Gold - An Anchor of Trust

Precious Metals Commentary

Not a very volatile week for precious metals prices in USD terms with gold trading into a tighter range this week, currently above $1,490 and silver $17.50, unchanged from Friday last week.

It was the move in the AUD/USD this week that provided a much-loved pullback for metals prices domestically as the Australian jobs numbers surprised most, sending the AUD back up to 68.2 US cents at time of writing. Australia added 26,000 full time jobs in the quarter and lost 11,000 part time jobs, pushing the unemployment rate down to 5.2%.

This alone was enough to see gold pullback to the $2,180 - $2,190 range and silver dipping to $25.70, perhaps looking like a good top up spot on AUD strength.

In other metals, Platinum has had a nice pullback and is looking a little oversold, despite our opinion that we remain in an uptrend and should see some improvement long-term. Palladium on the other hand is a raging bull once again, with the price adding 40% in the last 5 months. It seems there is just not enough to go around on the supply side so we continue to see this disconnect in the Platinum/Palladium ratio. Bullish sentiment on Palladium has been through the roof so is looking a little overcooked once again.

Gold Piggy Bank

We have noted previously that central banks have been adding to their gold reserves since the 2008 financial crisis. This week the Dutch Central Bank’s webpage on gold got some coverage on social media for its positive and upfront comments on gold.

Saying that “gold is the perfect piggy bank – it's the anchor of trust for the financial system” they note that central banks hold gold because it retains its value in times of crisis and that “if the system collapses, the gold stock can serve as a basis to build it up again”.

Contrast that to the RBA’s gold webpage, which says nothing about why the RBA holds $5.6 billion worth of gold and is just dry facts about where it is stored and how it is lent from time to time. You have to go back to 1997 when the RBA sold two-thirds of its gold (or should that be “our”?) where it said that “there was a case to hold some gold as a contingency against unforeseen events” but that as Australia has “large gold reserves in the ground and high annual production, derives negligible diversification benefits” from holding what was then 20% of its international reserves in gold.

All we will say to that is while Australia is the world’s second largest gold producer, as we noted a couple of weeks ago, the $22 billion worth of gold we mine a year is only about 6% of our annual $380 billion worth of imports and less than 1.5% of our gross domestic product. Not that much of a contingency, we’d argue.

The International Monetary Fund agrees with the Dutch, analysing the precious metals in its October World Economic Outlook. They say that gold and silver can function as inflation hedges (although not as much when changes in inflation are modest) but that gold stands out as a safe asset “during some (but not all) major economic and policy shocks, proxied by stock market swings, that triggered or reversed investor flight to safety”.

Below is a chart from the IMF’s outlook that shows clearly how gold differs from the other precious metals in terms of it demand components.

 
Gold has very little industrial usage, whereas silver is more closely related to platinum than gold. We would note that jewellery’s 52.3% share of gold demand is overstated, given that in many countries (India and Asia especially) the main reason for buying jewellery is investment rather than adornment, as it is in the West.

The chart below from Ping AnBank’s presentation at the LBMA conference shows the dominance of investment motivations for gold in the Chinese market.

Ping AnBank said that in the coming five years Chinese high net-wealth investors’ assets would increase by CNY 80 trillion and if only 2% of that was allocated towards gold, it would result in investment demand for gold in China climbing by over 4,500 tonnes.

To put that in context, total 2018 worldwide gold demand was 4,395 tonnes. The impact of such a dramatic increase in Chinese gold demand will be, simply, “price go up”!

Weak Forecast Westpac

A lot of price forecasts come across our desk. They vary in credibility but in total it is useful to see what the consensus is, as it provides some influence on institutional investor views towards the precious metals.

With the gold price breaking out of that long held resistance level of $1,375 back in June, most analysts have been revising their forecasts up, as they should given many were consistently pessimistic.

Westpac was recently reported to have revised its gold forecasts up but it was pretty pathetic, with the bank only seeing gold at $1,510 by the end of this year. Further out they see $1,480 by end of 2020 and $1,535 by 2021.

