AUD gold at one point pushed toward $1700 an ounce earlier this week, as the Reserve Bank of Australia joined the global interest rate easing cycle, cutting the local cash rate to a record low of 2.25%, sending the local currency at one point toward 0.76 cents vs. the US Dollar

Prices have since pulled back, as the AUD has staged something of a rally, whilst USD gold is also now trading at $1266 an ounce, down $20 an ounce or so on intra-week highs.

The decision by the RBA was very much priced into the market by the time they had actually made it, with most forecasters now predicting that rates will be cut again, to just 2% by the end of Q2 2015 at the latest.

On this point, whilst we jumped the gun and got our timing a little wrong, subscribers to ABC Bullion’s market reports will know we’ve been predicting lower rates in Australia for some time now.

We expect that the RBA will end up slashing rates well below 2% in the coming years.

The RBA’s rationale for the decision was perhaps best captured in this paragraph from their monetary policy decision statement, where they claimed;

“In Australia the available information suggests that growth is continuing at a below-trend pace, with domestic demand growth overall quite weak. As a result, the unemployment rate has gradually moved higher over the past year. The fall in energy prices can be expected to offer significant support to consumer spending, but at the same time the decline in the terms of trade is reducing income growth. Overall, the Bank's assessment is that output growth will probably remain a little below trend for somewhat longer, and the rate of unemployment peak a little higher, than earlier expected. The economy is likely to be operating with a degree of spare capacity for some time yet.”
No arguments from me that the economy is weak.

As usual, the rate cut was met mostly with support from the mainstream financial media, who talked of the stimulus it will provide to the economy via lower mortgage payments and the like.

Whilst that is true, everyone I’ve spoken since the decision who actually has a mortgage has been adamant they won’t be spending that extra cash in the economy, and will instead keep ploughing it into their record home loans.

Treasurer Joe Hockey also talked it up, and seemed delighted there’ll be more rate cuts to come, though of course when running for office he was describing ultra low interest rates as being at ‘emergency lows’. He was right then. Not now.

We therefore suspect that much like the previous 200 plus basis points of easing the RBA has done in the past few years, this latest rate cut will also fail to provide any kind of major stimulus to the economy, whilst continued pressure on the AUD brings as much pain as it does joy to the economy.

Nowhere is that more evident than in the pain those living on fixed incomes and with money sitting in term deposits will be feeling in light of the recent RBA decision.

$90 Billion of Pain

The problem I’m referring to is no small beer either. According to the latest monthly banking statistics put together by the Australian Prudential Regulation Authority (APRA), there are now just shy of $1.8 Trillion sitting on deposit with Australian banks.

You can access one of these reports here.

Every 0.25% cut in interest rates translates to a $4.5 billion reduction in interest income on this pool of deposits, effectively a pay cut for everyone trying to do the right thing by saving money and providing capital to our banks in the first place.

It’s no wonder Liam Shorte, director at Verante Financial Planning described the latest cut in interest rates as a ‘kick in the teeth’ for many seniors and people with SMSF’s and the like.

Since the pre-GFC peak in interest rates in Australia, which occurred in August 2008 when interest rates were 7.25%, we’ve now seen a full 500 basis points cut off the cash rate. Our $1.8 Trillion deposit pool would have generated $130 billion in interest income back then. Today it generates just $40 billion.

That’s a $90 billion hole in our annual income, equivalent to about 5% of our GDP.

Not small change in anyone’s language – not that you’ll hear anyone in the ivory towers of high finance talk about it in those terms

Gold Gets Technical

Short term there a number of bullish and bearish factors interacting to influence the gold market right now.

On the bearish side, futures positioning is quite aggressively now, with net longs among short term speculators now at it’s highest point since November 2012. That suggests there is less buying power to come into the market, and is often suggestive that a pull-back is around the corner.

Bond yields look like they could be rising, if only for a short time. This can also hurt gold, whilst ‘Fed chatter’, including that from James Bullard, president of the St Louis Fed, suggest they’d like to see interest rates rise soon. That might hurt gold and silver too.

On the bullish side, we’re still seeing renewed interest from ETF buyers, whilst central banks are also still picking up bullion. We’re also seeing quite significant easing from global central banks (outside of America), of which the RBA is but one. That’s great news for gold.

Finally, gold’s lack of correlation to equities will support the precious metal market in the event of any stock market volatility.

My colleague John Feeney wrote an excellent blog yesterday looking at the technical picture for gold right now, and why he see’s some potential short-term weakness in USD prices, which will make for a great buying opportunity.

This is particularly relevant for ABC clients in light of the latest interest rate with John noting that “Looking forward there are many commentators saying we could be looking at a full 1% cut to rates by the end of 2015, and we all know what that means for the AUD, and conversely the Aussie gold price.”

I agree with John that short-term we could see a little pressure come to bare on the gold market, with tonight’s US non-farm payroll report in United States potentially decisive.

The market is expecting that the US created some 235k jobs, so a print above 250k could see gold pull-back, though a print below 200k would likely see prices rally. Either way the USD $1250 to USD $1255 price area is one to watch.

John’s report can be accessed here.

It’s definitely one for the chart watchers.

