Gold eases as markets wait for Santa!

In this week's market update:

• Gold prices fell by 1% over the past five trading days, failing to hold the USD $1800 per troy ounce (oz) despite trading above that level earlier in the week.

• Silver was more resilient, rising by 1% and now sitting above USD $23 oz, with the gold to silver ratio (GSR) continuing its recent decline to sit at 77.

• Equity markets were mixed, with the local ASX 200 flat, while the S&P 500 fell 2% for the week.

• Commodities (+2% for the week) were firmer, led by oil, which bounced by 6% to stave off fears that it would fall below USD $70 per barrel.

• Bond markets were relatively calm, with 10-year yields in both the United States and Australia hovering around 3.5%, while breakeven inflation rates continue to ease.

• Interest rates and inflation continue to drive markets, with a hawkish Federal Reserve hiking rates by 0.50%, with the promise of more to come, despite softer than expected CPI data, with headline annual inflation in the US dropping to 7.1% in the year to end November.

Federal Reserve plays the Grinch

Gold prices started the week on very strong footing, at one point trading above USD $1820oz, as softer than expected US inflation data saw the smallest monthly gain in consumer prices in more than a year, sparking hopes that the US Federal Reserve will soon ease the pace of interest rate hikes.

As ING noted,

Whilst inflation is still higher than the Fed’s comfortable range, softening of inflation reinforces the view that the peak of the rate-hike cycle might be in sight. The interest rate hike this year has pushed investment money away from gold as investors chased higher returns (along with safety) in US treasuries. Total known gold exchange-traded fund (ETF) holdings have dropped by around 13.2mOz from the peak in April this year as the Fed hiked interest rates. A slowdown in rate hikes or the possibility of rate cuts later in 2023 could reverse the trend and help bring investment money back into gold.

ING were more or less on the money, as the US Federal Reserve did indeed slow the pace of rate hikes at its meeting earlier this week, raising rates by just 0.50% (after four monthly 0.75% increases), with rates now sitting at a 15 year high in the 4.25%-4.5% range.

ING were also accurate as it regards gold flows, as market data suggests we have begun to see a return to inflows into gold ETFs, a subject we discussed last week, while physical demand for gold bars and coins remains strong, something we can attest to at ABC Bullion, and which is also being seen at other mints globally.

Despite the widely anticipated rate hike by the Fed, markets didn’t like their perceived hawkishness, with the S&P 500 falling by almost 5% from its intra-week high. Far from facilitating a Santa rally, the Fed looks like it’s playing the Grinch this year, with the central bank making it clear there will almost certainly be more tightening of policy early next year, with inflation still several percentage points above a level it would deem palatable.

Indeed, once inflation is factored in, the question of how hawkish the Fed really has been this year becomes far more debatable, something analyst Jesse Felder commented on in a recent blog post where he noted,

The last time inflation posed as big a problem as it does today (with headline CPI above 6% for an extended period of time), the Fed either raised rates at an even faster pace than Jay Powell & Co. have done this year (in 1974 and 1980) or the central bank maintained a policy of continuous tightening for far longer than we have seen so far (in 1967 and 1976).

Felder also noted that in all prior inflationary spikes and rate hiking cycles, the Fed increased interest rates to a level that was higher than the inflation rate. We are nearly a year into this hiking cycle, and to date, interest rates remain well below headline inflation, with a circa 2.50% gap between the two.

Given that history, and current inflation readings in the US, Felder noted that it’s hard to argue that the Fed has been that hawkish this year, despite most of the market commentary about the Fed this year, which predominantly treats inflation as transitory, and therefore only focuses on the nominal interest rate hikes the Fed has implemented in 2022.

For precious metal investors, we see little to fear in terms of the interplay between inflation and interest rates as we head into next year. The reason we have some confidence saying that is that while current inflation rates have soared in 2022, markets have already priced in a collapse in inflation going forward, with 5-year and 10-year breakeven inflation rates now sitting at 2.25% or lower.

This can be gleaned from the following chart, one of our favourites for the year, with the chart showing both the USD gold price, and blue line showing the gap between current headline inflation rates (7.1%) and the US 10-year breakeven inflation rate.

