Dr Doom talks Gold as Inflation Accelerates

In this week's market update:

• Gold prices have rallied this week, with the precious metal rising by almost 1.5% to trade back above USD $1,650 per troy ounce (oz).

• Silver has also moved higher, up 4% toward USD $20 oz, with the gold to silver ratio (GSR) falling to 85 over the past five trading days.

• Equities, commodities and cryptocurrencies also enjoyed a bounce, with the S&P 500 +4%, oil +3%, and Bitcoin up 8%, with the latter now trading above USD $20,000.

• Bond yields have fallen aggressively, with prices for US 10-year treasuries up 3%, as yields for 10 years in both the United States and Australia fell below 4%.

• The surge in the US dollar, which has dominated markets this year, has at least paused in the last week, with the dollar index (DXY) falling by 2%.

Was that the top for the dollar?

Markets have rallied over the last five trading days, with equities, precious metals, cryptocurrencies, commodities and large parts of the fixed income universe all seeing price rises.
Precious metal investors have been particularly well rewarded by silver, which is up 4%, while gold has increased by 1.5% %. In Australian dollar terms prices have been more subdued, owing to a 4% rally in the value of the Australian dollar, which is now trading back above 0.65 US dollars (USD).

Expectations of a slow-down in the pace of interest rate hikes has contributed to the bounce seen across markets in the past five trading days, with the Bank of Canada’s decision to hike rates by just 0.50% this week (rather than the 0.75% hike many were expecting), and their communication indicating they are getting toward the end of their rate hiking cycle fuelling investor belief we may see a global slowdown in monetary tightening as we head toward Christmas.

There is no guarantee that belief will be rewarded, as the last time a commodity rich country with an heavily indebted household sector passed on a smaller than expected rate hike (we are referencing the RBA’s 0.25% rate hike from earlier this month), it was hardly a global signal, with the European Central Bank passing a 0.75% rate hike at their meeting overnight.
In the United States, stronger than expected US GDP data, which saw the economy growing by 2.6%, suggests there is no reason for the US Federal Reserve (the Fed) to pivot to more dovish policy.

While we will need to wait to see what the Fed does next, the bigger driver of markets in the last week was the fall in the USD, which, despite bouncing overnight, declined by 2% as measured using the US dollar index (DXY).

As we’ve covered in recent articles, the USD has been a wrecking ball for most of 2022, hitting multi-decade highs against other major reserve currencies including the Euro, the Japanese Yen, and Pound Sterling this year.

A multitude of factors, from aggressive rate hikes by the US Federal Reserve to political chaos in the United Kingdom, to the Russia invasion of Ukraine, and the still dovish Bank of Japan have driven investors into the USD, which is still up 18% since the start of the year.

That rally may now be on borrowed time, with DXY down 2% this week, at one stage falling below 110, by which point it had corrected by 4% from the intra year high closer to 114 seen just a few weeks ago.

If the dollar has indeed topped, and continues to weaken going forward, expect this to act as a major tailwind for gold, and the broader precious metal complex, including silver.

Budgeting for more rate hikes

All eyes were on Canberra this week, where the Albanese Government delivered their first Federal Budget. While this understandably generated much attention, in many ways the more important development came on Wednesday, when the Australian Bureau of Statistics released Q3 inflation (CPI) data, which showed consumer prices rising at 7.3% per annum.

The result was significantly higher than market expectations (which were for an annual price increase of 7%), with the trend set to rise into the end of the year, with higher energy prices and rents still feeding into official CPI data.

The CPI result poses a challenge to the Reserve Bank of Australia (RBA), who meet next week on Melbourne Cup Day. Earlier this month, the RBA surprised many by hiking rates by just 0.25%, a slowdown from the 0.50% hikes they implemented in each month between June and September.

This week’s inflation result puts some pressure on the RBA to again hike rates by 0.50% next week, though this may be counterproductive, as it will be interpreted as a knee jerk reaction.
They’ve also indicated they see benefit in slowly passing on rate hikes, to help keep it top of mind for households, rather than hiking more aggressively, but over a shorter time frame, with the October RBA minutes noting; “Drawing out policy adjustments would also help to keep public attention focused for a longer period on the Board’s resolve to return inflation to target”.

Irrespective of the path they take, there seems little doubt this week’s CPI data will lead the RBA to adopt a higher for longer approach when it comes to interest rates, despite the likely negative implications for consumer confidence, the housing market and overall economic output.

Market pricing, which is reflected in the below image sourced from the ASX as at the market close on Wednesday 26th October, now suggests the cash rate will peak at 4.17% in September 2023 and hold that level through to November at least.

Should this come to pass, Australians will have to deal with just over 1.50% of additional tightening in the year ahead, on top of the 2.50% of rate hikes the RBA has already delivered in 2022.

While higher rates are in theory a headwind for gold, they of course need to be analysed in the context of inflationary pressure. On that score, this week’s CPI indicates that we are likely to remain in a low to negative real interest rate environment, both in Australia and overseas, for years to come, even though rates themselves are scheduled to rise from here.

If history is any guide, those low real rates will be gold bullish, with the precious metal often leading markets in such environments, as a blog we published earlier in the week highlighted.

Central banks to wimp out?

Nouriel Roubini, who is widely known in the markets as ‘Dr Doom’, joined the OddLots podcast (hosted by Bloomberg’s Joe Wiesenthal and Tracy Alloway) on October 20th to talk all things economics and investing.

The podcast, which is worth listening too, covers a range of topics that should be of interest to all investors, including precious metal bulls, with Roubini highlighting

• The rising risk we are entering a stagflationary environment as we head into next year, with a crisis that could last for the better part of a decade

• How the challenges the global economy faces today are worse than the 1970s, primarily due to the high levels of debt (household, business and government), both in absolute terms and as a percentage of output, which complicate the policy choices available to deal with the challenge

• Why many of the challenges the economy faces, including forces pushing inflation higher, are structural (think deglobalization, reshoring etc) rather than cyclical, which makes it much harder for central banks to get inflation back within acceptable limits, irrespective of how hard they pull the interest rate lever

• Why central banks have no good choices, with Roubini effectively stating that they are ‘damned if they do and damned if they don’t’ when it comes to either needing to hike interest rates so far to squash inflation that they cause a major recession, or, in their desire to avoid a major recession, they end up allowing inflation to run hot for many years

When push comes to shove, Roubini believes higher inflation is the likely endgame as it were, noting that _“_There is a chance that central banks will wimp out and blink, and not be willing to fight inflation”.

Roubini also spoke of potential solutions for investors looking to protect and ideally grow wealth in this incredibly challenging environment he foresees, noting that he believes gold is one of the assets investors may wish to hold in their portfolios.

Specifically, he noted that:

You might want to go into gold. Gold has not done very well in the last year* but once inflation becomes unhinged when the central banks are going to blink, and until now central banks have played tough. That’s why gold has done poorly, because the real rates were going higher. Then gold is going to outperform like other precious metals, like probably many commodities. But the commodities are going to be hurt by the recession. So gold is actually less cyclical.

*Note: Roubini is likely referring to the USD gold price here, as gold in most currencies has done very well

We couldn’t agree more, with Roubini’s outlook covering many of the reasons why clients at ABC Bullion are adding gold and other precious metals to their portfolio today.

Warm regards,

The ABC Bullion Team

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 in this document. It is intended for the use of ABC clients and may not be distributed or reproduced without consent. © Australian Bullion Company (NSW) Pty Limited 2020.