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​Westpac’s Call = $2,000 Gold

31 May 2019

Precious Metals Commentary

This week saw gold trading back above USD$1,290 and silver relatively unchanged at USD$14.50. After such a consolidation in price, it seems like gold has formed a base in USD terms, so keep an eye out for a potential rally next week.

In local currency terms, the AUD clings to 0.69c for dear life for now, which sees gold in AUD a whisker from all time highs at $1,870, and silver back above $21 per ounce after briefly trading below $21 earlier in the week. 

The technical setup for gold is pointing toward a move higher as being more likely, as we have come off oversold levels on the weekly chart after successfully holding above $1,280 for some time. Will be encouraging to see a rally back up through $1,300 to confirm next leg higher is underway.

Palladium recovered higher this week and platinum is looking like the most depressed commodity on the planet, currently just under USD$800 per ounce and looking just a tad oversold.
Platinum chart

US Outlook

The yield curve inversion (when interest rates on short term maturities are higher than those for longer dated bonds) we mentioned back in March is still a thing. At the time we noted conflicting views on which inversion figure is the most predictive.

Mike Shedlock (SitkaPacific Capital Management) believes he has the “surefire recession signal” to watch for. His chart below shows two measures of inversion, or the difference between long and short-term interest rates, with recessions shown in grey. Inversion occurs when the lines go below zero.
Surefire Recession Signal

Mike says that inversion itself isn’t enough to indicate an imminent recession, what one needs to look for is a “sudden steepening of the yield curve following inversion”. This happened before the last three recessions, as marked by boxes 1, 4 and 5 – that is, the chart lines rose back into positive very quickly.

Mike says that this sudden steepening will occur when the US Federal Reserve “will either cut or signal it is about to cut” interest rates.

We do note that it is still early days for this signal, as the “10-year minus 3-month” has only just broken zero and it takes a year or two after that for it to steepen back above zero before a recession occurs.

Markets are pricing in at least one interest-rate cut by the Fed this year, but Federal Reserve Bank of Kansas City President Ester George recently said “lower rates might spur asset price bubbles, create financial imbalances and eventually lead to a recession”.

We were surprised to see such an acknowledgement from a central banker that maybe lower rates don’t work. Once indicator of the “asset price bubbles” Mr George spoke of comes from the chart below which shows how many initial public stock offerings were made by businesses losing money.

Reaching the peaks that occurred during the dot com bubble certainly isn’t encouraging for the prices of these stocks going forward. However, we note that overall the trend since 1990 has been for more and more negative earning IPOs, which hints that there are structural drivers behind this. The fact that interest rates have been falling since the early 1980s surely isn’t coincidental.

Ben Hunt (Epsilon Theory) argues that Mr George’s concerns are only part of the problem and that mainstream economists are also wrong in believing that lower rates create more risk-taking, which will then spur economic growth.

He says this belief is behind central bankers relentlessly lowering interest rates to zero and into negative when they don’t get the risk-taking behaviour and inflation they are expecting.

Instead, Ben claims, as interest rates approach zero people look to minimise risk as such rates send the message that “future growth rates are moribund and miserable, that our world persists in a long gray slog of deflation just as far as the eye can see”.

Below I’ve converted one of the charts in Ben’s article to show what he means.
Central Bank Theory of Money

Central bankers think the relationship between interest rates and risk taking is like the green line. It does make intuitive sense – the lower the price of money, the more you would expect businesses to borrow for their projects.

The observed reality is more like the black curved line - at a certain point risk taking starts to point downwards. Ben says that this “greedy but fearful” behaviour is behind the large amount of stock buybacks, profitless revenue and financialisation that have come to dominate financial markets in recent years, rather than real investment in property, plant and equipment.

We won’t hold our breath that the large majority of central bankers will heed Mr Hunt’s and Mr George’s warnings that zero and negative interest rates are counterproductive.

Chinese Weaponisation

A lack of real business activity was confirmed by the US Purchasing Managers’ Index (PMI) which came in at 50.9 for May, a 36-month low. IHS Markit, the index owner, noted that “trade war worries and increased uncertainty dealt a further blow to order book growth and business confidence”.

The US-China trade war could result in a $600 bullion hit for the global economy and would add to China’s woes (their economy had been losing momentum recently). Harvard University economist Carmen Reinhart said that “beyond trade-war risks and an uncertain monetary policy outlook, looming large for the global economy is the threat that China’s slowdown could be worse than currently seen”.

Some have argued that if the trade war worsens, China could dump US Treasury holdings in retaliation. The Official Monetary and Financial Institutions Forum says that such Renminbi “weaponisation” talk is overblown.

They say that as instability is anathema to Chinese leaders, they would not make “any abrupt or visible Chinese effort to sell off its $1.1tn-plus in Treasury holdings [as that] would set off considerable volatility in global financial markets” as there is no other market deep or liquid enough to absorb China’s reserves.

And no, the gold market isn’t big enough either. One would have to accumulate in a slow and steady manner. It just so happens that China and Russia are doing so.

Talking of trade and gold, we note yesterday that Malaysian Prime Minister proposed “a common trading currency for East Asia that would be pegged to gold” because it is “much more stable” compared to local currencies which were “affected by external factors and were manipulated”.

He only saw this gold pegged common currency for settling trade and “would not be used for domestic transactions”, so unfortunately no stable gold currency for the average person.

With the amount of gold purchased by Asian countries, the average person there doesn’t need any official endorsement. Bloomberg this week did disparagingly note that “you can still buy a house with gold bars in Vietnam” with the government observing that more than 95% of payments are made with cash and gold.

The Swiss also get it, with a recent survey revealing that gold is the second most popular investment behind real estate and with almost one in five planning to invest in precious metals in the next 12 months.

Why $2k?

So why do we see AUD $2,000 gold on the cards for 2019/2020? The above factors we do feel are supportive of higher US gold prices and we don’t think it is unreasonable to expect gold to get back into the low $1300s by the end of the year.

In terms of the Australian dollar, the outlook for Australia continues to be uncertain. Dwelling approvals fell 4.7% in April, which was less than market expectations. Private housing approvals are now down 20.5% for the year and down 28.8% for units. Business capital expenditures for the first quarter of 2019 also declined by 1.7% and decreases were recorded across all industries.

As a result, Westpac is now forecasting three rate cuts in 2019 that will push the cash rate from 1.5% to 0.75%. That has the bank lowering their forecast for the Aussie to a pitiful USD 0.66 by the end of 2019.
Westpack Twitter post 
That is a big call by Westpac Economics and such a low in the exchange rate would have a big impact on AUD gold prices. If the exchange rate reaches 0.66 by 31st December, the table below shows the $A gold price corresponding with various end of year US gold price possibilities.
 $US Gold Price   $1,200    $1,250     $1,300     $1,350     $1,400
 $A Gold Price    $1,818  $1,894  $1,970  $2,045   $2,121
If we chart the low, medium and high scenarios, you can see that a 0.66 Aussie dollar provides a lot of upside even if US gold prices go nowhere for the rest of the year, and if we indeed see the AUD this low, we would only need gold in US dollar to edge above $1,325 to see $2,000 gold for local investors.
Australian Gold Price Scenarious

Westpac also saw inflation at 1.4%, which with 0.75% rates means savers will be going backwards. That will push investors into dividend paying stocks and, we think, rekindle more mainstream interest in gold particularly if Australian gold price can break the newsworthy round $2,000 mark, ideally just before the ABC Bullion National Conference 2019 on 20th August, which will feature Jim Rickards and Evolution Mining's Jake Klein. Early bird tickets now available - an event not to be missed.
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.

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