Gold: Bored or Bullish?

It’s been a poor end to the financial year for precious metal investors, with both gold and silver declining for most of June. In USD terms, gold started the month around USD $1,266oz, failed in its second attempt to push through USD $1,300oz, before declining into the low USD $1,240oz range earlier this week.

Silver on the other hand has declined more meaningfully, giving up over 3% in the first 3 weeks of June, in USD terms. This has seen a move higher in the Gold to Silver ratio (GSR), which you can see in the chart below, with the GSR now sitting close to 76:1.

The generally poor performance of the sector this month has dampened sentiment, with some commentators suggesting gold may re-test the USD $1,200oz level.

On the more optimistic front, UBS put out a note recently stating that the gold pullback we’ve seen in the last few weeks, could present an opportunity to build positions at better levels.

Credit Suisse have also been bullish, stating earlier last week that they see they yellow metal finishing the year closer to USD $1,400oz, which would be a rally of over 10% from here.

From our perspective, we remain relatively encouraged by the gold charts right now, and the way it has held key support and respected the trendlines. Looking at gold in USD terms, we’ve seen a cluster of important moving averages converge around the USD $1,240oz level, which gold has so far held.

As per the chart below, which shows prices over the last year, we can also see that gold continues to make higher lows, having bottomed out by mid December 2016. This is a positive sign. 

In Australian dollar terms, the gold price did test the 200 day moving average around the AUD $1,640oz, which it held, with the metal bouncing back toward AUD $1,660z at the time of writing.

Encouragingly, as per the chart below, the AUD gold price looks like it has based, with MACD suggesting momentum is turning in favour of a rally, whilst RSI is swinging up as well.

Those are generally positive signs, and with the AUD still trading above USD $0.75, there is a good chance the currency will move in favour of Australian precious metal bulls in the coming months, especially if the RBA (who are unbelievably optimistic about the domestic economy given the fundamentals) is forced to change its tune re the trajectory of interest rates, as we expect.  

All up, we think it's a relatively safe entry spot, and we were personally happy to add to our exposure via our SMSF this week.
 
Boredom: The Enemy of all Investors
Earlier this week, Dominic Frisby, a commentator worth following, wrote an excellent article in MoneyWeek, titled “Gold Investors are going to need all their patience this year”, which you can access here.

The article gives a good recount of the last 15 plus years in the gold market, but it was the commentary around the current state of the market that really resonated, with Frisby stating (bolded emphasis mine); “Once upon a time gold charts began in the bottom left and finished on the top right. Now they start in the middle and end in the middle. Below we see the last four years of frustrating meandering. False dawns a plenty – but not crashing either. Just a boring nowhere investment, while money is made elsewhere.”

The chart below is the one he was referring to. 

It’s that final comment that is really relevant today, for investors have indeed grown bored of gold in the last few years, even if the worst of the price declines occurred back in 2013.

For this last few years of range traded pricing in precious metals has occurred alongside what financial market commentator Jesse Felder first started referring too as the “everything bubble” back in 2015 (more on this below when we look at the S&P500 vs. hedge funds).

It’s hard to stick with gold when its relative performance is so underwhelming, even if the reasons you own it (excess debt, cheap money, overvaluation) are more pronounced today than what they were when you first bought precious metals.

Most recently, the “everything bubble” saw investors sell out of precious metals to chase the explosive price growth in Bitcoin and other crypto-currencies like Ethereum.

That gold has done as well as it has this year despite this sentiment is testament to the strong underlying fundamentals. More importantly, the current level of apathy presages better days ahead, for asset markets rarely switch from overly bearish to overly bullish immediately.

Instead, they tend to go through three phases; from bearish, to bored, to bullish.

On the whole, the precious metals market is in phase two right now.

Is the United States About to Enter a Recession?
For some time now, economic data out of the United States has been fairly underwhelming, not that it’s been enough to hold the Fed back from raising interest rates. But if the market, as expressed through the yield curve, is to believed, we are still some way off from a US recession.

The chart below, which came from a recent article in Business Insider, shows the spread between 2 year and 10 year US Treasury bonds, which had dropped to just 79 basis by the time the article was written (19th June 2017).

The yield curve has clearly been flattening for some time, which is indicative of a slowing economy, but we are still a reasonable way off from the yield curve actually inverting (i.e. where the yield on a 2 year note is higher than the 10 year note).

If history is any guide, we would likely need to see this crossover occur, with RBC’s Capital Markets Jonathan Golub stating that there has, over the last 40 years or so at least, never been a recession without the yield curve first inverting. 

In the next few months, we wouldn’t be surprised to see this spread decline further still, even if the Fed does begin reducing the size of its balance sheet. That opinion is counter to the market consensus, but aligns with views first espoused back in 2013, when I first questioned whether tapering quantitative easing would really lead to higher bond yields.

How Bad are Hedge Funds?
We wanted to finish this weeks report with a fascinating chart we came across from an excellent edition of Epsilon Theory, which I read regularly, and you can access here.

In the chart below, the orange line is the S&P 500 Index from 1998 to today. You can see the enormous crashes in 2000 and 2008 (NASDAQ bubble bursting and GFC related), as well as the huge rally from early 2009.
 
The white line and blue-shaded area is the HFRX Global Hedge Fund Index divided by the S&P 500 Index.
 
It essentially represents the relative underperformance or outperformance of hedge funds versus the S&P 500. 

As you can see, as it stands today, hedge fund underperformance relative to the S&P500 is back to levels last seen in 1999. This is obviously not so much because hedge funds have done a terrible job in terms of their returns, or even satisfying their mandates and what they offer to clients.
 
Instead it's a simple reflection on the relentless onward march higher for equities, which are now trading at 30 times cyclically adjusted earnings, in one of Wall Streets longest bull markets on record.
 
Be that as it may, this bull market in stocks, which has also seen an unprecedented increase in the popularity of passive index tracking investment vehicles, is proving a huge challenge for hedge fund managers, and for many active equity managers, in terms of maintaining funds under management.

It has also negatively affected sentiment toward defensive assets, with the belief that with the Fed at your back, piling into stocks is a no brainer.
 
Inevitably, this cycle will turn, and when it does, the active managers of this world, as well as hedge funds, will find themselves back in favour.
 
With that in mind, it pays to remember that physical gold, a highly liquid monetary asset with zero credit risk, is the simplest hedge of all.
 
Until next time
Jordan Eliseo

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