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​‘Trade of the Century’

22 March 2019

Precious Metals Commentary

The battle for US$1,300 continued this week with the bulls taking the win for now – gold traded higher at $1,309 per ounce and silver was up slightly to USD$15.14. Fed chair Powell’s dovish comments sent the US dollar lower, seeing gold hitting a high of $1,320 before retreating.

In local currency terms, the moves were somewhat muted, with gold slightly higher at AUD$1,845 per ounce and silver creeping higher to $21.80 per ounce. The AUD/USD seems vulnerable just above 71.00 US cents, with any rally seeming to be met with selling pressure.

Once again, palladium was the star of the show with a Superman inspired rally towards the moon. Well, not quite, but we broke through the recent highs with enough energy to move north of USD$1,600 per ounce. Proceed with caution. Gold and palladium charts in USD terms below respectively.
Gold Spot Price
Palladium Spot Price 

Trade of the Century

A lot of commentary comes across our desk here at ABC Bullion and it is interesting to see which stories get picked up and which are ignored. One key to success is expressing conviction, and “macro trade of the century” (with an exclamation mark) certainly communicates confidence.

That call was made by Crescat, a US global macro asset management firm, late last week in a paper about gold in Chinese yuan. By mid this week, it had been picked up and eventually made its way to the mainstream Australian daily newspapers.

Crescat are negative on the Chinese currency due to China’s fiscal and monetary stimulus measures but also “believe gold is historically cheap versus all fiat currencies, including USD, we are extremely bullish on gold”.

Their expectation is for China to implode, leading the global economy into a downturn, so they are also short global equities. They also note that silver tends to perform better than gold in a gold bull market, so also own silver as well as gold and silver equities, with gold as a core holding.

Crescat are not alone in their bearish view. On the other side of the globe, Safehaven argues that Germany is in a slowdown and flirting with recession. As the fourth-largest economy in the world, they say “the global economy should be more than a little worried” by this and that it is not “a German problem or even a European problem—it’s a global problem”.

Gary Shilling, former chief economist for Merrill Lynch, has predicted turns in the economy in the 1960s, in 1991 and was warning about the housing boom in the lead up to the financial crisis in 2008. He is now saying the US is headed towards a recession (two-thirds probability, to be specific) based on:
  • near-inversion in the Treasury yield curve
  • swoon in stocks at the end of last year
  • weaker housing activity
  • soft consumer spending
  • tiny 20,000 increase in February payrolls
  • deteriorating European economies
  • decelerating growth in China
He says this recession “will probably be accompanied by about an average drop in stock prices” which he says will be 21.2%. Gray, writing prior to the Federal Reserve Open Markets Committee (FOMC) meeting, also said that “tighter monetary policy by the Federal Reserve that the central bank now worries it may have overdone”.

He was right about the “worries”, as the Fed kept rates unchanged, their dot-plot projections indicate no further increases this year and possibly only one increase in 2020, and they will start slowing down quantitative tightening in May, ending it in September.

The market’s reaction is best summed up by trading service NorthmanTrader: “this full capitulation by the Fed is an acknowledgement that the US economy is way worse off than acknowledged by optimistic markets” and is an attempt “to goose stock prices is an effort to avoid a recession”. If the Fed was hoping to boost the markets, it didn’t work as traders read their actions as signaling a recession and that the Fed may have made a policy error.

Prior to the FOMC meeting, the World Gold Council said that “historical analysis shows that when the Fed has shifted from a tightening to a neutral stance, gold prices have increased, even if this effect has not always been immediate”. Well the response by gold was immediate, rising $10 initially and grinding higher in the hours that followed.


Late Cycle Safe Havens

So what to do if the economic cycle is turning? Andrew McAuley from Credit Suisse says that we are late in the cycle and nearing the market’s peak. His recommendation to investors is to focus on reducing risk in their portfolios. For Australian investors, he suggests buying unhedged US Treasuries as “the AUD tends to depreciate in risk off periods” but he also notes that “gold also does well in times of extreme stress … [as] its rarity and acceptance as a store of wealth gives it a value unrelated to stock market movements”. We would say that if Andrew likes gold and sees the AUD falling (which increases the AUD price of gold), then simply buying gold is probably a lot easier for most Australian investors than unhedged US Treasuries.

David Lennox of Fat Prophets also sees gold acting as a store of value and safe haven “to counter value losses in other asset classes during heightened volatility and uncertainty” and sees gold ending 2019 between USD$1,375 and $1,400.

Another reference this week to gold’s safe haven nature came from fund manger US Global Investors in an article discussing the fact that the value of negative-yielding bonds is now at $9.32 trillion, in which they note that “low to negative-yielding debt has historically been constructive for gold prices”.

It is not just low or negative interest rates, but more the rate after inflation (often called the real rate or real yield) that has historically been related to gold price increases. This chart from Hedgeye Risk Management shows that when interest rates, after inflation, become negative, the gold price tends to post gains (the area in green).

Real Yields & USD vs Gold 
In terms of forecasts for interest rates, the Heisenberg Report notes that perma-bear Albert Edwards, of Societe Generale, is calling for US 10 year yields to be of minus 1% in the next recession (which he see as 2 years away “at most”). If inflation is still 2% that puts real yields at negative 3%, which based on the chart above would see gold up around 15%. He thinks that the Fed “has totally lost the plot” and “shredded their credibility” by reversing their balance sheet unwind.

If the market turns, The Felder Report thinks it will be “unprecedented” given that “current state of stock market leverage, adjusted for inflation or the size of the economy, is unmatched since the Great Crash” (see chart below).

Investor Credit and the Market
He says that this leverage “represents the amount of potential supply to come into the markets should they fall far enough to trigger margin calls”.

Gold’s Price Resistance

To date, gold has faced resistance as it moves into the mid $1,300s, although the news discussed above and shift in sentiment may help gold break out. Chris Vermeulen sees resistance near $1,370 and that this “level must be broken before the upside rally can continue above $1400, then $1500” and that on a breakout, silver is likely to “push well above $30 per ounce”.

John Kaiser of Kaiser Research Online agrees with Chris, saying that “gold is going to develop a subtle uptrend and the key inflection will be when it goes through that 2016 high of $1,370 or thereabouts".

Newsletter writer Jay Taylor thinks that “we need to get through $1,350, $1,360, and then the first major target that I see, and I’m not sure of the timing, I think we’re looking at $1,700”.

Maxwell Gold, director of investment strategy at Aberdeen Standard Investments, feels that globally low interest rates “are causing investors to misprice inflation expectations and any price shock within the global economy could be the catalyst that drives gold prices back to the top of its longer-term range above $1,350 an ounce”.

(Price) Resistance is Futile for Palladium

Palladium, on the other hand, doesn’t appear to have any price resistance level, having broken through $1,000 in September 2018 and moving consistently up since then on its way past $1,600 this week, for the first time.

Bloomberg reports that demand is high “as manufacturers scramble to get hold of palladium to meet more stringent emissions controls”. As it will take years for automakers can switch to platinum for catalytic converters (with Johnson Matthey saying “technological advances are needed before it can match the performance of palladium-based catalytic converters”) and with supply constrained as over “80 percent of palladium comes as a byproduct from nickel mining in Russia and platinum mining in South Africa” analysts and investors remain bullish despite the exponential price rise.

Until next time, 
ABC Bullion

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.