Gold Eases

USD precious metal prices have weakened over the past several trading days, with the price of gold currently trading at USD $1,264oz, down close to 2% from its temporary run up toward USD $1,290oz. Silver has also weakened, with the price dropping close to 3% in the past week, currently trading at USD $17.40oz.
 
Australian dollar investors in precious metals have been cushioned by the fall in the local currency, which has fallen vs. the USD over the past few trading days. AUD gold is trading just above $1,690oz, whilst silver is trading at AUD $23.30oz.
 
The biggest developments in markets over the past week or so were in France and in the United States, where President Trump unveiled his proposed tax reforms that, if enacted, would among other things, reduce the current multi-tiered personal income tax system to just three tax brackets, and reduce the corporate tax rate from 35% to 15%.
 
Whether or not this ever comes to fruition, and how it will all be paid for in terms of the impact it will have on an already dire budget position, is of course still up in the air.
 
We also saw the ECB recommit to their current QE program and monetary policy settings overnight, with the bank still on course to dole out EUR 60 billion a month until the end of 2017.
 
Over in Europe and the outcome from the first round of the French election largely went the way the market expected. The result, coupled with the current belief that Euro friendly candidate Emmanuel Macron will eventually become President in the second round of French election on May 7 is one of the reasons why there was no “Frexit” bid for safe haven assets like gold, as it has been interpreted as a win for status quo politics.
 
Back to the French election and I can see no reason to argue that the market is wrong in their view as to who will win, and indeed a Le Pen victory is indeed highly unlikely from here, though we can’t help but be reminded of the certainty markets had re Brexit (was never going to happen) and of course the election victory by Trump (who was unelectable).
 
Note that is not to say that we see the set up between Macron vs. Le Pen as the same as Clinton vs. Trump. For one, Trump was a complete maverick/outsider, Le Pen and her family are well known political forces whilst Macron doesn’t have 30 years of heavy political baggage like Clinton did. If anything, some would argue he’s an outsider (in politics at least) even if he’s very much a member of ‘the elite’.
 
Irrespective of this, the broader point, which the market will eventually realize, is that even if he does win, Macron doesn’t “change” anything, in terms of the emerging political realities in Europe.
 
As the chart below shows, apart from Germany, in every other major European nation we look at, consensus right and left parties have been smashed in their most recent elections, with a huge shift to non-mainstream parties.

In Austria, non mainstream parties won 78% of the 2013 vote, up from 21% in 2008. In France, its 74% in 2013 versus 44% in 2012, which is one of the main reason political analysts think Le Pen will win in 2022, even if she is thwarted in a couple of weeks, as now seems likely.
 
The just completed election was the first time in 60 years that an establishment candidate from either the Republican or Socialist parties made it through to the second round. Mon Dieu!
 
Greece, Italy, the Netherlands and Spain all tell the same story. Germany is so far resisting this trend, but it seems a fait accompli that consensus status quo politics is dying, irrespective of the pending outcome in France.
 
And it’s dying because the economy is failing too many of the people, even if they’ve not yet diagnosed the primary cause of this failure, and are clutching at straws for solutions.

Over the next decade, as this theme plays out, it is hard to see how this won’t prove a negative for economic growth, and for investor risk appetites, no matter how hard a floor central banks try to put under the market.

Gold Bears Stirring

The signs physical gold demand are good if not spectacular for 2017. Total gold imports for Q1 2017 out of India were 230 tonnes, a strong figure which suggests from the normally insatiable Indian consumer is returning, after a lackluster 2016.
 
Gold imports into China were up 20.6% year on year for Q1 2017, with the latest figure for March 2017 the highest one seen since May of last year.
 
This positive news on the physical demand side is not currently being matched on the sentiment front, though from a contrarian point of view, it’s always encouraging to see bearish headlines for gold, with predictions of imminent downside.
 
This week we’ve seen a definite stirring of the gold bears, with the below image from Sharps Pixley highlighting negative outlooks from both Goldman Sachs and UBS.
 
Not everyone is bearish it must be said, with Credit Suisse predicting a notable rally to USD $1400oz by year end, driven by lower US yields which they see “continuing to surprise to the downside”.

The rejection of the USD $1,300oz level poses a definite short-term headwind, and a period of weakness and/or range bound trading is a definite possibility.
 
Having said that, the pullback to date has been quite healthy, and indeed was expected. Precious metals as a whole had had a tremendous run from early March up until a week ago, and were due a healthy pullback.
 
Furthermore, as per this super long term chart below, which shows the gold price in USD from the late 1990s to today, we’re clearly at an important point in the market, with the USD $1,290oz level representing a key trendline going back to the all time high of over USD $1,900oz, which we saw back in 2011.

Source: Sharps Pixley

Gold was always likely to struggle to make it through this level first time around.

As such, we’re in many ways encouraged by the recent pullback, which likely sets the market up for another move higher, and potential break through of the key USD $1,300oz level.  Given that, at this point we think forecasts of an imminent move back down toward the USD $1,200oz level will prove incorrect.
 
