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Wealth Destruction on a Catastrophic Scale

08 May 2020

Precious Metals Commentary

Precious metals held up nicely this week with gold continuing to battle for the USD$1,700 per ounce level. After a 1% drop Wednesday night gold rallied 2% Thursday night to $1,712 on the back of futures traders pricing in the possibility of a negative Fed funds rate within months. We think negative rates in the US is not only a possibility but something very likely within the next 12 months in reaction to the COVID recession in the US, so don’t be surprised when it happens (more on this to come).

Silver remains solidly in the buy zone for us at USD $15.30 and we are fairly confident of the recent bottoming action with the gold:silver ratio remaining at an elevated 125.8. There was interesting action in the AUD/USD this week with the Aussie recovering to over 65c.

AUD Chart

Although we have been bearish on the AUD for the past few years it is now hard to remain bearish in the short term when you consider the likelihood of USD weakness. The impact of COVID19 is much worse in the US than here locally, and there are some positives for the Aussie economy returning somewhat back to normal in coming weeks. We also saw a record trade surplus of $10.6 billion for March thanks to mineral exports to China, with gold exports also having a positive impact. So no surprises in the AUD recovery we have seen in recent times.

We are not confident of a long-term economic recovery in Australia just yet of course, but think expected short-term strength in the AUD could provide some good entry points to average into metals. Later in the year the true test of the Australian economy and housing market will come to the crunch and we do not expect this to be positive for the AUD to say the least.

To other metals and platinum continues to trade sideways for now with very similar price action to silver. The COVID sell off to USD$570 per ounce is similar to the bottoming behaviour in Silver and prices have recovered to $766 for now. Palladium is hard to pick at this point with a recent V shaped recovery getting strongly sold off. Slowing demand for new vehicle sales this year will undeniably impact demand for these metals, however platinum trading close to 10 year lows would be our pick of the two for those betting on a recovery, but investors would probably sleep better with gold and silver being the main metals to benefit from safe haven demand.

The Curse of Negative Interest Rates

We have talked about falling interest rates and, in some countries, negative rates in previous updates. This week Harvard University economics professor Kenneth Rogoff upped the ante by calling for deeply negative interest rates to -3% or lower in a recent article.

Normally we would have ignored this as Ken has been pushing his negative rates barrow for some years but we think the risk of this being implement is increasing.

The market agrees, with Chris Weston of broker Pepperstone noting that traders are betting on a negative US rates by January 2021.

World Interest Rate Probability Chart

As Chris says, the US going negative “is certainly not straight forward and would require a change to the Fed Act” however we think it will be pushed through because in our view the extraordinary measures the Fed is engaging in will not work and as a result they will become increasing desperate.

The reason central banks have been pushing rates lower and lower is because they believe in the following theory:
lower rates = people borrow more = more spending = rising demand and employment

There is some truth to this. If interest rates drop from 7% to 5% certainly some projects an entrepreneur had previously dismissed become viable, or some renters can now afford to buy a house.

Our contention is that in abnormal circumstances this theory does not hold. If people feel their debt levels are too high, or that the future has become more risky, they will not want to borrow and rather save more to build up a buffer.

As an example, US consumer spending dropped 7.5% in March, the biggest one-month drop since the government began tracking the figure in 1959. In Australia, overall sentiment is now around the levels seen during the GFC, which is not surprising with 18.2% of mortgage holders being in “mortgage stress” as Australia entered shutdown in March.

ANZ Roy Morgan Chart

However, central bank economists seem incapable of recognising changing circumstances, or admitting they are wrong, and so their response to a policy of lower rates that is not working is to say “our theory is right, we just haven’t done it hard enough”.

As Ken says in this article “negative rates would operate similarly to normal monetary policy, boosting aggregate demand and raising employment”. He does not see that the absurdity of negative returns may force investors into unforeseen (to him) protective behaviours.

As the US Fed and government becomes desperate for success, it is this thinking that will push forward with negative rates.

One thing we will say is that at least Ken is upfront about what he wants. He says that the crisis we are facing will destroy wealth on a catastrophic scale and that “policymakers will need to find a way to ensure that, at least in some cases, creditors take part of the hit”.

Lets just be clear lest people think that the vague word “creditors” does not apply to them: if you have a bank deposit you are one of Ken’s creditors as you are lending your wealth to the bank.

To get his negative rates, Ken says that large-scale hoarding of cash has to be prevented using various regulations and the phasing out of large-denomination banknotes. In fact, he wrote a whole book about it back in 2016 called “The Curse of Cash”.

The Gold and Silver Refuge

Ken and other egghead economists need a bit of Warren Buffett plain speaking. At the recent Berkshire Hathaway annual meeting he said regarding negative interest rates and money printing that “you’d think the world would have discovered it in the first couple thousand years rather than just coming on it now”.

What smart investors discovered thousands of years ago was that gold and silver are one of the easiest ways to gain a refuge against such absurdities – such as 74% of the workforce being paid by the government, as CEO of Freelancer tweeted.

Matt Barrie Tweet

Our only quibble is that it isn’t the government paying the 74%, it is the other 26%. That is not sustainable.

As we have noted previously, we are seeing more and more smart money institutional investors picking up on the “catastrophic destruction” central bankers are leading us to.

Hedge fund manager Paul Singer said that the “fanatical debasement of money by all of the world’s central banks” is the perfect environment for one of the most undervalued investable assets existing today - gold - to take centre stage and reach its fair value, which  he said is “literally multiples of its current price”.

One story that hasn’t had much public traction is silver, but this week saw the UK’s Financial Times covering silver with a headline “investors make big bets on silver closing giant gap with gold”.

Silver is a much smaller market than gold, so if institutional money starts seeing silver as a value play, it will book some big gains.

As Grant Beasley, a Toronto fund manager, was quoted in the article saying, “the longer gold keeps having a good performance you will get speculators …  who will go ‘oh silver is really cheap’” and as the “speculative fever increases retail investors will go crazy”.

While ABC Bullion has been busy, the mass market is not yet awake to what is coming. Everyone has been focused on crushing the COVID curve but soon everyone will be wanting to get ahead of the debasement curve with 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 [email protected], or call us during trading hours on 1300 361 261.

This article has been prepared by Australian Bullion Company (NSW) Pty Limited (ABN 82 002 858 602) (ABC). The information contained in this article or internet related link (collectively, Document) is of a general nature and is provided for information purposes only. It is not intended to constitute advice, nor to influence any person in making a decision in relation to any precious metal or related product. To the extent that any advice is provided in this Document, it is general advice only and has been prepared without taking into account your objectives, financial situation or needs (your Personal Circumstances). Before acting on any such general advice, we recommend that you obtain professional advice and consider the appropriateness of the advice having regard to your Personal Circumstances. If the advice relates to the acquisition, or possible acquisition of any precious metal or related product, you should obtain independent professional advice before making any decision about whether to acquire it.

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