Gold Spikes on Iran/US Escalation

Precious Metals Commentary

Welcome to 2020! There has been plenty of action in precious metals markets since we left for the holiday break, with gold staging a breakout of the range that we mentioned in the last market update of 2019, rocketing above $1,550 USD and reaching highs of $2,350 in AUD terms. We note that the breakout and new leg higher in gold actually started before any of the news out of Iraq/Iran came out, so we expect prices to remain relatively supported even if we see a de-escalation of events.

By now, most readers would have heard the news around the US assassination of a very key Iranian Commander Qassim Suleimani, and the retaliation strikes by Iran on US bases in Iraq, so we won’t comment too much on it this week, but we do note that the gold price in the short-term will hinge on this event and how things progress from here. Of course, we much prefer to see metals rallying on the back of economic events and central bank buying versus geopolitical events, as these spikes can often be short-lived depending on how the situation plays out.

What is of concern though, is the possibility of further escalation on Iran’s part, as the initial assassination on Suleimani is much more likely to start a war than stop one. There have been speculations that Trump was convinced based on a small amount of information by those in the military industrial complex that have wanted war with Iran for some time.

Reports that Iran may have unintentionally shot down Ukrainian flight 752 earlier this week indicate how tense the situation is. As we can see by the funeral in Iran, it wouldn’t surprise us to see further retaliation over time, and the recent events certainly don’t help to heal any of the tensions that have built up in recent years.

If everything settles down we could see gold pull back in the short-term as it gives back those gains, but gold was already well into its latest leg higher before these events, trading well above USD$1,500 at the time. Scotiabank notes that $1450 was the previous floor price “but gold is now firmly in a spot where the risk/reward in being directionally short is not favorable - $1500 is increasingly looking like the new 2020 floor”.

On a technical level, we identified the potential area that would signal the end of the recent consolidation phase back on December 18th.

The chart below shows the breakout and rally following shortly after.
 
 

Silver got dragged up along with gold and is just under $18 as we write, while gold is holding above the crucial $1,550 level. In Aussie dollars gold is at $2,262, up a nice $100 for those who received gold for Christmas, and $26.17 for silver.

Costanza’s Gold Trade

Each year UK brokerage firm Prism puts out a list of contrarian ideas it calls its “Costanza Trades” for the coming year. The list is named after the Seinfeld sitcom episode where George Costanza realizes that if every instinct he has is wrong then doing the opposite must be right.

This year Prism has shorting gold as one of its ten Constanza Trades, based on the fact that “gold has become a widely popular macro trade” on the back of central bank balance sheet expansion, falling US dollar and low real rates. They say that gold is breaking out (note they released their list late last year, before the recent Iran troubles) with a target of $1,700.

There has been a lot of commentary noting that speculative positioning near all-time high and that this is a sign that gold prices are too high. However, we agree with Mike Shedlock that the futures position of commercial hedgers on Comex is not a strong indicator over the long run.

Below is a chart of gold prices with previous times futures positioning reached all time new highs.

It is clear from this chart that there is no level at which speculators are holding “too many” long or short contracts.

What interested us was that while Prism saw gold as a very crowded trade, they only gave the short trade a 20% probability of being right – the lowest conviction of their ten trade ideas.

They concluded that while the gold market will need a positioning cleanse, “the bull case is strong and the bear case is weak at best. The consensus will likely be proven right (for once)”.

We see increasing numbers of buy-and-hold investors coming to gold compared to speculators and believe this is supporting the market. As we have noted before, low interest rates is a key driver behind this, with this ABC News report about a retired Perth lawyer who has invested 20% his savings in the precious metal due to low rates as a perfect example of what we are seeing.

War on Cash Continues

Australians worried whether the local ban on cash payments over $10,000 will portend further restrictions should consider themselves lucky they aren’t in Greece, which has attempting to clamp down on tax evasion in a very blunt manner.

The new measures would require Greeks to spend 30% of their income electronically, otherwise they would be hit with a 22% fine on the shortfall. The country’s banks will help to impose the measures by reporting spending by their customers to the government.

