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Volatility is the New Normal

06 March 2020

Precious Metals Commentary

Volatility in equities continued this week sending Gold higher to $1,670 and Silver higher to $17.45 per ounce. Another “normal” trading day in the US overnight saw the Dow plunge 1,000 points (4%) in a single trading session, yet again, with coronavirus news not improving. Stock markets are finally starting to price in the possibility of a global recession and reduction in earnings for many companies and shrugging off Central Banks attempts to ease concerns with stimulus.

The AUD/USD recovered above 0.66c on USD weakness with the emergency 0.50% cut in interest rates this week by the Federal Reserve. This saw gold trading back above AUD$2,520 after hitting recent lows of $2,409 and Silver trading back to $26.30 up from recent lows of $25.30. Platinum and Palladium remain unloved, as car sales are plummeting globally.

There have been some obvious short opportunities of late in equities, with airline related companies suffering some of the biggest sell-offs. On the ASX, Qantas and Flight Centre have been crushed, along with banks and anything retail sales related. There aren’t too many places to hide in equities during these periods of heightened volatility and we do not expect this to change anytime soon.

QAN and 1 more chart

FLT and 1 more chart

In the recent past any of our readers would note that the record long bull market in equities has largely been driven by monetary stimulus, record low rates, and not so much by underlying earnings. What is important is the potential shift in psychology away from the previous years “don’t fight the Fed” mindset to a more realistic philosophy of “maybe monetary policy cannot fix everything”.

In COVID-19 news, global cases rose to 97,841 with deaths reported to be 3,347. Total recovered is positive at 53,786 but there was some concerning news this week out of China with a 36 year old man dying days after he was discharged from hospital being cleared as recovered. Epping Boys High School in Sydney closed this week after a student tested positive. Google, Facebook and Microsoft are asking Seattle-based staff to work from home and ratings agency S&P estimates that the virus could cost Asia-Pacific economies $211 billion and slow growth to 4%, the lowest since the GFC. So in general the picture continues to worsen this week, with Australian confirmed cases of 41.

For the technical setup in gold short-term, the rally last night saw gold stage a breakout of its consolidation range and these pullbacks are catching bids in shorter time periods. Short-term trend remains positive for now.  

XAUUSD Chart

Longer term, gold needs to test and break through the resistance area highlighted below, and may even do so this year. A break north of the all time highs in USD will surely feed into a true bull market for the yellow metal and really drive a FOMO mentality and animal spirits. Gold may even become a mainstream investment after that point, who knows?

If gold manages to approach the USD$1,800 level in the next 12 months that would put us at around the $2,700 AUD mark assuming an unchanged exchange rate.

XAUUSD Chart
 

Gold Brushes Off Sell Off

We mentioned last week that the recent sell off in gold was largely attributed to profit taking, given the net-long length of the market, and partly attributed to traders needing cash for margin calls. This is one of the downsides to gold being such a liquid market – when traders need cash they sell their most liquid asset as its price won’t fall as much as their less liquid or unwanted assets. As Refinitiv Metals said this week, “when times get really dire and anxiety is high, you don’t sell what you want, you sell what you can”. But it is very positive if not bullish to see gold recover quickly during this week’s equity market sell-off.

On the recent pullback in precious metals, gold found support at $1,565, which is around the levels where Nick Frappell said a lot of those long positions were put on (based on volume-weighted average price analysis).

The fact that gold found support within the $1,550-$1,590 range that it spend most of 2020 in is encouraging to say the least, as was its turnaround on the back of the US Fed rate cut to bring it back above the $1,630 floor it set towards the end of February. This shows that there are increasing amounts of latent demand being triggered as the negative news builds.

Silver has been much harder hit as traders focus on COVID-19’s negative impact on industrial production, which is a significant proportion of silver’s demand. This has resulted in the gold:silver ratio surging above 95, a level last seen on 6 March 1991, almost exactly 29 years ago.

We will be watching closely the data on silver investment demand moving forward. It is true that the last bull runs in silver were driven almost entirely by investment demand as opposed to industrial demand, so things can change quickly in the silver market if we do start to see investors flooding back seeing the value relative to gold. Keep a close eye out for silver starting to catch a ‘safe-haven’ bid.

Commenting on the sell-off, Baker Steel Capital Managers noted that “gold has been a consistent outperformer during periods of crisis” and that the policy response and macroeconomic conditions surrounding a crisis have tended to spark major rallies in gold and gold equities.

