Another week, another battle for USD $1200oz gold, as the market continues to trade just below this key level. After dropping below the critical mark last week, gold climbed back to USD $1197oz on the 5th May (London PM Fix), before easing back into the mid $1180oz range where we find it today.

The Silver market has been much the same, trading between USD $16.15 and USD $16.70oz, as the precious metal market continues to look for a decisive break out one way or another

AUD gold prices have pulled back below $1500oz, with silver below $21oz, as the strength in the Aussie dollar (despite the RBA interest rate cut), impacting the market for local investors.

I personally used that opportunity to top up my silver position, as I think the AUD rally will be relatively short-lived, in part because I think the RBA will continue to cut rates in 2015 and beyond.

As has been the case for some time now, the gold market is being impacted by a number of forces, some which are providing support, whilst others continue to dent demand for the metal.

In the last week or so, we’ve seen a not unsubstantial rise in bond yields the world over (something we’ll discuss in more detail below). Rising yields, especially in a period where official inflation is so benign, are of course a mortal enemy for precious metal bulls, as they effectively raise the opportunity cost of investing in the metal.

Anyone who can remember the gold price smash of 2013 will also likely remember that US bond yields rose substantially that year, with the 10 year note going from around 1.60% to 3%.

On the other hand, we’ve seen continued pressure on the USD, with the dollar index pulling back below 95 (down from near 100 in April). This is partly a result of a very oversold Euro gaining some traction, as well as the continued deterioration in US economic data, which is forcing more market participants to push back their expectations of when the Federal Reserve will first raise interest rates.

We’ve also seen a little risk aversion in global stock markets of late, with our own ASX under severe pressure in the last few days. Nervousness regarding equity positions will not necessarily have been helped in light of Janet Yellen’s comments this week regarding the markets, with the Chair of the Federal Reserve stating that she “would highlight that equity valuations at this point generally are quite high. They’re not so high when you compare the returns on equities to the returns on safe assets like bonds, which are also very low”

Finally, whilst this is a very early call, there are some who see inflation stirring – with oil near a 5-month high after the huge crash of 2014. This is despite the overnight fall of some 3%. The charts below (which go to the 7th of May) show what has happened in the oil market over the last year, with the huge fall between May 2014 and January 2015 easily observable, as well as the noticeable pick up since then.

It will be interesting to watch what happens with oil and in commodities more broadly in the coming weeks. Some analysts are chalking this up as a portent of higher growth in the coming months (and an expected US GDP bounce back in Q2), whilst others see it as a dead cat bounce, with further downside for the commodity complex in 2015 and beyond.

Bringing this back to gold, and it’s not hard to understand why we are seeing the continued consolidation of the market around key support, and a trading range between USD $1170oz and around USD $1210-USD$1220oz.

Looking at the chart below, which dates back to the start of 2014 and we can see how gold has been in a largely downward trend since failing to break above USD $1400oz in early 2014. As you can also see, the market has spent spend a lot of time pushing above and below USD $1200oz lately, after the recent failure to break above USD $1300oz earlier this year.

Technical indicators like MACD and RSI aren’t giving a clear signal either way now, though the market could move significantly overnight if the US non-farm payroll report is a major surprise. As is stands right now, the market is expecting that some 225k jobs will have been created in April, a huge increase on March’s disappointing result.

With a still uncertain outlook for the metals, dollar cost averaging is still the smartest approach to those looking to build long-term positions. For Australian dollar investors, this week’s cut in the cash rate is just another incentive.

RBA Cuts Australian Cash Rates to the Terrible Two

This week may end up being remembered as a watershed moment in Australian economic history. The Reserve Bank of Australia, as expected by the majority of market participants, cut interest to just 2%, the lowest rate in history, and nearly 20% lower than what they were back in the early 1980s

As the Daily Telegraph noted (with a little creative licence in places), “Since Captain Cook first stepped on our shores, we’ve had a gold rush, depressions, two world wars, the threat of nuclear annihilation – but never has the official interest rate been this low”

Whilst most market commentary discussed the savings for the ‘average home loan’ with another 25bps lopped off the cash rate, we’re also starting to see some acknowledgement of the pain low interest rate is causing to savers.

With over $2 Trillion sitting on deposit with Australian banks and ADIs, the 525 basis points of easing we’ve seen since the GFC arrived amounts to a roughly $100 billion hit to our national income, money that could be being spent in the Australian economy. And whilst the government is trying to talk up low rates and the ‘confidence’ they can instil, the Australian had a great article out today questioning this, with the full article available here.

As the article states; “Joe Hockey’s insights into interest rates were better when he was in opposition. When the Reserve Bank cut official rates to a then ­record low of 3 per cent in late 2012, Hockey said such “emergency” levels signified both a “falling economy” and the “huge ­challenges” facing Australia. They still do. Yet when the RBA cut rates to a new record low of 2 per cent on Tuesday, he said it was “good news” for households and businesses. The two statements can’t both be right — is it any wonder politicians lack credibility?

