Gold surges, inflation cools, crypto crumbles

In this week's market update:

• Precious metal prices surged this week, with gold rising 8% to trade back USD $1,750 per troy ounce (oz)

• Silver rallied even more aggressively, up 15% to almost USD $22oz, with the gold to silver ratio (GSR) falling from 86 to 81

• The strong performance suggests we may be entering a new bull market in precious metals, bringing to an end a two-year correction that dates back to late 2020

• Equity markets also rallied, as softer than expected (though still high) inflation results in the United States saw the S&P 500 rally 6% for the week, most of which occurred last night

• The US dollar fell, with the dollar index (DXY) down 3%, while US 10-year yields declined from 4.13% to 3.82% across the past five trading days, pushing prices up 3%

• Crypto prices were smashed lower, with Bitcoin down 11% for the week, now trading back near USD $18,000 per coin

Is the gold correction over?

The surge in gold and silver prices that we’ve seen over the past five trading days has excited precious metal bulls, with signs that the two-year corrective cycle the metals have been in is now over, with higher prices ahead.

It wasn’t just precious metal investors that enjoyed a good week, with equity markets surging too. The S&P 500 was up 5% just last night (we’ll likely see a strong upside move in the ASX 200 today too), while the NASDAQ was up by more than 7%, as technology stocks, which have been battered of late, staged a recovery.

While there could be more upside in equities, we think the risk/reward continues to favour precious metals. One of the reasons for that is while sentiment for both equities and gold has been battered this year, its only gold allocations that fell meaningfully.

That includes significant outflows from gold ETFs, with holdings falling by 385 tonnes (10% of total holdings) between April and October 2020.

We also saw a net short speculative position in the gold futures market, something that

• Only occurs rarely

• Typically occurs when sentiment is at or near all-time lows

• Often coincides with the end of a corrective cycle in gold, with higher prices to follow

So far, history seems to be repeating itself in that regard, given gold’s recent rally, which started in the aftermath of last week’s FOMC meeting, with the precious metal now back above important support at USD $1735oz.

As the team at Saxo Bank (who looked at not just gold, but silver and copper) noted in an update on November 9th

Gold, silver and copper's performances following last week’s FOMC meeting, when Fed Chair Powell delivered a hammer-blow to sentiment across markets, have been very impressive. All three metals have recovered strongly and are now getting close to levels that may trigger a change in the established "sell-into-strength" mentality

By contrast, equity markets, while plunging up until a month ago, have barely seen any meaningful outflows this year, even though investors have been expressing concern as to the outlook for the market for most of 2022.

There are a range of charts and data that support this, most of which show that while equity allocations have declined, they haven’t fallen as fast as sentiment has, nor are they anywhere near the levels you’d expect to see at an equity bear market bottom.

For a security specific perspective, consider the chart below, which shows the current shares outstanding for the ARK Innovation ETF (ticker ARKK), not the price of ARKK shares.
For background, ARKK is the poster child for formerly high-flying technology stocks that have since crashed, with the ARKK price falling 80% from its high set in February 2021 to the low seen a few days ago.

Despite the crypto like plunge investors have endured in the last 18 months, the number of shares outstanding has barely budged, noting that in simple terms, new shares in ARKK are created when investors buy it ETF, and are redeemed when investors sell it.

As Cameron Dawson noted; “This goes against the hope that sentiment is fully washed out”

It’s also a warning sign that equity markets could still fall a lot further.
This in turn bolsters the case for gold, given it’s strong-track record of outperformance in ‘risk off’ environments, and its value as a portfolio diversifier, while silver could rally even harder, given how cheap it remains relative to gold on a historical basis.

No one’s comparing Bitcoin to gold anymore

While gold and equity prices surged this week, crypto markets tanked, with Bitcoin at one point falling below USD $16,000 per coin. It’s recovered somewhat, last trading closer to USD $18,000, leaving it down 11% on the week, and 72% on the year.