Gold Equities Charts 2008-2020
 

Central Banks Can’t Cure Corona

While gold recovered on indications central bank would cut interest rates, here's a contrarian thought: monetary policy is not going to cure COVID-19. One does have to wonder about the market’s collective intelligence.

While a cut in interest rate would reduce interest costs on loans (at least for those with variable rate debt), if the virus results in businesses having to close or reduce output as staff are off work sick and/or in response to reduced sales as people hunker down, then a small cut in rates isn’t going to give them the substantial cash needed to make debt payments. The slowdown in the economy, we expect, will far outweigh any sort of governmental intervention in the form of monetary or fiscal stimulus. Sometimes you can’t solve a problem by simply throwing money at it, but we do expect governments and central banks to try regardless.

As financial commentator Frances Coppola says, central banks may be able to offset temporary disruptions but “they can't by themselves prevent such a shock doing permanent damage, or repair the damage once it has occurred”. She sees the market’s reaction as an indication of an “ever-increasing reliance on central banks to keep economies afloat under all circumstances”, which is now coming back to haunt us.

As supply chains start to shut down, cascading economy-wide bankruptcies become a real risk. In response, Chinese regulators have approved their banks to take extraordinary measures to roll over loans where payment deadlines have been missed and relax guidelines on categorising overdue debt.

Similar measures are likely to be put into place in Western countries as we have seen a number of academics calling for “pandemic-induced financial crisis plan, that forestalls bankruptcies and insolvencies where possible, without causing downstream crises among people who were counting on being paid back”.
 

Corona Hits Confidence

We expressed concern last week about Australia’s self-quarantining overseas rule and this week The Australian reported that authorities were trying to track the movements of a Chinese university student with COVID-19 who self-quarantined in Dubai before being let into Australia. No wonder then that Attorney-General Christian Porter warned “it may soon become necessary to activate drastic measures under the 2015 Biosecurity Act. Most notably, the power to ban gatherings and impose lockdowns”.

Roy Morgan reported that COVID-19 hit consumer confidence “in a big way last week, with overall sentiment falling to its lowest level in more than five years” declining 3.2%.

'Financial' & 'Economic' conditions gap widens further chart

One interesting feature from the survey is that while Australians are very negative on “current economic conditions” they are still quite content about their personal financial circumstances. If COVID-19 accelerates and starts to impact on employment and sentiment shifts negative on personal finances, then hoarding gold rather than toilet paper may become the trending topic on social media. At ABC Bullion we are seeing a rush to gold, with trading volumes last week up three times on our usual levels.
 

Central Banks Rush to Gold

Central banks have also been rushing to gold, although this has been a long-term trend. The World Gold Council released year-end 2019 central bank gold holdings this week and globally, central banks added 663 tonnes.

As we noted back in June, in recent years it has only been a handful of countries that have been buying but there was a major shift in central bank attitudes to gold following the global financial crisis, with a third of central banks adding 4,690 tonnes since 2009, an increase of 16% and the highest balance since 1996. Russia and China accounted for 66% of that shift.

The chart below shows this dramatic turnaround when looking over the long-term. At the current rate of accumulation, in just five years the balance should be back to where it was in 1971 when Nixon “temporarily” suspended the convertibility of the dollar into gold.

Global Central Bank Gold Holdings (tonnes) chart

Research and advisory firm CPM Group says that while central banks want to add gold to their monetary reserves they don’t see gold becoming the basis of a future currency regime. That may be the case for many minor countries, but we think that one of the drivers behind Russia and China’s accumulation over the past ten years has been to re-weight their reserves to gold and away from the US dollar and other fiat currencies.

While Russia and China each hold around a quarter of the amount of gold the US does in terms of tonnage, as a percentage of their total returns they are well behind the US and Europe.

Central bank gold as % of total reserves chart

Russia is now up to a more respectable 20% but China is well below because even though it is increased the value of gold it holds from $3.5 billion to $95 billion since 2000, its foreign exchange reserves have increased from $160 billion to $3,127 billion over the same time period.

CPM Group claim that central banks are more price sensitive than private investors and have been buying more lately because investors were buying less and that they will back off when prices rise.

We beg to differ. As the chart below shows, the amount of central bank increases in gold as represented by the green bars has been steadily rising for many years and does not appear related to the gold price at all.

Quarterly change in global gold reserves (tonnes) chart

Our view is that central banks know that the world’s financial problems have not been addressed, as evidenced by their continued low/negative interest rates and other unconventional measures, and they will therefore continue to acquire gold to protect themselves should things “break”.

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.

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