We’re not sure they’ll pull the trigger yet, but we can see value conscious investors who were thinking of adding to their metals exposure likely to take advantage of this recent pullback, and will be happy to accumulate gold in the USD $1,245-$1,265oz range.  
 
A weaker than expected US GDP print tonight could well prove a catalyst for that buying, as it would likely reduce market expectations regarding the next rate hike from the Federal Reserve.

Market expectations are looking for a result of around 1% according to Bloomberg, though not all are that bullish, with JP Morgan expecting it to come in below 0.5%.
 
The Atlanta Fed GDPNow forecast is even more dire, coming it at just 0.2%, with their forecast declining notably since early March, as the below image highlights.

If the Atlanta Fed is even close to being right, then we’d expect at least a small bounce across the precious metals complex.
 
Australian Dollar
The Australian dollar has fallen over the past few weeks, currently fetching just below USD $0.75, down from closer to USD $0.77 at the end of March 2017, as the chart below highlights.

Source: Yahoo Finance
 
Technically, the Aussie is now looking fairly weak, with a number of commentators downgrading their views. Some are forecasting a relatively swift move down toward the USD $0.71-0.72 range, which would of course be a boost for AUD gold investors.
 
Should yield differentials between the US and Australia continue to decline, then the currency downside could be even more severe, with TD Securities chief Asia-Pacific macro strategist Annette Beacher warning the Aussie could fall as low as USD $0.62 “if the Fed hikes three or four times, and the RBA sits tight”.
 
Interestingly the team at Capital Economics (worthy commentators on all things Australian economy related) have changed their tune post the latest CPI data out this week, and are now no longer forecasting any more rate cuts in Australia.
 
To be fair, they have also noted that if the RBA were to move at all, they’re more likely to fall than rise, and that they don’t expect any rate hikes in either 2017 or 2018.
 
They also still expect the AUD to weaken, though to just USD $0.70 by the end of this year, rather than USD $0.65, which was their previous forecast.
 
Our view remains unchanged. We believe the RBA will end up being forced to raise rates, though we admit that the rally in iron ore and recent terms of trade boost has pushed back the timing of the cuts.
 
Medium term though that won’t change a thing, and the recent baton-pass from the RBA to APRA in particular re financial stability (read excessive private debt that has been funneled into property), will give the central bank the cover they need to justify more rate cuts to stimulate the broader economy.

It won’t work of course, but they’ll do it anyway.
 
Mom and Pop are Trading Stocks
An item of interest that we came across this week related to the popularity of stock trading in America amongst “Mom and Pop” investors, who typically use discount brokerage services.
 
The chart below shows the S&P 500, and the percentage of total New York Stock Exchange transactions that came from E-Trade and TD Ameritade. As you can see, trades from these two brokers account for roughly 17% of total trades now, a level that at least matches where it was in 2006, a year out from the GFC.

To be fair the reading also hit these levels in 2013 (stocks are much higher since), so its not a screaming sell signal, but rather another piece of evidence suggesting future returns for stock market investors will be harder to come by.
 
That line of thinking was reinforced by another piece of research we came across, which highlighted the last 25 years of the S&P 500 index price to sales ratio, which in effect measures the current index level of the S&P 500 by the total sales companies within the S&P 500 are generating.
 
This measurement, which you can see in graphical form below, is at nosebleed levels today – far exceeding the readings we saw just prior to the GFC. Indeed it is back near the same level we saw at the height of the NASDAQ bubble, which was the most overvalued point in the last 100 plus years for the US stock market. 

This has next to no implications for what stock market returns are likely to be 1 week, 1 month or 1 quarter from now. But for those wanting to construct a well-balanced portfolio for the decade ahead, it has profound implications, with returns in this space likely to be highly constrained at best, sharply negative at worst.
 
Australia – Print Money & Hide the Debt
Most of the international attention this week has been focused on President Trumps tax plan, and political developments in Europe. Despite that, it has been quite the week in Australia, with Treasurer Scott Morrison flagging an intention to alter the way the governments reports on and discusses public finances, with a desire to categorise borrowing (or debt) as either “good” or “bad”, depending on what the money is used for.
 
The idea behind this is that a portion of the spending that the government takes part in is for long-term productivity enhancing activities such as infrastructure, and this shouldn’t be treated or analysed the same way as spending on recurring items (welfare/health, etc.) is.
 
Amusingly, the Treasurer likened good government debt to the kind of debt that households take on when they buy a home. By that logic, private debt levels in Australia, which have exploded over the past two decades, are nothing to fear, as the vast majority has gone into mortgages. Furthering this argument, one could argue the proximate cause of the GFC was the explosion in good debt we saw in the United States in the lead up to the sub-prime crisis.
 
To be fair to the Treasurer, in principle, there is some logic to the idea of splitting expenditure (and the debt required to fund it) between recurring expenditure and longer-term investments.

