Precious metal prices have continued their rally this week, with gold rising from USD $1151oz to USD $1182oz, up 2.5% since last Friday. Silver has also rallied, rising just over 1%, to USD $16.24oz.

We’ve also seen a rally in AUD prices, with the yellow metal now comfortably back above $1600oz. Note this is despite the local currency trading back above USD $0.73, a move we expect to be short-lived

Back to gold, and the rally over the past couple of months (the London PM Fix on the 22nd July was USD $1,088oz), has of course had many drivers, not least of which was the Fed decision not to hike interest rates in September.

With US data almost overwhelmingly poor over the last few weeks, it is clear that the Fed has now missed its window to hike interest rates in 2015. Further evidence of this was seen at least a couple of times this week, with;

• The Philadelphia Fed manufacturing index falling 4.5 points. New orders, workweek, inventories all fell noticeably

• Retail sales (ex autos), falling 0.3% for the month, far worse than forecast

Indeed so poor has data been of late that the market is starting to doubt that we’ll even see a rate hike by Q1 of 2016.

Unsurprisingly, this has scared a lot of gold shorts out of the market, whilst the more constructive technical outlook (more on this below), is encouraging a few more longs into the game. And whilst we wouldn’t be surprised to see gold spend a few days consolidating recent gains, a strong finish to 2015, with gold finishing the year above USD $1200oz is looking possible.

For Australian dollars investors, the news could be even better. The main reason we say that is that we expect the RBA to cut rates at least once more this year, or at least market expectations of that cut to strengthen. With that in mind, a weakening of the currency between now and Christmas is likely.

Should this happen, returns for local investors will be magnified. As we stated earlier, the AUD has rallied back above USD $0.73, up some 6% from its mid September 2015 low.

Were the AUD to fall back below USD $0.70 by the end of the year, then we could easily see the AUD gold price start 2016 above $1700 an ounce.

That would be a return for calendar year 2015 of some 20%, which will have gold comfortably outperforming stocks, bonds, cash and even Sydney property for the year, should things stay as they are for the next two months.

With that, we’ll take a quick look at the technical picture for the gold market.

Technical Outlook

with John Feeney
In last weeks market update we spoke of the tightening trading range for gold and the possible breakout if we could see a close above the $1,160 level. This has indeed happened, and gold quickly rallied back above the $1,180 US level in a few days. The $1,180 level is an import one for US gold as it was the absolute bottom for 2013 and 2014.

The recent rally which can be seen below may be due a small pullback as we have the RSI almost overbought and William % signalling short-term overbought. But we feel this move has a lot of momentum, as faith in the Federal Reserves economic prowess is slowly diminishing.

A pull back from this level (USD$10-$20 an ounce) could pose a buying opportunity.

We have further confirmation of a shift in sentiment with the gold miners index rallying hard during October, and the relative outperformance of silver over this period too. The breakout and close above $1,180 can be seen below and is about as positive a start to October that one could wish for.

The chart above is supportive of those who argue that the August low for gold was a meaningful long-term bottom.

Of course back in August, most market participants were still expecting a rate rise, whilst the US stock market (S&P 500) was at 2100. Hedge Funds were also net-short gold for the first time, whilst the mainstream financial press was incredibly bearish gold.

From a contrarian perspective, the sentiment toward gold in August was about as bad as it gets, something we commented on in this piece (published 7th August), where we pointed out that “Sentiment, and the current positioning in the precious metals market is truly awful. It is a wonderful opportunity."

Inflation – it’s here all right.

The other piece of ‘market news’ overnight was the release of the latest US inflation data. Ex food and energy, the number came in at 1.9% for the year, whilst the number including food and energy registered 0.00%, a result of the huge fall in commodity prices over the past year or so.

Low official inflation is something that “haunts” the developed world right now, as low wages growth, excessive debt levels and a more prudent consumer all contribute to slower rates of growth.

