold deserved a correction, and was given a bear market, which sapped away a decent chunk of western investors’ appetite, as stocks were in one of the biggest bull markets of our time. So gold seemed boring and useless to US investors whilst the Fed had endless liquidity pumping into these other markets.
So today gold remains incredibly under owned as an investment class in the west, and needs money to flow out of the other asset classes that benefited from the expansionary monetary policy adopted by the Fed and other central banks.
The largest shift we see moving forward is the collaborative attempt of central banks to tighten monetary policy. The Fed balance sheet below signals a change in the tide, as the days of easy investing may be coming to an end.
The Fed balance sheet 
This attempted shift in monetary policy is what we see as creating market volatility and economic calamity over the next few years, and how central banks react to this will be interesting, but we see two possible scenarios playing out:
1-         Central banks continue down the tightening path regardless of financial markets’ reaction, leading to heightened volatility, particularly in equities, and a global growth slowdown.
2-         We see a pause in this tightening as an answer to the above, and central banks reverse course and turn stimulus taps back on in an attempt to reflate the economy (or bubble).
It’s hard to imagine another scenario where central banks successfully normalise rates, and return their balance sheets to pre-crisis levels whilst the global economy ticks along fine and dandy, as there has been a huge increase in government, corporate and private debt under the recent ultra low interest rate environment.
The two above scenarios are actually both bullish for precious metals, as the equity market volatility should lead to save-haven buying and increased western investment, whereas the latter scenario will lead to a plummeting USD and a disintegration of confidence in the Federal Reserve’s capability.


Goldman Target Could Mean AUD$2,000 an Ounce

As gold gains momentum once again, it is this momentum that should attract western investors back into the market. So don’t be surprised if we see the trend continue and money to flow back into gold, pushing prices through all time highs in AUD, and eventually some years later, perhaps, all time highs in USD terms.
Assuming an unchanged exchange rate, we would only need to see gold trading at around USD$1,450 to see AUD gold in the $2,000+ range per ounce. A fairly reasonable assumption given that even the usually bearish Goldman Sachs analysts have a 12 month price target of, coincidently, USD$1,425.
Warren Buffet once said “The stock market is a device for transferring money from the impatient to the patient” but I think this can apply to all financial markets. Those looking to get rich quick should look for alternatives, but those with the patience to accumulate and hold through the next few years should likely be rewarded.
Until next time,
John Feeney
ABC Bullion
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