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The Mathematical Case for Gold

06 December 2019

Precious Metals Commentary

Gold remains range bound this week, despite trading higher in USD terms to $1,475 with silver relatively flat, just under $17 per ounce.

In AUD terms we saw some action with the RBA holding rates for now, sending the AUD up through 0.685c briefly, with gold trading as low $2,133 earlier in the week. We finish the week much the same in AUD terms at $2,163 and silver at $24.95.

In terms of near term technical levels, gold is trading just under the 50 day and 100 day moving averages, remaining in this short-term downtrend channel for now. The top of the channel sits at around $1,490 highlighted below, so we are watching this level closely as the next technical catalyst to see prices trend higher. We need to break through this channel convincingly to be comfortable in saying the next leg higher is underway. A very similar setup to the consolidation period we saw between March and May earlier in the year.
 
CFDs on Gold Chart
 
The raging bull that is Palladium has continued through all time highs again this week and we have stopped trying to guess when it’ll end. So far, Palladium is defying any sort of prediction of Platinum substitution from car manufacturers as it has rallied over 50% for the year.

CFDs on Palladium Chart
 
Some good news for silver investors, with CPM Group recently issuing a buy recommendation for metal, with an intermediate-term 2-3 year investment horizon. “The silver market is at a critical vertex at present,” CPM Group’s Vice-President in charge of Research Rohit Savant said in announcing the buy recommendation for the first time since 2001. “Silver market fundamentals are precariously similar to the critically poor conditions that existed in 1989.”

CPM Group is a very credible and balanced researcher with an incredible record when it comes to their intermediate Buy/Sell recommendations on the silver market, which you can see in the chart below. Their presentation slides on the silver market are well worth a look as they cover the rising demand and falling supply in the market. One needs a lot of patience to be a successful silver investor and we may finally start seeing patience is rewarded in coming years. 

Performance of CPM Group Silver Research Intermediate Recommendations Chart

Benevolent Central Bankers

For those who thought our comments last week about central bankers becoming increasingly political was mere speculation, Neel Kashkari (President of the Federal Reserve Bank of Minneapolis) was explicit about it last week, saying that monetary policy should play a redistributing role, one that was usually the preserve of elected officials.

To achieve this he has set up an “Opportunity and Inclusive Growth Institute” which looks to “transform an intensely political debate about inequality into a scientific endeavor that the Fed’s 21st-century technocrats could take up”.

European Central Bank President Christine Lagarde has also been reported as wanting to move the ECB beyond its traditional goal of controlling inflation to incorporate climate change and in particular, to purchase green bonds under its quantitative easing program. This would be a change from its current policy of market neutrality which aims to avoid stimulating particular sectors of the economy.

We say that before central bankers get involved in redistributing wealth and expanding their mandates they should focus on their original targets, which they don’t seem to be able to reach. Or maybe that is the point of all this mandate expansion, to cover up the fact that they don’t know what they are doing and there has been no real economic recovery.

In the case of Australia maybe the problem is MARTIN, short for Macroeconomic Relationships for Targeting Inflation. This is a 147-equation computer model of the Australian economy, which the technocrats at the RBA use to forecast the economy and estimate the impact of policy changes. Below is a simplified diagram of the model.

Overview of Key Aspect's of MARTIN's Structure Chart

While 147 equations is quite complex, it seems like a highly abstracted simplification of the activities of 25 million people. Models also incorporate explicit and implicit assumptions that may not be correct.

The other problem with models is GIGO – Garbage In, Garbage Out.
 

Deflated Inflation

The garbage we are talking about is inflation. In the US there are two alternative measures of inflation. Most well known is Shadow Government Statistics, which calculates inflation applying the methodologies used in 1980, before they were changed. On that basis they estimate inflation is just under 10%

The Chapwood Index takes a different approach, using the unadjusted actual price changes in the top 500 items on which Americans spend their after-tax dollars. As you can see below, they also estimate actual inflation rates of around 10%.

Chapwood Index Chart

We don’t think we will get anyone disagreeing with the statement that the real inflation rate in Australia is much higher than the official CPI. We don’t know of any service which calculates an alternative Australian rate, but Roy Morgan does survey 4,000 Australians per month to come up with the average person’s expectations for inflation.

Inflation Expectation Chart

As you can see in the chart above, the average person sees inflation much higher than the official 1.7% rate.

