Gold Pulls Back as Markets Hit New All Time Highs!

Precious metal prices have pulled back meaningfully in the past 10 days, with gold falling to just USD $1,309oz, a decline of almost 3% from levels seen in earlier September.

Silver has fallen too, declining by over 5.5% over the same time period, with gold’s little cousin currently trading at around USD $17.28oz.

Australian dollar prices are sitting at $1,638oz for gold, and $21.69oz for silver, with the local currency trading above USD $0.80, largely unchanged over the month, even though iron ore has been clobbered by over 10% over the same time period.

The pullback in USD precious metals is not unexpected, and can be attributed to a multitude of factors, including:

• An easing of the ‘safe-haven’ trade as markets fade the rhetoric emanating from the Korean peninsula

• A stabilisation and slight rally in the USD, which had been falling almost uninterrupted for most of 2017

• New all time highs in equity markets (more on this below)

Those who focus on the speculative end of the market were also expecting a pullback, as the hedge fund community had been aggressively adding to long positioning in recent weeks.

This is captured neatly in the chart below, which plots hedge fund positioning and the price of gold (in USD) over the majority of the last decade.

As you can see, anytime positioning has approached the levels we’ve seen in the past, a correction has followed, so this recent pullback, which we are treating personally as a buying opportunity, needs to be seen in that context.

The bigger picture is perhaps better seen in the following chart, which plots gold over a similar timeframe, but clearly denotes a reverse head and shoulders set up in gold.

Source: Goldbroker

Shorter-term, we can see this corrective phase pushing the gold price as low as USD $1,280oz (55DMA), especially if some length continues to come out of the market, or some of the recent inflows from the ETF community reverse course.

But with open interest and volumes rising, and a handful of supportive factors still in play, we are still of the view that this is a correction to be bought, especially for longer-term physical investors.

The Everything Bubble
One of the key reasons we think precious metals will perform well both in absolute as well as relative terms in the decade ahead is the paucity of return we expect more traditional assets to deliver investors, and the potential for a portfolio rotation toward precious metals (both physical bullion and gold mining stocks).

This week, we saw another great illustration of the difficulty investors will face in traditional markets, with Deutsche Bank publishing an analysis of how expensive or cheap financial markets are.

Their analysis was based on an equal weighted index of 15 developed market bond and 15 developed market equity indexes, looking back over more than 200 years. The results are seen in the chart below, which, according to Deutsche, highlights the fact that; “at an aggregate level, an equally weighted bond/equity portfolio has never been more expensive”. 

 
Given gold is less than 1% of total financial assets, gold ETFs are less than 2% of total ETF assets (down from 10% in 2012), and gold mining stocks are just 0.6% of the value of equity indices (down from 2% in 2012), the potential for outperformance in the decade ahead is clear, irrespective of one’s view’s on the evolving macro and monetary environment.

You can read more about the above findings by Deutsche Bank, and 10 other potential items that could cause major economic issues between now and the end of the decade in this article here. We agree with issues two and three in the article in particular.

Extreme valuations in stocks and bonds are largely being ignored by retail punters, who are holding record low levels of cash right now, based on the following chart from the Atlas Investor.

Whilst there is seemingly little fear amongst the retail investing public, extreme valuations are certainly being noticed across at the other end of the marketplace, but even there, only a few very well known asset managers are ‘doing anything’ about it.

Hedge fund titans like Seth Klarman, who are apparently sitting on more than 40% cash in their portfolios, are looking to return capital to investors, citing a ‘lack of opportunity’ in the market, whilst Hugh Hendry went even further, and is moving to shut his hedge fund, Eclectica.

Hendry’s performance over time can be seen in the chart below, with his standout years coming in the aftermath of the tech bubble bursting, and again back in 2008, when he bet heavily against US and European banks. 

Though he is exiting the stage, Hendry did tell investors to ‘bet on volatility in fixed income’ going forward.

You can read more about these developments about Klarman and Hendry from Bloomberg in articles linked here and here.

From our perspective, the likelihood of constrained returns in traditional markets in the coming years bolsters the case for an allocation to physical precious metals, alongside its demonstrated qualities as a inflation hedge, it’s simplicity, liquidity, and complete absence of credit risk.

Bitcoin and ICO Mania
It would be remiss to discuss the “Everything Bubble” (a phrase that belongs to Jesse Felder) in assets the world over, without touching on the latest developments in crypto-world.

Bitcoin has obviously been in the news, with the price going through a particularly volatile period over the past two weeks, as Chinese authorities looked to end exchange trading of Bitcoin.

At its worst, Bitcoin had fallen some 30%, though it has since rebounded back toward USD $4,000 per coin, another illustration of the volatility (which is not necessarily a bad thing) that we’ve come to expect from this asset class.

