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Worst Crash Since 1987

13 March 2020

Precious Metals Commentary

Stock markets have gone from bad to worse this week with the most vicious sell-off since the 1987 “Black Monday” crash. The Dow plunged 2350 points to 21,200, a fall of 9.99% and is 11.84% lower in after market trading. Europe’s Stoxx 600 Index had the worst day on record falling 11%, German’s DAX and France’s CAC 40 both plunged over 12%. Gold was dragged down lower on liquidating longs to USD$1,576 but the AUD took an absolute beating to 62.7 cents falling over 2.7% overnight. After all of that action, Gold in AUD terms remains only slightly lower this morning at $2,510 and silver traded lower to $25.35 an ounce.

Market Report Chart 1
 
Flashback to our market update from the 7th of February and our friend and portfolio manager Tony Bradley form Hunter Burton Capital called the sell off in the Dow to a tee. Back then the market was still rallying and we talked of the highly probable sell-off when the market finally woke up. The chart above is the latest daily chart of the Dow and the one below is Tony’s call from the 7th of February. Fair to say our readers were warned.

S&P 500 Weekly Chart
 
Gold is proving itself as a safe haven in light of the market sell-off and we have been stressing for weeks that the US stock market reaction did not match the potential economic impact of COVID-19.

They say if you are going to panic, panic early and those heeding warning to reallocate out of equities would have to feel a lot better than those holding or trying to buy the ‘dip’. We feel when it comes to global stock markets, given valuations started at such a historically high level, that unfortunately the market has a lot more room to the downside this year. Expect wild swing and some massive green reversal days along the way, but we wouldn’t be buying into any bounces in the near term.

So is it too late to buy gold? Well, given the price is still some USD$300 an ounce lower than the 2011 highs, (despite the US money supply expanding by trillions of dollars since), we think there is a long way to go with this bull market.

Physical gold has been the ultimate safe haven in this environment and those looking to get leveraged gains through gold mining equities would have been bitterly disappointed in recent times. We have commented previously that one should consider gold mining equities and physical gold as entirely different asset classes and not get the two confused.

Gold mining companies’ success depends first and foremost on the quality of the operation and managerial skill. If that is in place with tight cost control then a rising gold price can result in leveraged gains. However, in times where the broader market is selling off gold mining equities can get caught up and often do not act as a safe haven.

Year-to-date the Australian Gold Mining ETF XGD is negative 3.77% whereas physical gold has risen 17.8%. That is a whopping 21.5% outperformance by the more boring and lifeless variety of gold exposure, and really drives home the point that investors should hold physical metal, even if they have gold exposure through mining equities.

Simple Moving Average Chart

Picking individual miners can provide higher returns but it comes with higher risk. Many of the companies on the ASX were already trading at very high valuations relative to earnings at the start of 2020 and many have had production issues impact their relative performance.

A sell off in Australian gold equities doesn’t make sense when the Australian gold price is at all-time highs and we may indeed see these miners bounce back after the selling of the broader market slows. However, we want to stress the difference between the two. Gold is a defensive asset class that should reduce the overall volatility of a diversified investment portfolio. Gold mining equities, on the other hand, are a speculative growth investment with the potential of having extraordinary gains if you pick the right one. With greater potential returns comes greater risk, and if we do see this stock market sell-off gain momentum and trend lower throughout the year, there is some additional risk in mining equities. 


Gold Underperforming?

Given the dramatic stock and bond market movements over the past two weeks we have seen questions raised that gold should have moved up much more than it has. As we noted last week, a common answer is that gold’s underperformance is related to margin selling as investors taking losses elsewhere need to sell their winners.

While this is no doubt a factor, Scotiabank suggested two other reasons. First, that as gold is considered by some traders as a commodity (wrongly in our opinion) and as commodities are being hit on fears of COVID-19 economic contraction, gold is being likewise sold.

We do note that gold is often lumped in with other true commodities in fund manager commodity baskets or ETFs or as part of a fund’s allocation to “alternatives”, so there is some truth to this claim. We are not so sure how much downward pressure this does exert on gold and for proof of that, one just has to compare gold’s performance to that of oil. The fact that the gold:oil ratio has increased from 25 to 40 this year shows gold’s resilience.

The second reason Scotiabank raise is poor Asian demand. They say that gold prices in Asian currencies are at all-time highs (as it is in Australia) and as a price sensitive market this has resulted in Asian bullion and jewellery demand being well down.

The World Gold Council noted that the volume of physical gold trading on the Shanghai Gold Exchange is at subdued levels with an extremely quite jewellery trade, as can be seen in the chart below.

SGE Volumes: 9999 (physical) contract, 5 day MA

Interestingly, when looking at the T+D (paper gold) contract we see a dramatic turnaround in recent weeks from Chinese speculators and investors. Possibly physical buyers who are unable or unwilling to leave their homes are instead looking to protect their investments with online trading instead?

SGE Volume: T+D (fiancial) contract, 5 day MA

TD Securities confirm that Chinese physical demand has been weak and has not been helped by the lack of flights due to COVID-19 and import restrictions. They are seeing signs that imports will open up April.

Research firm Refinitiv note that the UAE gold market has been struggling to return to growth owing to the high gold price and an economic slowdown. Gold imports into Thailand also fell sharply in January as the market recorded a rise in jewellery scrap and dis-hoarding of investment bars as their local prices reached a six-year high.