Regardless, I’m against the idea as there is no doubt the primary reason its being flagged at all is because the government realizes there is no way they’ll return to a surplus during this term in office, and they want to change the conversation and the narrative around government spending and escalating debt levels.
 
It will also no doubt lead to an explosion in accounting chicanery, as all kinds of spending will no doubt somehow magically be deemed to be long-term productivity enhancing initiatives, much like companies in the United States play games with the non-GAAP earnings figures they like to “sell” to the market.
 
It will also create no shortage of potential absurdities (spending to build hospital = good debt, spending to train competent doctors = bad debt) that will need to be monitored.
 
Importantly, the ratings agencies aren’t falling for these potential accounting gimmicks, with S & P answering “in short, the answer is no to all 3 of your questions”, when the team at Macrobusiness asked them:

“Does today’s mooted changes in Budget accounting, which divides supposed good and bad debt, alter the way S&P views the Budget? Specifically:

• will it alter the calculation of general government debt to GDP?

• will it alter S&P’s view of the 30% general government debt to GDP red line for support of the AAA rating?

• will it change S&P’s view of the Budget in any other way?”

Amazingly enough, budget fiddles around good and bad debt were not the most interesting or alarming Australia story we came across this week, with former NSW Treasury boss Percy Allan suggesting the RBA should print money, because the government “is broke” and therefore needs “cost-free” methods of funding infrastructure like transport.
 
In an article appearing in the AFR, Allan commented that central banks should fund public works directly, and that “the real issue acing Treasurer Scott Morrison with his budget is that the government is broke and there's very little he can do.”
 
According to Allan, the Treasurer needs to think about costless options, though of course one wonders, if you have access to unlimited free money from the RBA, how can you ever really be “broke” as he argues.
 
Allan also suggested that whilst his ideas might sound revolutionary; “you have to go back to basic principles” including asking; “Why do quantitative easing?”
 
Why do quantitative easing indeed!

Housing Troubles in Canada
House prices are not just front-page news in Australia on a daily basis. Canada too is in the midst of a raging bull market (or bubble as many would argue) in housing, which has been highly concentrated in select cities, primarily Toronto and Vancouver.
 
I spent a few weeks in British Columbia in late 2016/early 2017 and found it to be a wonderful place. Canada is in many ways a northern hemisphere colder version of Australia, with an economy that also has a heavy reliance on raw commodity exports.
 
News this week from Canada suggests that our cousin the north is starting to witness some real trouble in their housing market, with the share price of their biggest mortgage lender, Home Capital Group, plunging by well over 50% on news it had entered an emergency liquidity agreement for a $2 billion credit line to counter a shrinking deposit base.
 
Whilst the news affects only Home Capital Group directly, the contagion has already spread across the Canadian mortgage lending market, as the chart below, which shows the decline in share prices for major Canadian mortgage lenders highlights.

Depending on which way you look at it – the troubles we are now witnessing in Canadian housing could be a very short-term (and I stress short-term) net positive for the Australian housing market, especially on our East Coast.
 
The reason for this is that select cities in both Australia and Canada (Sydney and Melbourne locally) have been strong beneficiaries of foreign capital inflows.
 
Both countries today have expensive property, and a political backlash of sorts too, with residents (particularly non homeowners) starting to begrudge the inflows of foreign capital that are pricing locals out of their housing market.
 
Canada is ahead of the curve relative to Australia on this front, and has already passed legislation making it a less desirable home for foreign capital. Problems in the Canadian housing market, or for the institutions that fund it, will only raise more questions for wealthy foreign nationals who may now pause before investing large sums into Canadian real estate.
 
Until Australia catches up, we may ‘benefit’ as more wealthy foreign nationals turn their attention to the investment opportunities our local property market has to offer, though there are also warning signs that foreigners taste for Sydney and Melbourne is beginning to sour.
 
Treasurer Scott Morrison, apart from discussing “good” debt and “bad” debt in the lead up to the budget, also touched on foreign investor interest in Australia, and has suggested that “foreign investment applications for residential housing has fallen to an expected 15,000 this year from 40,000 last year”, according to an article in Business Insider.
 
We’re also seeing no shortage of trouble for some of the higher profile real estate agents, most notably bellweather stock McGrath, which is now down some 72% from their listing price. Given the explosion in East Coast house prices over the last 2 years, that really is an extraordinary development, and a potential harbinger of the pain to come across the entire real estate value chain.
 
Either way, whilst we do see potential for one last leg higher in East Coast property prices, we’d be avoiding the market today, with little on offer in the way of yield, expensive transaction costs, liquidity concerns, and way more potential downside from a value perspective.
 
Instead, we’ll stay in gold and silver, which will benefit further on both an absolute and especially relative basis if long-mooted downside to Australian property finally arrives.

Until next time,
Jordan Eliseo

 
Disclaimer

 
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