So if the MARTIN computer model has been built to replicate a garbage inflation rate then the policy suggestions will also be garbage. Possibly the RBA is actually causing the excessive real inflation rate because by looking at the wrong 1.7% figure it keeps on with policies to create inflation that is already there?
 

Declining Standard of Living

Alan Kohler recently questioned Australian’s living standards, noting that “in the 1970s, most families were single income. Now most are double-income, both parents working are needed to pay off the mortgage”.

He thinks the cause is due to increasing home prices (from a price-to-income ratio of 2 in 1980 to 7 today) requiring families to take on more debt.

Certainly that is a factor but we would suggest that understated official inflation is also contributing to the problem.

With government benefits and many pay increases all based on the official inflation rate, it results in the average person’s income failing to keep up with actual cost of living. Over many years that compounds into a declining standard of living.

No surprise then that Digital Finance Analytics reports that 32.5% of households are in mortgage stress, with the switch from interest only loan to principle and interest loan repayments as a factor along with underemployment and unemployment and the drought.

Recent Australian economic growth statistics were a disappointing 0.4%, below the market consensus, with Westpac most concerned about the fact that this was the fifth quarter where private demand had failed to show any growth.

It appears that the average person is hunkering down and looking to build up precautionary buffers, if housing equity figures are a guide.
 

Housing Equity Withdrawal Chart
Inequality

The latest contender for the “biggest backflip now that I’m no longer working for The Man” award is Janet Yellen being worried about “a very substantial share of the U.S. workforce feeling like they’re not getting ahead”.

She says she used to get emails from people trying to save for retirement saying they were getting nothing on their money in the bank. This from someone who during their time at the US Federal Reserve held interest rates near zero.

We don’t think her concern for the average person, now, is enough to beat the current (in our view) title holder – Alan Greenspan – who told the World Gold Council in 2018 that he “is an admirer of gold and the gold standard” and that gold “has an inherent stability when looked at across decades or even centuries”.
 

Outrageous Prediction

For almost two decades the financial markets look forward to the release of Saxo Bank’s outrageous predictions for the coming year.

This year our eye was caught by the prediction that the Asian Infrastructure Investment Bank would create a new reserve asset called the Asian Drawing Right to address rising US threats to weaponise the US dollar.

Asian Drawing Right
 
They speculate that this Asian Drawing Right, backed by a basket of currencies and gold, would result in the US dollar weakening “20% versus the ADR within months and 30% against gold, taking spot gold well beyond USD 2000 per ounce in 2020”.

Sounds very similar to Jim Rickards’ idea about the IMF bailing out central banks during the next global financial crisis using special drawing rights (SDR), and in which gold would play a prominent role.

An outrageous prediction or obvious perception?

Perhaps this prediction may have been the motive behind the very large $1.75 million gold call option bet for $4,000 gold by June 2021 we mentioned last week.
 

Tin Foil Hat Preppers

Speaking of outrageous predictions, what would you estimate the chance of a revolution or civil war to be? Probably some single digit percentage we’d guess.

In an interesting article looking to why “preppers” plan for disasters and hold guns, the author BJ Campbell looks at the mathematics and concludes that there is a 0.5882% annual chance of nationwide violent revolution against the ruling government – in the US at least.

While that doesn’t sound like much, he notes that as probabilities compound, that 0.5882% means that there is a 37% chance that any American of average life expectancy will experience at least one nationwide violent revolution.

He concludes that prepping is therefore not as crazy as it first appears and particularly not for the less wealthy who “experience the preponderance of the suffering, violence, and death” in such situations. The elites of a nation, he says, can just hop on a plane.

Gold is certainly the go-to asset to husband one’s wealth through a revolution but most holders of gold are looking for protection against financial, rather than civil, disasters. As Mr Campbell says, the point of disaster planning is not to be “not-screwed”, it’s to be notably less screwed.

In the case of Australia we have had five financial fiascos: 1840s, 1890s, Great Depression, 1980s and the GFC. Being generous and using a time period of 231 years (from 1788 to 2019), five events equates to a probability of 2.2%.

If we assume that the average person only starts accumulating significant savings from the age of 45 and is looking to protect that until 75 (near the average life expectancy of 82), then that is 30 years during which an investor needs protection from a financial crisis.

The mathematics of 2.2% over 30 years results in a probability of 48.1% that an investor will experience a financial crisis during their crucial wealth accumulation period.

Use that statistic the next time someone looks at you funny because you hold some gold or silver.

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.