Debt Watch 1: Mckinsey Update on Global Debt Levels

Just this week, the Mckinsey Global Institute released another cracking report, titled “Debt and (not much) deleveraging”.

The report delves into the explosion in government, or public debts that we have seen since the onset of the GFC, and how the private sector has barely deleveraged at all.

The summary to the report didn’t mince words, and vindicates everything that precious metal bulls have been warning about for years, with Mckinsey stating that; “Seven years after the bursting of a global credit bubble resulted in the worst financial crisis since the Great Depression, debt continues to grow. In fact, rather than reducing indebtedness, or deleveraging, all major economies today have higher levels of borrowing relative to GDP than they did in 2007. Global debt in these years has grown by $57 trillion, raising the ratio of debt to GDP by 17 percentage points (Exhibit 1). That poses new risks to financial stability and may undermine global economic growth."

The three key findings from the report were that

• Government debt is unsustainably high in some countries

• Household debt is reaching new peaks

• China’s debt has quadrupled since 2007

At a global level, the trends in government debt are something we’ve been warning about for years (yes – we know we sound like a broken record at times), but reports like these are timely for they help illustrate the scale of the problem clearly.

The following chart, which plots public and private debts in advanced economies, expressed as a percentage of GDP, and how these have changed since 2000 is an absolute gem, for it highlights just how large the spending spree that governments have been on since the GFC hit truly was.

As you can see, government debts in advanced economies have exploded in the last few years, rising by over 30 percentage points relative to GDP.

By comparison, whilst the private sector isn’t any more indebted than they were when the GFC hit relative to overall GDP, you can also see that there has been no major deleveraging at all, and that private debt levels are still significantly higher than they were back at the turn of the century.

Onto China, and whilst many gold bulls rightly focus on the insatiable gold demand out of the Middle Kingdom, broader economic developments there shouldn’t be ignored.

That is particularly relevant for Australians, what with our current position as China’s southern most economic province, and key supplier of raw commodity inputs.

The debt developments in China really are quite dramatic, with total debt rising from $2.1 Trillion to $28.2 Trillion in the past 24 years, up over $20 Trillion in just the past 7 years.

Whist government borrowing has risen in China, the majority of the growth has come from financial insitituions and non-financial corporates, with the total debt to GDP ratio in China hitting 282% of GDP in 2014, up from just 158% in 2007.

The Mckinsey report can be accessed here

Debt Watch 2: CBO Update on US Budget Position

Continuing on with the debt theme, in late January the Congressional Budget Office in the United States also released updated forecasts for the US Federal Budget and Economic Outlook, covering the period 2015 to 2025.

These reports are always worth a read, and the official summary (with a link to the full report), can be found here.

The most obvious finding from the report is that, as a percentage of total economic output, CBO forecasts suggest that the deficit will increase from 2.5% to 4.0% of GDP over the next 10 years.

In pure dollar terms, the CBO is predicting that the annual budget deficit will fall to ‘just’ $468 billion in 2015, remain steady in 2016, and then head higher from 2018 onwards, with the annual deficit pushing back above $1 Trillion by 2025. Between now and then, the CBO forecasts that total deficits will come to some $7.6 Trillion, pushing the expected total federal debt above $25 Trillion within a decade.

We suspect they’ll get their far sooner than that, with economic growth numbers likely to disappoint, and budget outlays likely to rise further, and faster than expected.

I've included my favourite chart from the whole report below, which shows federal outlays by type of spending, breaking these down between mandatory, discretionary and net interest costs.

As you can see above, mandatory spending has risen from circa 4% of GDP, to circa 13% today, whilst discretionary spending has decreased from over 12% in the late 1960s to barely 7% today, and is projected to fall further going forward.

Net interest costs have actually fallen in the past few years, largely as a result of the Federal Reserves various QE and bond buying programs, as well as their slashing of short term interest rates, all of which have helped government borrowing costs hit record lows, despite government debts hitting record highs.

If the US Government was paying 5% on its borrowings rather than closer to 2%, it would be shelling out an extra $540 billion in interest payments alone, which would push that net interest cost from around 2.5% to 5.5% of GDP alone.

Make no mistake about it, the US Federal Governments budget is in tatters, with no likely improvements on the horizon.

The desperate position they find themselves in will necessitate low interest rates and continued support from the Federal Reserve via money printing for years to come.

That this will end up causing a run to physical precious metals is highly likely, with only the timing in question.

This move will be highly profitable for those of us who continue to position capital into the sector.

Until next week

Disclaimer

This publication is for education purposes only and should not be considered either general of personal advice. It does not consider any particular person’s investment objectives, financial situation or needs. Accordingly, no recommendation (expressed or implied) or other information contained in this report should be acted upon without the appropriateness of that information having regard to those factors. You should assess whether or not the information contained herein is appropriate to your individual financial circumstances and goals before making an investment decision, or seek the help the of a licensed financial adviser. Performance is historical, performance may vary, past performance is not necessarily indicative of future performance. Any prices, quotes or statistics included have been obtained from sources deemed to be reliable, but we do not guarantee their accuracy or completeness. This report was produced in conjunction with ABC Bullion NSW.