In the case of China, we were surprised to learn via financial blogger JP Koning that since 2013 Chinese ATMs and tellers are required by law to record the serial numbers of all banknotes. The claimed purposed is to prevent counterfeit yuan from entering into circulation but as JP notes, “one could imagine this technology being used by the authorities to track licit money flows”.

In Australia, the RBA estimates that only 8% of cash is used in the shadow economy, with around a quarter used for everyday transactions and maybe 10% having been lost. The remaining cash must therefore be “in safes, under beds and at the back of cupboards, both here in Australia and elsewhere around the world”, according to the RBA governor.

Regarding cash and privacy, we note a speech by the RBA governor in December where he said that “the RBA’s Payments System Board would like to see further progress is the provision of portable digital identity services”.

He notes that the Australian Payments Council has developed a TrustID framework and the Federal government has also been working on a Trusted Digital Identity Framework. Sounds like Australia Card version two to us.

If a country really wants to reduce the use of cash then they could use the example of Sweden. The chart below shows the value of 1000 Krona (approx $A 150) notes in circulation.

A study has found that this huge reduction is due to frequent issuance of new notes combined with deeming old notes as invalid in less than one year, burdensome old for new note exchange provisions, and decreasing availability of cash services at bank branches.

In classic government “one hand doesn’t know what the other is doing” bureaucracy, while the Swedish central bank has been working to make cash unattractive, the Swedish Civil Contingencies Agency released a booklet in 2018 titled “If Crisis or Ware Comes” which included a recommendation for people to hold cash in small denominations as one preparedness measure.

Reduced cash usage has impacted British company De La Rue, which has prints currency for over 140 countries. They suspended future dividend payments late last year. It was the result of a combination of increasing competition, unpredictable and rapid demand changes for banknotes, and exceptional items like a £18 million write-off after Venezuela's central bank failed to pay the company for its services.

It seems printing money isn’t an actual license to print money.

Green Gold and Underground Vaults

Consumers are increasingly concerned about the environmental impacts of the products they consume. The gold industry is continually improving its environment impact, such as initiatives like Gold Fields’ Agnew gold mine being powered predominantly by renewable and low-carbon energy or Clean Mining offering miners a CSIRO developed cyanide-free gold recovery process.

At ABC Refinery we are also focused on sustainable and environmentally sensitive precious metal production, being the only refinery in Australia and one of the first globally to implement Acidless Separation technology that does not use chemicals or produce fumes like conventional refining process do.

Responding to these concerns, academics at the University of Western Australia propose that instead of digging for gold, the greenest form of gold is that which is simply left in the ground with nature acting as a natural vault and custodian.

They argue that a portfolio of gold exploration companies provides significant exposure to the gold price and can “perform similar to major gold mining ETFs and outperform physical gold depending on the number of firms in the portfolio” and degree of rebalancing.

Certainly explorers can be considered “cleaner” and environmentally more friendly as they do not actually mine gold but there is a reason why investors would prefer their gold above, rather than under, the ground.

Firstly, no matter how good the exploration data is, determining the amount and grade of gold in the ground involves estimation and thus has varying amounts of uncertainty associated with it.

Secondly, the idea also relies on investors trusting the management team of the explorer, stock exchange rules/supervision and a legal system to enforce contracts. Such trust requirements are counter to many investors’ store of value and safe haven asset reasons for buying physical gold.

Amusingly, the academics note that many investors don’t seem too perturbed about uncertainty and asymmetric information issues given they invest in ETFs or accept their central bank gold reserve statements that often lack of independent or infrequent auditing.

They do conclude that the uncertainty and intrinsic illiquidity of in-ground gold means that their “green gold would continue to trade at a major discount relative to “classical” gold”. So for the time being ABC Bullion won’t be adding “Underground” to its range of Pool, Secure, Premium and Safety Deposit Box storage options.

Until next time,
 
John Feeney and Bron Suchecki
ABC Bullion
 
If you have any questions or feedback about this week’s report, we would love to hear from you. You can contact John Feeney (@JohnFeeney10) and Bron Suchecki (@bronsuchecki) directly on Twitter, otherwise please feel free to send us an email at [email protected], or call us during trading hours on 1300 361 261.

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