Source: BLS, Federal Reserve, LBMA, ABC Bullion

The chart shows that an unprecedented gap between current headline inflation and market expectations of future inflation developed in 2022. And while it has begun to close in the last few months, there is still a gap of almost 5%, which is larger than what we saw just prior to the GFC the better part of 15 years ago, when gold prices absolutely soared.
Given this backdrop, inflation could fall by several percentage points in 2023, and gold would likely take it all in its stride.

Indeed, it wouldn’t shock to see gold rally in such an environment, just like it did earlier in the week, as a collapse in inflation of such magnitude would almost certainly be accompanied with recession like conditions and a pause in the interest rate hiking cycle, which would likely boost demand for precious metals.

Commodities unloved despite strong year

Commodities have been the market leaders for most of this year, rising by 9% over the last twelve months, as investors have sought to take advantage of the momentum in the sector, which is underpinned by a range of bullish factors.

By contrast, fixed income assets have had one of their worst years on records, with the price of 10-year treasuries falling by almost 30% in the last twelve months.
Despite the contrasting fortunes of the two asset classes this year, we head toward 2023 with professional investors positioned in such a way that they are now more underweight commodities relative to fixed income assets than at any point since April 2009.

This can be seen in the following chart from the most Bank of America Fund Manager Survey, shared by @RonStoeferle

Data likes this suggests that professional investors are positioned for three things:

• A potential global recession, or at least a notable slowdown in growth next year, which could see equity markets fall another 20-25% based on past episodes

• A sharp fall in inflation next year, with the 0.1% rise in US headline inflation in November  raising expectations that we may see annual CPI increases head down toward 2% by late next year

• Easier monetary policy, with the expectation central banks will cut interest rates in 2023, something that Jeremy Siegel discussed in detail recently, with the Wharton Professor castigating the Fed for its recent actions.

Gold exploded last time this happened

The Bank of America Fund Manager Survey had another insight directly relevant to precious metals that is worth sharing in this update. That insight is captured in the below chart, which shows that a net 21% of asset managers think gold is undervalued.

at reading is even lower than where it sat in both January 2009, and September 2018. Gold went on to stage very significant rallies in the two- and three-year time periods that followed, with gains of between 44% at the lower end and 90% at the higher end, depending on which specific time frame you looked at.

If history were to repeat, then it wouldn’t shock to see gold trading anywhere between USD $2,600oz and USD $3,400oz within the next two to three years.

Inside the office this week

This week has seen clients take add to their holdings of silver, no doubt encouraged by the recent price rally. ABC’s 100oz Silver Cast Bar and 1oz Silver Coin range have seen a notable uptick of sales. Clients are using this time of year to not only add to their own personal investments but purchase our smaller Minted Tablet range for gifts to their friends and family.

Warm Regards,

Jordan Eliseo
General Manager

ABC Bullion Australia

Disclaimer: This document has been prepared by Australian Bullion Company (NSW) Pty Limited (ABN 82 002 858 602) (ABC). The information contained in this document or internet related link (collectively, Document) is of a general nature and is provided for information purposes only. It is not intended to constitute advice, nor to influence any person in making a decision in relation to any precious metal or related product. To the extent that any advice is provided in this Document, it is general advice only and has been prepared without taking into account your objectives, financial situation or needs (your Personal Circumstances). Before acting on any such general advice, we recommend that you obtain professional advice and consider the appropriateness of the advice having regard to your Personal Circumstances. If the advice relates to the acquisition, or possible acquisition of any precious metal or related product, you should obtain independent professional advice before making any decision about whether to acquire it. Although the information and opinions contained in this document are based on sources we believe to be reliable, to the extent permitted by law, ABC and its associated entities do not warrant, represent or guarantee, expressly or impliedly, that the information contained in this document is accurate, complete, reliable or current. The information is subject to change without notice and we are under no obligation to update it. Past performance is not a reliable indicator of future performance. If you intend to rely on the information, you should independently verify and assess the accuracy and completeness and obtain professional advice regarding its suitability for your Personal Circumstances. To the extent possible, ABC, its associated entities, and any of its or their officers, employees and agents accepts no liability for any loss or damage relating to any use or reliance on the information in this document. It is intended for the use of ABC clients and may not be distributed or reproduced without consent. © Australian Bullion Company (NSW) Pty Limited 2020.