An example of how gold’s recent performance has been paper trading rather than physical comes from the London Bullion Market Association (LBMA) which said that on Monday trading volumes in the private over-the-counter market almost reached $100 billion, its highest ever daily volume. Last week close to $400 billion was traded by the LBMA’s member banks.

Interestingly, and probably not surprisingly, TD Securities reported that it was very obvious that high speed algorithm trade has been dominating the volume. They said that the dips were becoming shallower and shallower, which suggested gold positioning was becoming stickier at higher levels.

BNP Paribas says that gold’s performance to-date was not all about COVID-19 fears and “gold is going to continue to attract investor interest, driven by the monetary policy environment that continues to ease” with a steady zig-zag move higher to $1,800.

Our take is that markets were a bubble looking for a pin, and COVID-19 looks to have been that pin. The result may well be a reassessment by retail and institutional investors about the value of financial assets, the result being continued financial/paper market flows into gold as those investors rebalancing towards defensive assets like gold.

At ABC Bullion we are up around 141%, or nearly three times off the baseline buying volumes we saw in the second half of 2019. Many other Western dealers are reporting similar and when Eastern demand returns that will add a further boost to gold, in our opinion.
 

Silver Shocker

If some consider gold has been underperforming, than silver has been a shocker. As we said last week, silver has been much harder hit as traders focus on COVID-19’s negative impact on industrial production, pushing the gold:silver ratio above 100 for a brief time this week.

As you can see in the chart below silver, relative to gold, is at historically extreme levels that we find hard to believe can be sustained.

Gold:Silver Ratio Chart

While 50% of silver’s demand is industrial, we think it is being overplayed as a negative but it seems the paper jockeys are in control for the moment. Silver is a monetary metal like gold and when investment demand returns in force then silver should turn, and hard, as it is seen as the leveraged version of gold.

Last year when the gold:silver ratio was at 92 we thought silver was set for some positive outperformance relative to gold and we are certainly disappointed that COVID-19 has derailed what we thought was going to be a long-term move in the ratio back down to 70 and lower.

In terms of ABC Bullion’s clients, silver is a small part of their precious metal allocation. The table below groups our clients by what sort of metal they have been buying since July 2019.
 
Type of Buyer % of Clients
Gold Only 63.4%
Silver Only 18.7%
Gold & Silver 13.1%
Other 4.8%

Most of our clients, around 83%, are faithful to one metal with gold the metal of choice. For those that invest in both metals they skew towards gold as well, on average holding 80% in gold and 20% silver.

By dollar value, gold has averaged around 90% of ABC Bullion’s sales this financial year, with silver taking up the balance and platinum metals only a few percent, as the weekly sales by metal chart below shows.

ABC Bullion Sales by Metal Chart
 
Interestingly, we have seen a shift toward silver in recent weeks from the usual 10% of sales to 15%, as the gold:silver ratio has shot up, so some see value in silver at these levels.
 

Snowed under with Super

Over the past couple of weeks we have been snowed under with phone calls to buy gold but particularly with those wanting to get some gold in their superannuation - the market correction has focused investors on diversification and safe assets.

This is not surprising, with this correction being one of the fastest on record as the chart below shows (the thick pink line is 2020). This chart was from two days ago, so is already out-of-date, but it does indicate that further declines would not be unusual.

All Dow Drawdowns Greater Than 20% chart

Wall St seems to have changed its bullish tune and Australian fund managers have also shifted conservative, as these quotes show:
  • REQON Broadcap Fund: “90 per cent of our fund now in cash … we feel its prudent right now given the risks in our view are unfortunately stacked to the downside”
  • Marcus Padley: “We run money as if it is our own (and some of it is). I would personally cash out sometimes if it was all my own, so why wouldn't we cash out our clients as well”
  • Nucleus Wealth: “We went to cash & bonds (within mandates) at the end of January and spent 4 weeks explaining to clients that even though markets kept rising the risks were real.”
Of course, mainstream fund managers don’t consider gold or silver as an alternative to cash (or even just a part of that safety allocation), which is surprising given the gains it has provided relative to interest rates on cash.

Many of the calls we had were from people without a self-managed super fund (SMSF) who were looking for a way to get some gold exposure. If your fund has a range of investment options, we suggest looking through the list as there are fund out there with allocations to gold.

We mentioned the Dragon Portfolio a few weeks ago which has 19% allocation to gold and this week we came across Dynamic Asset, whose Wealth Builder Portfolio has an 18% allocation to precious metals.

DAC Wealth Builder Asset Allocation Chart

If you and your family have a reasonable amount of super in total, a SMSF can be cheaper than a retail or industry fund. It is not that hard to set up and operate a SMSF these days and it gives you the benefit of full and direct control over your investments and the ability to hold physical gold outside the financial system.

We have just recently updated our two guides to precious metals and super, so if you are looking to really diversify your super, download them today:
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 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.

Although the information and opinions contained in this document are based on sources we believe to be reliable, to the extent permitted by law, ABC and its associated entities do not warrant, represent or guarantee, expressly or impliedly, that the information contained in this document is accurate, complete, reliable or current. The information is subject to change without notice and we are under no obligation to update it. Past performance is not a reliable indicator of future performance. If you intend to rely on the information, you should independently verify and assess the accuracy and completeness and obtain professional advice regarding its suitability for your Personal Circumstances.

To the extent possible, ABC, its associated entities, and any of its or their officers, employees and agents accepts no liability for any loss or damage relating to any use or reliance on the information in this document.

This document may not be distributed or reproduced without consent. © Australian Bullion Company (NSW) Pty Limited 2020.