Buying opportunity for gold as yields to peak?

In this week's market update:

• Precious metal prices fell sharply this week, with the market finally buckling under the weight of higher bond yields and a surging USD.

• Gold, which had been holding support above USD $1,900 per troy ounce (oz) for some time, fell by 3% over the past five days, last trading at USD $1,865oz.

• Silver was also hit, falling by 3% and last trading at USD $22.60oz. Over the past month silver has pulled back by 8% in USD terms, from closer to USD $24.50.

• Equity markets also continued to correct in the past week, with both the S&P500 and ASX200 down a further 1%.

• Oil prices continued their recent rally, up 2% and now trading above USD $90 per barrel.

• 10-year US treasuries continued their recent spike, last yielding 4.61%, up by 0.52% in the last month. Australian bond yields are trading at similar levels, having also risen by 0.49% since late August.

Bow to the King

Precious metal prices broke to the downside this week, with both gold and silver falling by 3% in USD terms. For Australian dollar investors, the pullback was more modest owing to continued weakness in the local currency, with the Australian dollar last trading at USD $0.638.

Surging bond yields were the primary driver of the pullback in precious metals, as well as risk assets which were also weaker, with US 10-year treasuries now trading at their highest level in a decade and a half.

Alongside the rise in yields, which we explore in more detail below, no other factor has been more responsible for the pullback in gold than the seemingly unstoppable rise in the greenback.
This can be seen in the chart below, which shows the USD index (DXY) in a weekly candle formation, with green candles being weeks that the DXY rises, and red candles weeks it has fallen.

As the chart highlights, DXY has risen for 10 weeks in a row, an almost unprecedented period of strength, with the index rising by more than 5% in the last three months after starting the year on softer footing.

While DXY strength will continue to hinder to gold to some degree as long as it lasts, there are already signs the rally will soon run out of steam.

Over the medium to long-term, rising recession risks, combined with a parlous fiscal outlook (not that the USA is alone in this regard) and an eventual pivot from the Fed make the case for an eventual significant fall in the value of DXY even more likely. Gold is set to benefit from those dynamics as they come to fore.
 
Bonds vs Bullion

While readers of these market updates will likely be paying more attention to the USD gold price, spare a thought for investors in long-term treasuries, who are seeing the market price of their holdings evaporate before their eyes.

This can be seen in the chart below, which plots the price of TLT, the 20+year treasury bond ETF issued by i-Shares. After reaching a high above 170 in early 2020, it has been all downhill, with the price of this ETF having fallen by almost 50% in the past three years.

The price has fallen so far that TLT is now trading at levels last seen more than a decade ago, back in April 2011.

This mark to market downside is often not discussed by financial commentators when looking at the rise in yields. Yes, all other things being equal, higher yields make bonds more attractive investments, but for existing holders, those higher yields equal capital losses.

And not only are the capital losses that long-term bond holders are currently sitting on far worse than those that gold bullion holders are enduring, those bonds are, over the medium to long-term at least, far more susceptible to both inflation risk and default risk, though the latter is obviously an extreme tail risk for sovereign issued debt.

Nevertheless, this collapse in long-term bond prices and the continued risks owners of these securities face highlights clearly why gold can play such a beneficial role in a portfolio, something the World Gold Council recently opined on, in an article specifically written for Australian investors.

Looking ahead, there is also the very real possibility bond yields do in fact peak and begin to decline soon afterward. That also would be expected to be a tailwind for gold, given those lower yields would mean there is a lower opportunity cost of holding precious metals.

Given this outlook, the current pullback in gold may be seen as a buying opportunity.

Stay the course with gold.

While the daily price volatility in gold can understandably worry investors, especially when that volatility is to the downside, there is no reason for long-term investors to panic on any given price drop.

Gold’s role as a highly liquid, zero credit risk asset, with a history of outperformance in periods of high inflation and/or market stress has been built over generations.

Outside of its portfolio role, it also remains a premiere monetary asset, with the team at Incrementum AG releasing a timely article on gold’s stock to flow ratio, and why this ratio helps explain gold’s unique suitability as form of money.

This is best expressed through what is referred to as the stock the flow ratio, whereby stock equals the total supply of a given item, and flow refers to annual production of the same item.
For most commodities, this ratio tends to oscillate around 1, as while a degree of security is preferred, it would not be economical for humans to build up indefinite stockpiles of oil, wheat, copper etc.

Gold is different, for the simple reason that unlike other commodities, gold is never truly consumed, meaning all the gold that has ever been mined still exists in some form today.

This leads to the incredible scenario, where, as per Incrementum, the “global stock of gold per capita since the beginning of the 20th century is fluctuating in a fairly tight range of 0.6 to 0.85 ounces. This is remarkable, as the global population has exploded from 1.65bn people in 1900 to some 7bn people today.”

With annual production of close to 3,500 tonnes, and just over 200,000 tonnes of known supply globally (most of which is in jewellery, coin, bar form), the stock to flow ratio of gold is roughly 60:1. This means it will take another 60 years of current production to double the current gold stock.

Changes in gold’s stock to flow ratio over time are seen in the chart below from Incrementum, with the ratio averaging just over 65 in the last 100 years.

Expressed another way, the total gold supply increases by approximately 1.5% each year, based on the newly-mined gold produced by companies around the globe, including those who refine their production at ABC Refinery.

Furthermore, this increase in the total gold stock on an annual basis is incredibly inelastic. Production volumes for gold miners may go up or down, but as a share of the existing total stock, the overall change driven by that slightly higher or slightly lower production will be minimal.

Geology, economics, and history combine to give us great certainty in that regard, and that certainty is valuable.

By contrast, the supply of fiat currencies has grown by closer to 10% per annum for most of the last five decades, with the inflation in fiat currency issuance accelerating in the aftermath of the Global Financial Crisis that first hit in 2007, and more recently, the COVID pandemic.

Note this stock to flow ratio doesn’t mean the dollar price of gold will always go up, as price action over the last five days has highlighted. But it does help highlight the unique monetary attributes that gold has, and why investors should feel confident gold will continue to do what it has always done.

Protect and build wealth over the long-term. 
 
Inside the office this week

We’ve seen a notable uptick in sales volumes at ABC Bullion this past week, with the pullback encouraging investors to add to their portfolio. This has been particularly notable for silver, with sales of our leading coins spiking, including clients taking advantage of our soon-to-end promotion on these products.
 
We also continue to see solid buying of our ABC Bullion 5kg silver cast bar, with SMSF trustees and HNW investors leading demand for those products, while they are also allocating to ABC Bullion 1kg gold cast bars, and pool allocated products.
 
In our Global Flagship store and amongst our state offices, we’ve also seen a pick up in sales activity, with a lot of this being driven by clients with a preference for our 37.5g ABC Bullion Luong Cast Bar, as well as our 37.5g ABC Bullion Gold Tael.
 
On top of these products, we also continue to see very strong levels of buying for our signature 1oz ABC Bullion Gold Cast Bar, which remains our most popular product by total sales.

Jordan Eliseo
General Manager
ABC Bullion Australia

Disclaimer: This document has been prepared by Australian Bullion Company (NSW) Pty Limited (ABN 82 002 858 602) (ABC). The information contained in this document 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