Gold prices have eased again this week, as markets increasingly anticipate a benign end to the 'Grexit' drama, and equity markets show continued strength.

As it stands now, gold has given up the majority of its early 2015 gains, currently sitting at jus USD $1213oz. That is up just 1.2% from the London AM Fix at the end of 2014, with the recent weakness disappointing the bulls who were encouraged by gold’s very brief trip back above USD $1300oz in late January 2015

Silver, which at one point had climbed above USD $18oz, is now back to just USD $16.63oz, up just over 4% for the year.

Australian dollar gold has also had a decent pullback in the last few weeks, currently sitting at just $1553oz, down from above $1650 just a few weeks ago.

In USD terms, the market is looking supported at around the $1200oz level, though a break through that marker would likely see more downside ahead, with a move back through USD $1180oz likely.

On the bearish front, solid moves in equity markets are slackening demand for precious metals, with less ‘safe haven’ demand in the face of any share market strength.

Momentum is also against the precious metals now too. Had gold held above USD $1250oz, then anyone short the market would have been second guessing their positions. Instead, they’ve been emboldened by the recent weakness. As a result, if anything we’ve seen those we’ve been long precious metals winding back their positions, which has of course contributed to the recent weakness.

Commodity news and market moves are generally very bearish now, with oil slumping again, and some extreme headlines even telling us that we’re on our way to USD $10 a barrel oil. Whilst I don’t believe that for a minute, it’s evidence of where market sentiment is right now, not only towards oil, but all inflation sensitive assets, including gold.

On the plus side for gold we still expect some kind of safe haven bid to stay in the market until the end of February, or until the Greece scenario plays out.

We’ve also had a stream of negative US economic data of late, which if anything will force markets to reconsider when they see the Fed raising interest rates (more on this below).

Net positioning in the futures market also looks healthier than it did a couple of weeks ago, whilst physical demand out of Asia is also holding up OK.

Federal Reserve Minutes Released

Overnight, market attention was focused on the release of the latest Federal Reserve minutes. With most people predicting that mid 2015 will be the time that the Fed finally raises interest rates, the minutes of the FOMC are watched like a hawk by traders, asset allocators, fund managers, economists and the like.

The minutes released overnight were definitely interpreted as dovish, with the minutes showing that many officials were inclined to keep rates at zero for a longer period, with concern that further economic weakness abroad would impact the US economy negatively.

Interestingly, despite the mainstream consensus that lower oil prices will be good for the US economy, the Fed didn’t seem so sure, noting that “several participants noted that there were signs of layoffs in the oil and gas industries, and that persistently low energy prices might prompt a larger retrenchment of employment in these industries.”

All in all the Fed’s clear concern over the direction of the US economy capped a bad 24 hours for US economic data. We also saw housing starts data released, which indicated a 2% fall in January to just 1.07 million. Industrial production figures also underwhelmed, rising by just 0.2% for the month, below expectations, whilst the capacity utilization rate was 79.4% in January, a fall from it’s previous reading. US January producer prices also dropped 0.8%, with the core rate -0.1%.

Over 75% of US Macro data releases in February have been below expectations, highlighting a weakness that equity market investors are continuing to ignore (or gambling on depending on how you view such things)

With inflation so low and trending lower, you’d think the barrier to a rate hike is rising rather than falling. Mortgage application data was also released overnight, and it was a shocker. Week on week, mortgage applications fell by 13%, and are now down a stunning 66% on where they were in 2004.It is very hard to believe that the United States is experiencing a genuine housing recovery when looking at data like that.

The other factor impacting the Fed or that would be cause for concern is the still weak wage growth were are seeing in the United States. It has picked up marginally of late, but as this chart, which appeared in Business Insider shows, it is still incredibly low by historical standards, and nowhere near as strong as you’d expect this far into an economic ‘recovery’

The full Federal Reserve minutes can be read here.

Inflation is Dead:

Inflation is Dead. Long Live Inflation. That was effectively the message in a Washington Post article dated February 13th, which you can read in full here.

The article started; “R.I.P., inflation. You had a good run, but it's over now that prices are rising less than 1 percent in the United States, United Kingdom, Europe, China, and Japan. Now this isn't the first time that inflation has died. The Black Death killed it, along with a third of Europe's population, for most of the 1400s.”

The article goes on to state that plunging oil prices are the primary driver behind record low inflation rates around the world today, and that those lower oil prices are predominantly due to a slowing global economy. The author then goes onto blame the slow growth rates as a symptom of credit bubbles and the excessive accumulation of debt in the developed world.