Of course, low official inflation only encourages the high priests of neo-keynesian economics push for ‘more stimulus’, which inevitably means more money printing, and the accumulation of even higher levels of debt.

With no inflation to worry about, they see no harm in this policy, arguing it will encourage spending, levitate asset prices and create a ‘trickle down’ wealth effect.

But is there really no inflation? We aren’t so sure, and wanted to share a few observations on this phenomenon.

One place to look in the United States is healthcare, where we’ve seen quite colossal price inflation in the past 15 years. According to a recently published article by Mauldin economics, the total premium for family coverage for healthcare just topped $17,500.

That is up from $5,700 at the turn of the century, an annualised inflation rate of 7.70%

Lets stay in the US, but move from healthcare to the stock market.

Wall Street, and the legion of brokers, analysts, asset consultants and fund managers who profit from it have of course celebrate the bull market in stocks we’ve seen since early 2009. And they’ve had much to celebrate too, with the S&P 500 rising from under 700, to over 2000 points.

But what has it cost?

Well, if we look at the cyclically adjusted price earnings ratio for the S&P500, we can see that it has risen from roughly 15 to over 25.50 since early 2009.

Put another way, the cost of buying a share in the earnings of the companies that make up the S&P500 has risen by 70% in the past six and a half years, which represents annual inflation of around 10%.

Hardly benign!

In Australia, whilst many in the market celebrate our soaring housing market, mortgage holders are faced with no choice but to go ever deeper into debt, in order to secure a piece of the Australian dream.

An article in the Sydney Morning Herald from early October 2015 highlighted that the average NSW mortgage for owner occupiers had risen by $78,100 in just 1 year. That is about equivalent to the full time wage of an average Australian, and represents a rise of 22% in JUST ONE YEAR.

If that isn’t high inflation then I have no idea what is.

Finally, consider the amount of money one needs to have accrued in their working life, in order to afford a comfortable retirement, without depleting their capital.

According to ASFA, a couple needs $58,784 in income per annum, in order to live what they define as a comfortable lifestyle. Let us round that up to $60,000 for simplicities sake.

The question is, how much capital must one have in order to earn this income in any given year.

Assuming a diversified portfolio can be expected to earn an income equivalent to the RBA cash rate plus 1%, then we can safely state that

• Pre GFC, when the RBA cash rate was 7.25% (ergo an 8.25% income on assets), a couple would need to have accumulated capital of just over $725,000 in order to generate an income of $60,000 a year

• By Q3 2015, the same couple will need to have accumulated capital of exactly $2,000,000 in order to generate an income of $60,000 a year (assuming a 3% rate of income on assets invested)

That increase, from $725k to $2m represents an annual inflation of over 15% in the past six years in terms of capital accumulation required to preserve a comfortable retirement.

The bottom line to this is that prices, whether we look at healthcare, housing or holding financial assets, are rising, and the economic path we are heading down is a dangerous one.

For those who want a final read, and a different take on inflation, we recommend this piece by Chris Joye from the AFR, which is well worth the time.

So is the Gold Bear Over?

The strength in precious metals over the past few weeks has many asking if the cyclical bear market in gold and silver is now finally over. Pater Tenebrarum, an analyst I have the highest respect for seems to think so, stating in this worthy read that he thinks that “a significant low has finally been put in”.

Whilst we share Pater’s confidence in the long term direction of this market, and are highly encouraged by the recent price action, it does pay to mention that we’ve seen a number of counter-rallies in gold over the past couple of years, none of which have endured.

As such, dollar cost averaging still seems an appropriate strategy for long-term investors.

In Australian dollars, we are still more than comfortable with our position that the worst of this cyclical correction is over, and we have personally been adding to our own positions for the entirety of 2015.

I remain confident precious metals will be the best performing liquid asset class between now and the end of this decade, and certainly the most important one to physically own, but patience is a virtue, or so they say!

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.