Corona Cramps China Supply Chains

Precious Metals Commentary

Gold moved higher this week, particularly in AUD terms. Spot gold in USD rallied to $1,577 and silver fell back to USD $17.66. The AUD/USD was on struggle street last week hitting an 11 year low last Friday night at 66.7 US cents. A slight recovery to 67c at time of writing puts us at $2,346 an ounce as the trend in AUD gold continues higher. 
 

 
In the short term, it seems the price is being supported with safe haven buying stemming from fears of coronavirus not being contained in China and news of a longer incubation period than initially thought. For now, gold remains in the trending range above in AUD, and momentum is still positive.

CPM Group released their ‘Gold and Other Metals in 2020’ presentation slides and they are well worth a look. Citing increased risks globally, they predict gold to be trading above USD $2,000 within the next 5 years, before falling off after 2025.

Corona Cramps China Supply Chains

Up until yesterday, stock markets seemed unconcerned about the impact of the coronavirus. However, markets took a hit and gold got a bump after a shock announcement of 14,840 new cases and 242 additional deaths following a “broadening of the definition of confirmed cases”, supporting claims that there has been under-reporting of the impact of the virus.

There are reports out of Bejing and Shanghai that massive parts of the cities are in complete shutdown, with no one leaving their homes to go to work or school. Some residents are reporting that they must carry a special ID card to check in and out of their apartment with only one person allowed to leave at a time. Upon return to the apartment, guards check their temperature before being allowed back in.

We expect that most market participants are still shrugging off the actual scale of the virus and are experiencing a case of ‘normalcy bias’ as the numbers internationally or outside of China have muted fears. No doubt the lock down of major parts of China will have a massive impact on Chinese Q1 GDP as commerce and trade is being greatly affected.

Further troubling updates have been reported this week with Chinese scientists suggesting the incubation period (which was previously thought of having an a maximum of 14 days) is now showing signs that carriers of the virus may not show any symptoms for up to 24 days. This could mean we need around 24-48 days after flights were cancelled from China to know the true level of the contagion overseas.

Saxo Bank say that the resulting economic disruption and reduced growth and economic activity has them favouring “__defensive positioning and haven plays (gold, US rates)”.

They also note a longer-term impact from the virus on China, saying that it will create additional impetus by companies to diversify their supply chains and pull production out of China.

With nearly 85% of the core components of many medicines concentrated in China, which could compromise the global supply of medicines, that is probably something the West should be doing.

The effect of the coronavirus on gold appears mixed at this time. China Gold Association expects jewellery demand to plunge as coronavirus keeps consumers at home.

TD Securities reported this week that no gold was going into China because many of the entry ports are still closed and most flights suspended, “so right here, right now – the market is effectively shut”.

The fact that the gold price has held above $1,550 in the face of that curtailing of demand shows how strong Western buying is. ETF inflows remain robust in the US and investment demand is currently still improving. Scotiabank says that with coronavirus fears triggering renewed growth concerns, $1,550 an ounce is a new price floor for gold and a buying opportunity.

Currency Competition – No Thanks

Back in June when Facebook announced its Libra stablecoin project, we noted how currency competition isn’t something governments are keen on.

In our view, the timing of the Libra announcement when central banks were grappling with how to implement negative interest rates when people can hoard cash crystallised central banker attention on the potential of digital currencies.

The potential for people to hoard cash isn’t theoretical either, with Bloomberg reporting that the physical cash holdings of German banks rose to a record $43 billion in December.

The growth follows the European Central Bank starting to charge for deposits in 2014 and has reached the point where banks have run out of space and have been approaching precious metal dealers to store notes in their vaults.

Moves like the $10,000 cash ban in Australia, or Germany’s cash transaction threshold of 2,000 Euros (which resulted in bullion dealers being overrun before the deadline), are examples of one approach to the “problem” (as they perceive it).

The other approach is for a central bank to issue its own digital currency, which US Federal Reserve Governor Lael Brainard recently said they were looking at.

Of interest to us was Lael’s specific mention of Libra as having the potential “to be adopted globally in a short time period and to establish itself as a potentially new unit of account”.

While mention was made of risk to consumers from private currencies operating outside of existing financial system “regulatory guardrails”, we think the new unit of account is what the Fed and other central banks are more worried about.

Once cash is banned or severely restricted and everyone is using digital money, then imposition of negative interest rates becomes easy, even more so if people are holding digital (rather than physical) currency issued directly by a central bank.

One issue that has been raised a central bank digital currency is that it could increase the risk of bank runs as people could quickly transfer their bank deposits into their central bank “wallet”.

We think this is actually something central banks aren’t too fussed about, as it means that the central bank becomes truly “central” to the financial system with banks being primarily lending, rather than deposit taking, institutions reliant on funding from the central bank with all its consumer deposits.

As the Bank Policy Institute observed, the Fed’s role in the financial system used be small and only supported the markets once in a generation. Today, however, the “taxpayer now supports - directly and daily - a massive, unprecedented, and growing Federal Reserve role in U.S. financial markets”. Such empire-building is unlikely to be scaled backed.

If you are reading this then you know that gold is the easiest way to exit such a socialistic financial system, both in terms of privacy and “hoardability” as gold’s value density is much better than cash.

We wonder how long before those German banks realise gold takes up less space than cash and comes with upside potential?

Australians Overexposed to Housing

Fixed income investment manager Ardea had an interesting article noting that while average Australian household wealth exceeded a million dollars in July 2019, hidden in the figures was an excessive exposure to housing.

It would be no surprise that owner occupied housing was the largest contributor to household wealth but the next two largest assets - super and other financial assets – resulted in indirect exposure to the housing market.

With banks comprising 25% of the Australian equity market and 30% of the bond market, money in super has significant exposure to banks, who are very exposed to housing mortgages.

They also note that the other financial assets category includes 15% in equities and 33% in deposits and offset accounts – again direct exposure to banks and thus housing.

When it comes to non-bank equities, fund manager Staude Capital says that while the ASX200 has finally crossed the peak it set in October 2007, company earning for 2019 are 20% lower than they were in 2007.

How can the markets be valued the same when they are 80% as profitable? Staude Capital says it is because interest rates have “have fallen from 7.25% in 2008 to an all-time low of 0.75%” and that “increase[s] the relative value of other future income streams, like company profits”.

Those profits don’t look good if Roy Morgan’s Business Confidence survey is any indication, with their index dropping to a nearly nine-year low and only lower during the last decade at the height of the European sovereign debt crisis.

 
Reduced profits combined with rising interest rates would be devasting to share prices. No doubt one of the reasons why central banks are so intent on lower and, if necessary, negative rates.

Fund manager Goehring & Rozencwajg says that the problem, although not if you are holding gold, with such an interest rate policy and resulting increase in indebtedness is that it has “led to major distortions including the emergence of widespread speculation in the global bond markets”.

In their view, these distortions will create the perfect backdrop for a bull market in precious metals during “a period of huge speculation not unlike one we saw 40 years ago” the end of which they see a gold price target of $12,000 per ounce.

Although we won’t go out on a limb and claim such a bullish target, we do note that gold looks like a much better investment than many bonds out there. The yield on Greece’s 10y bond just dropped below 1% for the first time ever, highlighting just how absurd bond markets are in 2020.

Greece has the highest debt to GDP ratio in the Eurozone at over 180% and you can lend them money at a return of 1% p.a. today, when at the peak of the GFC they were trading at a 45% yield. Go figure.

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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