No arguments from me in any of that.

Personally, articles like this make me more convinced than ever that gold is only half-way through what will end up being seen as a roaring bull market. Despite a trend towards lower inflation (officially) over the last decade, and despite current readings at some the lowest levels on record, gold is still above USD $1200oz, and has risen nearly five fold in over a decade.

As even the author states; “Central banks, for their part, are trying to push prices up by pushing interest rates down even below zero, but it hasn't been enough so far. At some point, if they really, really want to, they should be able to revive inflation—after all, they can print as much money as they want—but for now it's dead.”

When inflation does finally take off, then there is a very good chance that both physical gold and physical silver will move significantly higher.

When the Washington Post, the New York Times and Bloomberg carry headlines that inflation can’t be stopped, and that gold is the only asset worth buying, then we’ll know it’s time to sell, or at least reduce our holdings.

We are many years away from such a scenario.

Gold as a Call Option:

One of the better publications I’ve come across this week came courtesy of Australian financial news site Livewire Markets, a source I visit (and occasionally contribute too) everyday. This week they contained an update from Freehold Investment Management, which correctly highlighted that cash, even though it’s low yielding, is still a valuable part of a portfolio.

Here is an excerpt; “Just because cash is not ‘high returning’ does not mean it is not valuable… A major assumption regarding the attraction of the ‘yield trade’ is cash is an impaired asset class because it is earning such a low return. We strongly disagree. Despite cash providing little return, it provides an optionality that has value. Warren Buffet for example, thinks of cash as a call option over every asset class and with no expiration date. The question Buffet asks is “how much can the cash return if I have it when I need it to buy other assets that are cheap, versus the upfront cost of holding it?”.

Nassim Taleb, author of The Black Swan also highlights that the optionality of cash allows the holder to buy assets from people who are over exposed when a crisis hits. “Let’s assume that you have cash in the bank and there’s a big crisis. You have dry powder. You can buy anything you want. Cash is the opposite of leverage.” Conclusion: Despite cash returning little in real terms, it still has value in a diversified portfolio”

You can see Freeholds report here.

I couldn’t agree more with this kind of analysis, and it’s why I’m happy to hold cash in my portfolio today, even though I know it’s going backwards at the rate of inflation minus interest (what little of that there is). It also helps highlight why I have such a large allocation to physical gold and silver in my portfolio, for they are the ultimate form of cash.

As Jim Grant once said, “nothing beats a little cash in a bear market, of course, and the oldest form of cash is gold”.

Now of course if volatility is your primary concern, then cash will be preferable to gold, as it won’t move around in price on a daily basis.

But if preservation of purchasing power, and the elimination of counterparty risk are also concerns you’re trying to allay, then gold will prove a far superior option. Indeed a look at the 5 worst years on the ASX since the 1970s will highlight, gold has provided a superior call option to cash in most instances, and often by a substantial margin.

As you can see, gold has been a far superior call option to cash itself if one was looking to capitalise on falling prices for risk assets like shares. And over the long run, it's almost guaranteed to be a better (if not only) call option, for the very reason that, unlike cash itself, gold won't be ruined by inflation.

For as Matthew Mclennan, an Australian Fund Manager based out of New York, where he runs circa $80 billion in assets for First Eagle Funds once commented; "The paradox of gold is that its utility as a monetary reserve is its uselessness as a commodity. ….. And as it does not rot, rust or waste, it is not just resilient but also a natural resource perpetuity, out-lasting corporate fads and sovereign regimes."

That comment comes from an excellent and very wide ranging interview that Mclennan had with Chris Joye at the AFR, the full transcript of which can be accessed here.

Jean Marie Eveillard, Mclennans predecessor at First Eagle, also understand the value of gold, and it’s role as the ultimate call option over financial assets.

In a early 2015 interview with Consuelo Mack of Wealth Track, Eveillard was asked what would be the one asset class he thinks every investor should own. “My answer would be gold bullion” was his reply!

According to First Eagle’s January 31st, 2015 portfolio composition report, some 9.65% of their portfolio is in precious metal related investments, it’s third biggest exposure outside of technology and industrials.

Their latest portfolio is viewable here.

Conclusion:Despite the volatility and the lack of yield, investing in gold and silver is an incredibly prudent thing to do. By doing so, you’re doing the same thing that many of the world’s central banks and some of the most sophisticated asset managers on the planet are also doing. There is no need to change approach.

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.