Fear and Uncertainty Drive Gold

Precious Metals Commentary

A constructive week for precious metals. After trading between $1,490 and $1,510 last week, gold jumped $30 Friday US time on tit for tat tariff increases from both the US and China. Then followed Fed Chair Jerome Powell’s Jackson Hole speech which focused on uncertainty around trade and risks to the US economy.

We say constructive because gold held on to its Friday gains and now seems to be trading in a $1,520-$1,550 range, testing the bottom of that as we write.
 

Silver did not want to be rangebound like gold and made a run up to $18.60 and is comfortably above $18.
 

This resulted in a fall in the gold:silver ratio this week to around 83 (having peaked at 93.5 in early July). Even with this fall in the ratio, we still think that “the probabilities favour a weighting towards silver at this time”, which we said back on 28 June when the ratio was 92.

As we noted back in June, Metals Focus sees the ratio dropping to 70. If gold does nothing and holds at $1,520, this would equate to $21.70 for silver. However the path to 70 will not be a straight line if the last couple of months is a guide – silver appears to have periods of outperformance relative to gold, then consolidation.

If you currently hold gold and are interested in increasing your allocation towards silver, note that ABC Bullion offers a preferential rate by reducing the buy/sell spread on gold to silver swaps.

The Australia dollar spent the week grinding lower to the 0.6710s after an initial pop on Monday to 0.6788. This left Aussie gold and silver following the performance of their US prices to be trading at $2,273 and $27.27 as we write.

Fears and Fundamentals

We have seen commentary questioning whether the run up in precious metal since gold broke its long-term resistance of $1,375 has been too fast and not supported by fundamental (i.e. physical) buying.

Since the June breakout, we have seen a dramatic increase in Comex open interest to levels similar to those as the metals peaked in 2011. Positioning by future market participants is also at extreme levels. At the same time, commentators point to continued poor US Mint coin sales. The claim is that the price action less fundamental and has been primarily speculative in nature (even if fear-driven) and subject to reversal given the leverage involved by traders of futures and options.

In contrast, we would point to strong inflows into physically backed ETFs and our own experience as we have not seen any let up in physical buying in Australia.

While it is not unreasonable to expect the metals to see a correction after a 10% rise in two months, our view is that while we still see positive statements regarding gold from mainstream media and banks (see bullet points below for some recent examples) a “buy the dip” mentality will prevail and see gold and silver prices supported.

• Citigroup - ratio between gold and the S&P 500 is testing a critical pivot point and a break higher could trigger a rally that pushes gold prices 25% higher (i.e. $2,000 an ounce)

• UBS - further escalation in the US-China trade war would heighten the risk of an economic slowdown and see gold prices trading between USD 1,600/oz and USD 1,700/oz

• Bank of America - the risk of quantitative failure, which was not a concern in 2008, makes gold an attractive asset

• Aberdeen Standard Investments - developed economies are at a crisis point, the powers of unconventional monetary policy are exhausted, and markets are just beginning to wake up to this

• FOX Business – reporting fund manager saying “The more the governments mess up, the more gold becomes attractive to me. I do not trust governments and the way they handle currency”

• Wells Fargo - gold has a place in a well-diversified portfolio; offer upside and help reduce the downside during volatile times

Further to the Wells Fargo comments, they listed the following investor fears behind gold’s rally:

1. collapsing global interest rates

2. swelling amounts of global negative-yielding debt

3. inverting yield curves and central banks that are “behind” the curves

4. heightened equity volatility

5. slowing global growth

6. volatile currency exchange values

7. escalating global trade disputes

We’d say that is an impressive list and with no indication that any of those issues are going to be resolved in the near (or medium) future, speculators or not, gold and silver will continue to be bid.

To that list you could add a radical change in the entire international monetary and financial system as proposed by Governor of the Bank of England Mark Carney’s Jackson Hole talk. The thrust of his talk was that "blithe acceptance of the status quo is misguided" and that the dollar's position as the world’s reserve currency must end.

He floated the idea of a “new Synthetic Hegemonic Currency (SHC) [that] would be best provided by the public sector, perhaps through a network of central bank digital currencies”. Whether this global currency would happen or not, any talk of an entirely new monetary system just raises uncertainty levels, which are already at long-term highs according to this chart from Mark’s talk (note: uncertainty today is higher than during the entire 2000-11 precious metal bull market).
 

Unsurprising Mark did not mention gold as part of his Synthetic Hegemonic Currency. In contrast (and also unsurprisingly) Chinese think tank Anbound Consulting (whose research is “sought after by governmental decision-makers at all levels [and] greatly valued by the central government of China”) sees a floating gold exchange standard as the only clear solution to a "Trumpian future" of the global financial system.

They argue that a gold standard means monetary autonomy for the world but would require “the world's gold reserves in America … to be repatriated” and for other central banks “to increase their gold reserves in preparation for the gold standard”. China and Russia have been steadily adding to their reserves. Australia meanwhile, continues to sit on its measly 80 tonnes while digging up and exporting 6,919 tonnes over the past 20 years.

Markets don’t like uncertainty and talk of changes to the global monetary and financial system and gold standards is uncertainty of the highest order. Unsurprisingly, that fuels interest in the sort of insurance that only gold can provide.

Australian Property as an International Safety Asset

Daniel Want, from Australian financial advisory and investment firm Prerequisite Capital, released a research paper on Australian property this week. In it he argues that Australia’s property market is an international safety asset.

He says that financial stress in the world results in an initial sell-off in the Australian dollar. However, Australia’s relative stability results in international capital flowing back, particularly as we now have a cheaper currency. Such flows provide funding to our domestic banks, helping to support credit creation (and thus local borrowing to buy property) but also direct purchasing of Australian property.

Daniel notes that while the Australian property market is worth around US$5 trillion USD, only about US$180 billion worth of property transactions take place each year. Therefore, he says that “it doesn’t take much money from overseas to move the [property price] needle and backstop our [bank] credit engine”.

At this point, Daniel doesn’t see any risk of an “escalation in debt impairment or unemployment/bankruptcy [and] we still may be 12-18 months away from such issues gathering pace to the point of being problematic”.

Note that Daniel will be speaking at the Gold and Alternative Investments Conference in October on “The Next Sovereign Default Cycle”.

Pet Rock

A recent article by Zero Hedge drew our attention back to an infamous 2015 blog post in the Wall Street Journal with the headline “Let’s be honest about gold: It’s a pet rock” that came with the brutal cartoon below.
 

At the time it was hard to refute, as gold had seen relentless downward price pressure, but it looks like the WSJ’s Jason Zweig called the bottom.
 

We will keep an eye on Mr Zweig for you and let you know if he writes an article saying gold is a good investment, as that will probably mark the top.
 
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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