In any case, the latest interest rate cut is unlikely to do much more than the previous series of cuts have: puff up ever further Australia’s world-beating house prices and household debt. Ultra-low interest rates, abroad and ­increasingly here too, are a symptom of stagnation and severe ­financial market distortion. Households and businesses should not be rushing to celebrate — and they evidently aren’t, given the gloomy confidence indicators.”

We couldn’t agree more with the analysis. Low rates are a sign of desperation, not prosperity or confidence, and it’s no wonder they aren’t working the way most economists and the government would wish.

The other interesting component of the RBA rate decision was the reaction of the markets. Conventional theory would suggest that a cut in interest rates should see your stock market rise and your currency fall, but the exact opposite occurred on Tuesday afternoon in the aftermath of the RBA decision.

The reason for the surprising (on the surface at least) movements in markets and the currency was the immediate pricing in of a bottom in interest rates in Australia, even though the RBA stressed that the Australian dollar needed to fall further. This was off the back of the statement by Governor Glenn Stevens discussing the interest rate cut, which the market clearly didn’t think was dovish enough.

In other words – the market essentially told the RBA that what they did (cut interest rates) was less than important than what it sounded like they were preparing to do (not cut them anymore).

The sell off in stocks and the rally in the AUD essentially represent the market calling the RBA’s bluff, tempting or daring them to cut rates further in the future, something I expect they will end up doing, no matter how reluctantly.

And indeed today we’ve seen a slight repricing toward further cuts, with the just released RBA statement of monetary policy including the following key predictions

• AUD not offering enough support to economy, further fall seen likely and necessary

• Non-mining investment not likely to pick up in coming quarters as had been expected

• Unemployment rate seen peaking at 6.5 pct in mid-2016, stay elevated for longer

• Spare capacity in labour market to last longer than previously thought

• Expects wage growth to stay contained, but not fall below inflation

They also had some more than optimistic forecasts for commodity prices and future growth rates, neither of which is likely to be met, and will therefore only further pressure them to cut lower. I still expect to see rates head closer to 1% by the middle to end of 2016

Watch the Bond Market

Whilst Australians were almost totally focused on the actions of the RBA this week, and the sell off on the ASX that saw tens of billions of dollars wiped off the market cap of some our largest stocks, the real move globally has been in bond yields.

Over the last week or so, we’ve seen an extraordinarily violent upswing in sovereign bonds around the globe, most notably in Germany, where 10 year bunds rose from 0.07% to over 0.50% in a matter of days.

The chart below (as well as the table which is also included in this report), comes from an excellent report into the bond market, published yesterday by Morphic Asset Management. It shows the decline in German Bund Yields over the past few months, and then the huge spike over the last week or so.

The bond market isn’t just selling off in Germany either, but all around the developed world, as the following table highlights, showing yields for the US, Italy, Japan, Australia and the United Kingdom too.

As is evident from the table, the bull market in fixed income is now more than 30 years old in the entire western developed world, with borrowing costs some 90% lower than what they were at the start of the 1980s.

A senior credit analyst for NAB discussed this sell off earlier in the week, noting that; “the collapse has finally happened after a few weeks of wondering, self-doubt and then a blasé attitude that the rest of Europe could survive a Greek default, concerns escalated and led to a widespread selloff in both sovereigns and company credit.”

That comment, as well as a look at some other charts depicting the sell off where carried in a report by Business Insider Australia, which you can see here.

My own view is that it’s still a little early to be calling this the end of the great bond bull market. That it will eventually end, and come crashing down seems a mathematical and historical certainty, but trying to call it to the day or even week that it happens is an impossibile and ultimately meaningless task.

Indeed I find myself broadly agreeing with Morphics take on the recent moves, with the asset manager nothing that;

“A week of selling isn’t really enough to call the end of a 35 year bull market. But we would note the speed at which this occurred on what was nominally not much “new news” this week. The most likely outcome is this abates at some point as bond markets adjust to realising growth and inflation this year aren’t as bad as first feared. Japan has shown us how hard escaping debt deflation is. But what was most concerning, was just how quickly the market fell away last week. What news marked the top of the Tech bubble in March 2000? Nothing. It was an otherwise boring week. It had been overvalued for years and some of the greats had gone bust trying to short it. No, we’re not saying the bond market is that egregiously overvalued, but we return to the prior point that rates had gone negative in many places, where people were handing over money with the guarantee of losing some of it!”

The Morphic report can be found here

In a perfect world, government bonds really would be low risk safe investments, but we don’t live in that world anymore, with trillions of dollars of unpayable debt and even more in unfunded liabilities practically guaranteeing some form of developed market default in the coming years.

The fact that investors have become so desperate that they were literally paying those governments to take their money off them, in the form of negative yields, is another sign of how distorted financial markets, and our economy have become.

That doesn’t mean you can’t, or shouldn’t own bonds in your portfolio, but truly diversified and conservative investors also need to have a healthy allocation to physical precious metals.

Until next week

Disclaimer

This publication is for education purposes only and should not be considered either general of 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, 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. This report was produced in conjunction with ABC Bullion NSW.