Long Bitcoin also popped up at the very top of a recent Bank of America Merrill Lynch Global Fund Manager Survey of “most crowded trades”, which should be a warning sign no matter what asset class tops the pile.

At a theoretical level, analysis of the potential in the crypto space continues unabated too, with the Bank for International Settlements (BIS) releasing a study titled; “Central Bank Cryptocurrencies” this week (read here).

This report looks at the potential for central banks to issue cryptocurrencies in their own right, with the potential for them to be used by the public direct, who could in theory end up holding a central bank liability in digital form.

As a quick aside, we can’t but help think that possibility is surely the greatest fear of the growing army of monetary revolutionaries attracted to crypto in the first place, given Bitcoin’s genesis lay in the aftermath of the GFC, and the implementation of ZIRP/NIRP and QE.

The entire report is worth a read, though our favourite line has to be following (bolded emphasis mine); Precious metal coins are examples of commodity money. They can be used as an input in production or for consumption and also as a medium of exchange. This is in contrast to fiat money, which has no intrinsic use. Although commodity money is largely a thing of the past, it was the predominant medium of exchange for more than two millennia.”

This reminds us of a comment recently made by JP Morgan quant Marko Kolanovic, who in a study looking at currencies in all their form noted that; “In fact, on a long enough timeline, all currencies that were not made of a valued commodity such as gold or possessed exceptional artistic value and rarity became worthless.”

Moving on from the BIS and perhaps more interesting than the recent Bitcoin price gyrations though is the flood if ‘initial coin offerings’ or ICO’s that are coming to market, many of which are listed here.

Regulation light (to put it mildly), these ICOs cover an enormous range of industries, from trading and investing, to gambling (honest at least), payments, data storage and real estate. The marketing is frenetic, with some ICO’s attracting celebrity endorsement, including Paris Hilton, Jaime Foxx and Flloyd “Money” Mayweather.

One that we’ve paid a little bit of attention too is GoldMint, whose offering includes, amongst other things, to ability for investors to earn money by transferring “gold cryptoassets to the companies trust management fund for X% ROI”.

The mechanism for how this works is spelt out in the diagram below. It comes from a whitepaper which you can access here. 

Source: GoldMint

This offering, whilst interesting and I dare say it potentially lucrative (no one knows what could happen to the price of this or any other ICO) is quite clearly not gold. It involves placing trust in a new business (those running GoldMint), ETF providers, pawnshops, crypto currency exchanges, you name it, not to mention spreads of up to 5% for an ounce of gold.

There is nothing wrong with any of this per se, but it should serve as a clear illustration of the difference between:

1. Physical gold and silver

2. Bitcoin

3. The plethora of ICOs coming to market

If you want a highly liquid, zero credit risk monetary instrument as a defensive asset in your portfolio, you should stick with number one alone. The other two most definitely belong at the other end of the risk spectrum.

‘Liar Loans’ in Australia
Before finishing up this market update, we wanted to touch briefly on a recent article to do with a supposed 500 billion dollars of ‘liar loans’ in Australia. This figure, published by UBS, suggests that up to a third of Australian mortgages are based on incorrect information, with borrowers either overstating income and assets, understating expenses, or some unholy trinity encompassing all three.

Whilst the headline is alarming, the detail is likely not as bad as the headline (funny that, clicks are another truly global currency after all), with most ‘liar loans’ likely to contain modest exaggerations of income and or assets for example, whilst the most common ‘lie’ was to understate living costs according to UBS.

Regardless of its scale, it does bring to mind the NINJA loans of the United States, and it does pose a challenge for our banks, and for the housing market as a whole, as investors and owner occupiers are likely not as financially resilient as their lenders would hope they are.

It’s potentially particularly acute amongst the Big 4, whose percentage of borrowers whose applications were not “completely factual and accurate” way higher than the industry as a whole (see chart below).

You can read more about the UBS study in this report from the ABC here, but from our perspective, we see this as another headwind to the Australian economy. Most importantly, it is yet another reason why the RBA will not be able to meaningfully raise rates anytime soon, even though the market is currently pricing in almost two full rate hikes by Feb 2019.

When (and if) the market changes its tune around the likely direction of interest rates, expect to see an AUD that heads meaningfully lower from its current levels around USD $0.80, especially if prices for key commodity exports continue to decline.

As this plays out over time, this decline in the local currency should provide an additional boost in the portfolio value of Australian precious metal investors.

Warm Regards,
Jordan Eliseo
Chief Economist
ABC Bullion

Disclaimer
This publication is for educational purposes only and should not be considered either general or 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, and 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.