Given gold has been well above these prices just this year, it is hard not to feel that they really just don’t like gold.

It puts them at odds with the majority of precious metal analysts. Standard Chartered’s Suki Cooper sees retail demand as the key to the next leg higher in gold, who she sees as wanting “confirmation of further rate cuts, some weakness in the equity markets before they move into gold”.

At the London Bullion Market Association’s (LBMA) annual conference held earlier this week, a poll of attendees (which cover the whole global supply chain, from miners, refiners, mints, jewellers and dealers) resulted in a forecast of $1,658 in a year’s time. For silver, they see silver making a bigger run up to $23. Together, those equate to a gold:silver ratio of 72, which is well below the current ratio of 85 but such a fall is consistent with what we have been saying for some months now.

Above is a history of the LBMA gold forecast. They have been on trend for the past few years and the attendees generally tend to be optimistic, on average seeing prices rising by 9.7% on where they currently are.

Housing Flip-Flop

A lot of price forecasts come across our desk. They vary in credibility but in total it is useful to see what the consensus is, as it provides some influence on institutional investor views towards the precious metals.

This week, the government announced that the ACCC would be conducting an inquiry into home loan interest rates and specifically why the banks often fail to pass on RBA rate cuts. It wasn’t that long ago that the banks were being kicked for irresponsible lending, but as Deloitte Access Economics observed in its September Business Outlook, “the short term costs to economic growth of reforming banking spooked policymakers, who’ve opted to sweep some things under the carpet and to throw stimulus at housing prices”.

With tighter lending standards being considered a factor in recent home price falls, might the flip-flop have something to do with the fact that 96% politicians own a property, as the ABC reported back in 2017?

One of the reasons the banks aren’t passing on interest rate cuts is that as rates approach zero there is very little margin left between deposit rates (which, for the moment at least, can’t go below zero) they pay and what they earn on loans.

Forcing the banks to fully pass on rate cuts actually counterproductive. It can harm the banks by making them less profitable and thus more financially unstable and/or worsening their debt ratings (thus increasing their funding costs in wholesale markets).

However, if you shouldn’t force banks to pass on cuts, it means there is less point to the RBA continuing to cut rates as savers lose income from the full rate cut but borrowers don’t get as much back as they only get part of the cut.

The other dynamic lower interest rates introduce is that banks and other financial firms like insurance companies and pension funds cannot handle any increase in interest rates because it would reduce the value of the large quantities of bonds they hold.

Clime Asset Management say therefore the RBA simply cannot allow interest rates to rise and that QE is thus inevitable in Australia and will become embedded in the financial system, as “bank revenue [then] predominantly comes from asset revaluations or asset sales rather than borrowers paying interest”.

It is a trap, which has Clime seeing “central bankers acting like a group of mad professors”.

On top of that, Montgomery Investment Management argue that rate cuts incentivise businesses to invest in labour saving technology that works against the RBA’s stated goal of reducing unemployment.

They say with “a large portion of Australia is already in an income recession and a bunch more are about to enter one” the solution is permanent tax cuts for lower income earners, as they spend more of their income than higher income earners do, and this is the only way to “avoid a recession we don’t have to have”.

The RBA is not listening to these arguments, with Westpac reading the tea leaves of the RBA’s minutes and concluding that they are “a very detailed justification of the decision to cut in October and a general argument as to why lower rates still work in Australia” and appear to lay the ground for even lower rates in the future.

The solution, if you don’t want bank profitability and stability to be squeezed by low rates, is to do away with zero rates on deposits and make savers pay with negative rates. As crazy as that sounds it can’t be ruled out with a growing number of German banks passing on negative rates as Europe is far further along on the mad professor path than Australia.

We saw reports that Germany’s second-largest cooperative lender has started to apply a minus 0.5% rate on retail deposits exceeding 100,000 euros.

All this will do, in our opinion, is cause disgruntled investors to look at other ways to protect their wealth, and gold is going to be one of those options.

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.

Disclaimer
This publication is for educational purposes only and should not be considered either general or 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, and 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.