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The Great Central Bank Bubble of 2020

26 June 2020

Precious Metals Commentary

Gold marched higher this week, topping out at $1,779 before pulling back to settle around $1,765. Silver is being capped under $18.00 per ounce for now which seems an area of resistance. Overall, gold remains in a very strong uptrend with bulls in charge for now. The next big test would be a clear break through $1,800 and we are watching the market with anticipation.

With gold well on the way and trending towards new all-time highs in US dollars, we have many questions around silver of late. Given the amount of demand we are seeing we expect silver to play catch up soon, but it needs to break up through $18.50 to confirm the next leg higher is underway.

Silver spot price chart
Covid-19 continues to wreak havoc in the US with a new single day record of 45,557 new cases recorded on Wednesday, only to be beaten Thursday with 72,502 additional cases. The previous high for daily cases was back in April amid the initial pandemic, so although certain states have contained the spread somewhat, we now have other states going parabolic as the chart below highlights.

COVID cases in the US
The longer it takes to contain, the slower the economic recovery, but we all know by now that the economy matters little when it comes to the stock market. There seems to be a strong correlation between rising coronavirus cases in the US and a rising stock market (go figure), but in this case we are pretty certain correlation doesn’t mean causation and markets have simply gone ‘full-2020’.

It is hard to make an argument that more coronavirus cases will lead to greater consumer spending, but if you think of Amazon as a barometer of US economic activity you can see some traders must have drawn this conclusion?

Amazon versus covid cases
Only in 2020 would an overlay of Amason’s share price on US Covid cases in the picture above make any sense. The Great Central Bank Bubble of 2020 is starting to put the Dotcom Bubble to shame.

Virus Bubble

Last week we discussed the dislocation of the US stock market to the broader economic macro environment. It doesn’t look like it is any different down under with this chart from State Street Global Advisors showing that we also need a reality check.

Australian share price dislocation
Damien Klassen from Nucleus Wealth agrees, saying there is no doubt we are currently experiencing what he calls a “Virus Bubble” with the important question now being how long will it run.

His assessment of the state of the four key sources of new money that keep bubbles inflated are:
  • New investors - with 280,000 new and reactivated accounts in Australia over six weeks it does not appear there will be many more retail investors to add to the market
  • Increased gearing - with margin debt in decline since 2018 this does not look like a source
  • Derivatives - Damien notes significant increase in US options volume and involvement by retail investors and questions whether it can grow any further
  • Switching asset classes - hedge funds and fund managers appear fully invested so not much more buying to come from them
Based on the above factors, he thinks that we are in a situation that resembles the China 2015 Bubble which took four months before it blew up, rather than a US tech boom style bubble, which took two years to play out.

Damien says that the stock market party seems to be dying down and that “given the amount of alcohol already consumed, you will feel a lot better in the morning if you leave the party now”.

Yield Breakdown

This week ABC Bullion’s Nick Frappell spoke at a webinar held by Metal Focus, a respected precious metals research firm.

Nick had an interesting chart (below) in his presentation that provides an explanation of a key force behind gold’s rally out of the 2013 to 2019 channel.

gold versus yields
Interest rates, and particularly after inflation rates as charted above, have a big impact on gold. Cash is a competitor to gold for the dollars of investors looking for safety. If the return on cash is low, or even negative after inflation, then gold becomes a lot more attractive.

Nick says another positive force for precious metals has been the impact of coronavirus and the policies designed to help economies get through the demand shock arising from lock-down.

As the chart below shows, the response of governments around the world has been huge. The IMF believes that the fiscal response is about triple that of the GFC, being incredibly broad-based covering primary and secondary markets for corporate debt as well as state and local government debt.

US Fed and ECB balance sheets
The third factor in gold’s favour is the potential for inflation given the willingness of central banks to run the printing press. As we have documented over the past few months, the smart money has been moving into gold to protect themselves from this possibility.

However, Nick says that even if inflation doesn’t appear, then the more likely alternative economic outcome is a period of stagnation, where low returns would continue to favour gold.

Outlook for Gold

At the close of the Metal Focus webinar, participants were asked for their outlook for gold. Nick said that $1,880 is the next major rally point, which he thinks has 1 in 3 probability of occurring over the next 6 months and he also sees an attempt at the 2011 high of $1,920 during the rest of this year as a possibility.

Metals Focus said that aggressive stimulus measures mean the already problematic government debt levels “will now be even more worrisome” and that the institutional money that will flow into gold on these concerns “will be strategic and therefore sticky”, giving gold plenty of upside from current levels.

PAMP see gold prices breaching $2,000 in the first half of 2021, silver getting to $23 and thus the gold:silver ratio falling back into the 80s.

The Historical Case for Gold

The World Gold Council (WGC) has done good work to make a logical case for gold in investor portfolios to counteract the uninformed disparagement of the precious metal by mainstream financial advisors and commentators.

Their research shows that investors can obtain a material enhancement in performance of a well-diversified portfolio by allocating the following amounts of gold:
  • US investors - between 2% and 10%
  • UK investors - between 2% and 10%
  • Indian investors - between 6% and 17%
  • Chinese investors - between 3% and 8%
  • Japanese investors - between 2% and 10%
ABC Bullion has been talking with the WGC about extending their research to Australia, particularly since the size of Australia’s superannuation system ranks number four globally at US$1.9 trillion, but given the above results it is likely we would also come out with a 2% to 10% recommendation.

The WGC research, however, is only based on data from the mid-1970s onwards, when it became legal for people to own gold. While 45 years may seem like a long time it only covers two real stress periods – the 1970s inflation and 2008 GFC - and therefore it is fair to ask if gold can perform during a real great depression like the 1930s.

Fergal O'Connor, Lecturer in Finance and Economics at the Cork University Business School has made a step in answering that question. He painstakingly gathered missing daily UK gold price data from 1919 to 1968 along with daily equity and fixed income data.

In the 1930's the gold market was free in the UK and Fergal found that gold was a diversifier for investors (called “hoarders” at the time) with low correlations to other assets classes - reducing the riskiness of a portfolio.

gold correlations to bond and stocks UK 1930s
Fergal calculates that a 1930's investor should have held between 6% and 30% of their money in gold and that it held its value when bonds and equities crashed.

His research should give investors comfort that gold will “work” to protect their portfolio during periods of extreme financial disruption.


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.