Gold and silver break out of their trading range

After weeks of consolidation in and around the USD $1200oz level, gold prices finally broke to the upside this week, currently sitting at USD $1222oz. Silver has also rallied strongly, up an impressive 7 percent for the week, last trading at USD $17.48oz.

Earlier in the week, strength in the Aussie dollar had helped limit gains for domestic investors, though the AUD gold price is now back above $1500oz, with silver closing in on AUD $22oz at present. There have been no shortage of potential catalysts, with weak retail sales in the US all but confirming the serious slowdown that has occurred in North America in the last several months.

Probably more important that the retail sales number itself was the impact it had on investor expectations regarding interest rate hikes by the Federal Reserve. Back in January and February it was considered a near certainty that the Fed would be hiking by June 2015 at the latest, which is obviously next month. As economic data has continued to underwhelm in the USA, even after Q1 2015 (which the market wrote off to ‘bad weather’), expectations of that imminent rate hike have now been pushed out to at least September this year. Whilst that is still the consensus date, increasingly, it’s looking like a rate hike may not happen in 2015 at all.

Indeed were it not for the improvement in the headline unemployment rate, something even the Federal Reserve is a poor indicator of the overall health of the labour market, there would be no calls for rate hikes at all. After all, wage growth is still largely non-existent in real terms, underemployment remains a huge issue, and the decline in the labour force participation rate remains the major reason why the headline unemployment rate has declined.

As such, whilst there are some who are arguing that the US is approaching “full employment”, the majority of market participants know this isn’t true, and the broad based weakness in economic activity most data releases are highlighting are becoming increasingly hard to ignore.

Furthermore, officially (and that is the key word here), inflation is also dead in the water, which weakens the case for rate hikes, as the Fed has long acknowledged that they’d like to see core inflation rates closer to 2% at a minimum. This lack of inflationary pressure, and the ‘pricing in’ of a delay to interest rate hikes has clearly played into the recent USD weakness and gold strength of the past few days, though how long that lasts remains to be seen.

With that in mind, and whilst we are delighted with the solid move in the metals this week, we still see it as way too early to call a definitive bottom, or change in trend for the metal market. As such, we reiterate our statements that dollar cost averaging is the most appropriate strategy for metal accumulation today, confident that both gold and silver will outperform most if not all traditional assets in the coming years.

Physical demand remains robust

On the physical side of the market, we know that demand remains robust, with the World Gold Councils just released Q1 2015 Gold demand trends report highlighting the fact that;

• Jewellery demand was still +600 tonnes for the quarter, down slightly but still in line with demand from last 2013. The current readings are still 5% higher than the 5 year quarterly average too.

• That ETF flows were positive for the first quarter since late 2012, offsetting a decline in bar and coin demand. Remember that there was a mass exodus out of Gold ETF’s in 2013 in particular, with nearly 1,000 tonnes of gold sold out of the major Gold ETF’s that year, a major contributor to the price weakness we saw. And whilst that bar and coin demand slipped in the first quarter of 2015, it remains robust, and is still elevated compared to historical levels

• Central banks added another 100 plus tonnes to their reserves in the last quarter, suggesting that over the course of 2015, they’ll collectively add another 400 to 500 tonnes of gold to their holdings in total. As has been the case since the GFC hit, diversification of foreign reserves remains a key reason underpinning their new found desire to increase their gold allocations.

We’ll now take a look at the technical picture for the precious metal markets, with this week’s price action definitely influencing the outlook for the sector. Thanks to my colleague John Feeney who helped whip up the charts and commentary for this piece.

Technical Outlook

Price action this past week has created an incredibly interesting chart set up for gold, silver and the USD at the moment. Starting with the USD, it was two weeks ago that we posed the question of whether or not we have seen a top in the parabolic rally that started back in July 2014. If this rally were to unwind and start heading south, it could signal that the bottom of the latest bear market for gold might be in, but may be a bit too early to call yet.

Looking at the USD today, we can now see that the upward trend line has been broken and the MACD, seen at the bottom of the weekly chart below, has finally turned bearish and signaled a sell sign for the USD. This weaker technical picture aligns with the fundamentals (persistently weaker US economic data and low official inflation) perfectly, as faith in the Feds ability to raise rates peaked saw the USD index top 100 in February and March. The now expected delay in that initial US rate rise is clearly putting downward pressure on the USD.

On to the gold and silver charts and both metals have broken out of their lethargic slumber of the last month. We can see below the result of the falling USD has pushed gold from $1,188 US to $1,220 in just a few days. I have circled two things on the chart below that are worth nothing in this move. Firstly, that it was on large volume and secondly, MACD, which, as you can see from the bottom section of the chart, could be turning to the upside. It’s too early for the champagne, but there are clearly some positive indicators on the daily gold chart for now.

Silver too has had a breakout to the upside and we are almost back at $17.50 US in a matter of days. The higher volume and MACD look pretty positive, and could be suggestive of further short term strength.

As the moves over the past few days were largely based on a US dollar fall, the AUD prices for gold haven’t moved up as much, though the market has climbed above $1500oz, as discussed earlier.

One thing to bear in mind though, is if the falling USD continues, and pushes the AUD higher, it could spark further rate cuts from the RBA, as we know they want the AUD lower than where it is now (0.80c). We still expect to see interest rates of 1% by late 2016 down here, further bolstering the case for precious metal investment in Australia.

In the coming months, there is the potential for the USD to fall, whilst the RBA cuts rate further, and we could see both currencies losing value against a rising gold and silver market.

This would be a perfect scenario for precious metals investors, though we’re not sure the market is yet ready to head in this direction decisively. The performance of the USD index over the next month or two will be very interesting.

Why Aren’t Australian Businesses Investing!

This week, Australian financial commentators have been almost overwhelmingly focused on the just released Federal Budget. We don’t have a huge amount we want to say on the matter this time around, except to point out that the assumptions underlying the forecasts (re growth, commodity prices etc), seem incredibly optimistic, and we expect the bottom line in the coming years to be much worse than what was released.

More important in our eyes is the continued reluctance of Australian businesses to invest, something that even the RBA has commented on, when they recently stated that ““indicators of non-mining business investment intentions suggest that a significant pick-up is not in prospect over the next year or so.”

Earlier this week, we published a lengthy article discussing the issue, looking at six areas that we would try and assess before making any major capital investment decision ourselves. Those areas include;

• The outlook for the Australian consumer (we are very negative)

• The outlook for the Australian economy,

• The outlook for the Global economy

• The state of the Budget and local politics (another area we are worried about)

• Global monetary settings Finally, we’d be thinking about the hurdle rates we’d consider before making any investment decisions, and we’re not sure we’d use today’s record low ‘risk-free’ government bond yields as our reference point, something that again even the RBA seem to acknowledge. We are outright negative or at least cautious on all the area’s we’d be assessing, for reasons we discuss in more detail here

Until next week.