Gold and the year that was!

In this week's market update

• Gold is approaching Christmas on solid footing, with the precious metal trading above important support at USD $1800 per troy ounce (oz), while AUD prices are again above $2700 oz.

• Silver has also continued to push higher, up 1% since last week, and now approaching the USD $24 oz level, with the gold to silver ratio pushing falling to 76.

• Equity markets have continued to weaken, with the S&P 500 and ASX 200 down 3% and 2% respectively over the last week, while oil continues to rally, up 2% and again approaching USD $80 per barrel.

• Bond markets are approaching the holiday period on the defensive, with prices for US year treasuries off by 4%, with yields in Australia and the US rising by 0.36% and 0.19% respectively.

• Crypto markets maintained their relative calm, with Bitcoin still trading just below USD $17,000, down 6% for the week and largely unchanged from where it sat in mid-November.

A Messi end to the year for markets

While most of the world’s attention has been on the heroics of Lionel Messi and the Argentinian football team in Qatar, it’s shaping up as a messy end to the year for markets, with bond and equity prices retreating in the lead into the Christmas holiday period.

The proximate cause of the volatility was the announcement by the Bank of Japan that they would widen the allowable band for yields on 10-year Japanese government bonds, increasing the number from 0.25% to 0.50%.

Markets interpreted this as a hawkish signal that paves the way for eventual rate rises, leading to a sell off in risk, and a flight back into safe haven assets, including gold, which rallied back above USD $1800oz after falling below this level late last week.

The latest rally in gold leaves the precious metal essentially unchanged in USD terms across the course of 2022, while in other currencies it has rallied strongly. This can be seen in the following chart, which was shared on Twitter by World Gold Council Chief Market Strategist John Reade.

Back to the BOJ, and their implicit tightening of monetary policy dovetails in with one of the key themes that drove markets this year.

We explore these, how they relate to gold and silver, and the potential outlook for the precious metal below.

The stories that shaped the market

No matter what happens in the last few trading days between now and the end of the year, 2022 will be one for the record books, with several key themes driving the market.

We summarise these below.

Inflation is back:

• After a 40-year period of declining annual rates of consumer price inflation (CPI), prices surged in 2022, with CPI figures registering multi-decade highs across much of the developed world, including Australia. The problem was particularly acute in Europe, where energy supply issues driven by the Russia Ukraine war saw CPI figures head above 10%. While price pressures are easing somewhat, this will arguably be the key item to monitor as we head into next year.

Central banks will raise interest rates:

• For most of the post GFC era, central banks have kept rates at or near zero, particularly in North America and Europe. Even in Australia, rates were either declining or were at low levels even prior to the onset of the pandemic, with the RBA cash rate for example ending 2019 at just 0.75%, before anyone had even heard of COVID.

• And while 2020 was characterised by record levels of fiscal and monetary stimulus, we’ve seen rates rocket higher this year, as central banks try in vain to control the high levels of inflation we now face.

• While it’s likely we are close to end of the current rate hiking cycle, expect interest rates to push higher as we head into 2023, even if that only increases the chance of a recession.

• As an example of how high rates could go, market pricing in Australia suggests the cash rate will peak at just over 3.75% by September next year.

Stocks really can go down:

• The stock market enjoyed one of its sharpest rallies on record between late March 2020, and November of 2021, with the S&P 500 in the United States for example rallying by more than 100% over this time period.

• Since then, the market has been in correction mode, falling by almost 25% at one stage, though it has since recovered somewhat. While valuations are at more reasonable levels now, and margin debt excesses have been purged, allocations to stocks remain high by historical standards relative to previous market bottoms, while earnings can be expected to take a hit due to a slowing economy and persistent inflationary pressure.

• Diversification against equity market risk still seems like a sensible strategy as we head into 2023.

Bonds aren’t the safe haven they were:

• More than 40-years of declining interest and inflation rates led to the greatest bull market in fixed income in history, with bonds almost matching the performance of stocks over this time-period.

• This was a historical anomaly, and was always going to end at some point, with 2022 likely marking the turning point of a multi-decade cycle from bond bull to bond bear markets.

• Indeed, this year fixed income markets are on track to fall by more than they have at any point in the last several decades. Far from being a safe-haven asset going forward, they may be an additional source of risk, especially if inflation rates stay north of 3-4% per annum between now and the late 2020s, as historical observation suggests they will.

Bitcoin isn’t digital gold:

• In November 2021, Bitcoin traded at an all-time high of close to UDS $68,000 per coin, with many a proponent claiming it had displaced gold as the premiere safe haven asset for investors to hedge against market and/or inflationary risks.

• Since then, Bitcoin has crashed by approximately 75%, and currently trades closer to USD $15,000 per coin, lower than it was at its previous cycle peak in late 2017.

• It remains to be seen what, if anything, Bitcoin will become, but the last year has demonstrated that it’s not a form of digital gold.

Pandemics and property don’t mix:

• When historians look back at the pandemic era, they’ll no doubt think it was strange that the biggest economic dislocation that Australia (and indeed the world) had seen in 100 years led to surging, not crashing property prices.

• But this is indeed what happened, with ABS data suggesting residential real estate values rose by 28% in the two years from the end of 2019 to the end of 2021.

• This year, higher rates have turned the property market on its head, with prices nationwide beginning to fall, led by key markets in Sydney, Melbourne and Brisbane.

• Given inflation is higher, rates are now higher than they were when the GFC hit, and households are so much more indebted, this downswing in property likely has a way to go.

• Indeed, it wouldn’t shock to see prices fall by 15-20% nationwide over a two-to-three-year time period, which would likely equate to a 30-35% decline in real terms, given inflationary dynamics at play.

The next secular bull market in gold
 
As we head into next year, all of the above factors that drove markets in 2022 will be important as regards the role that precious metals can play in a portfolio.
 
Heightened recession fears, persistent inflation, declining property prices and speculators abandoning cryptocurrencies all help support the case for gold, and silver, as they reassert their position as the preferred safe haven asset and portfolio diversifier.
 
Of arguably more importance than all of the above factors though is the performance of the stock market, with gold often doing best in periods equity markets are falling.
 
This can be seen in the following chart (sourced here), which shows that major equity market rallies tend to follow on from peaks in hard asset prices, and that conversely, major rallies in hard assets like gold tend to follow secular peaks in equity markets.

That’s exactly how the market is shaping up as we enter next year, with this signal indicating that a potential multi-year bull market in precious metals is set to unfold.

Warm regards,
 
Jordan Eliseo
General Manager
ABC Bullion Australia

The ABC Bullion Team
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