The proximate cause of the sell-off was the implosion of cryptocurrency exchange FTX, which was unable to secure a deal with rival trading platform Binance (who dominate crypto trading volumes, as per the below chart), in an effort to stave off a liquidity crunch.

While it remains to be seen exactly how the FTX situation plays out, its yet another hit to confidence in the cryptocurrency ecosystem, with most investors in this space now sitting on realised or unrealised losses.

It’s also another brutal reminder that for all the marketing hype around ‘decentralisation’ and the transparency of data when it comes to public blockchains, the crypto ecosystem itself, which drives cryptocurrency prices, remains centralised, opaque, and unregulated.

We’ve written a separate blog post on cryptocurrency trading and three risk factors investors should consider, which also help highlight why, despite often being referred to as ‘digital gold’, Bitcoin is nothing like the real precious metal.

Is the inflation burst over?

Inflation data for the year to end October in the United States was released overnight, with the headline inflation rate now sitting at 7.7% per annum, down from 8.2% at end September.

The result, which undershot market expectations (most investors were expecting an 8% figure), has raised hopes that

• inflation will begin to fall meaningfully from here

• central banks don’t need to continue tightening policy as hard as they have been

While the market is no doubt right, noting that inflation is already down from a peak of 9.1% in the year to end June, it’s all about the degree to which inflation moves relative to expectations, not just the direction.

On that note, 10-year breakeven inflation rates in the United States are still below 2.50%, with this number having increased, not decreased, since September. In other words, the market has to a large degree already priced in a collapse in inflation.

And while goods inflation will decline, services inflation is likely to be stickier, wages are still going up, and energy prices are set to remain high for years to come, partly due to the lack of capital investment in production expansion, which is evidenced by the green line in the chart below.

In terms of where inflation settles, research from Deutsche Bank suggests that it will likely prove a lot stickier than all of us want, and the market expects.

Indeed, Deutsche analysed 318 separate occasions since 1920, across both developed and emerging markets, where inflation had risen above 8%, with their findings suggesting that once inflation went above that level, it typically took around two years to get back below 6%.

Inflation then historically sat around the 6% mark for up to five years after the initial inflation spike.

Nothing like this is priced into markets. If the next few years even mimic the historical observations Deutsche analysed, it will not surprise to see gold and silver could explode higher.

Inside the office this week

This week we’ve seen an increase in clients, including first-time and regular investors, turning their attention to higher valued products such as the ABC 1kg Gold Cast Bar and the ABC 5kg Silver Cast Bars.

The persistent threat of higher inflation, financial market uncertainty, and concern regarding the direction of Australian property market are all factors driving these investors to diversify their wealth with physical precious metals.

Warm regards,

The ABC Bullion Team

Disclaimer: This document has been prepared by Australian Bullion Company (NSW) Pty Limited (ABN 82 002 858 602) (ABC). The information contained in this document or internet related link (collectively, Document) is of a general nature and is provided for information purposes only. It is not intended to constitute advice, nor to influence any person in making a decision in relation to any precious metal or related product. To the extent that any advice is provided in this Document, it is general advice only and has been prepared without taking into account your objectives, financial situation or needs (your Personal Circumstances). Before acting on any such general advice, we recommend that you obtain professional advice and consider the appropriateness of the advice having regard to your Personal Circumstances. If the advice relates to the acquisition, or possible acquisition of any precious metal or related product, you should obtain independent professional advice before making any decision about whether to acquire it. Although the information and opinions contained in this document are based on sources we believe to be reliable, to the extent permitted by law, ABC and its associated entities do not warrant, represent or guarantee, expressly or impliedly, that the information contained in this document is accurate, complete, reliable or current. The information is subject to change without notice and we are under no obligation to update it. Past performance is not a reliable indicator of future performance. If you intend to rely on the information, you should independently verify and assess the accuracy and completeness and obtain professional advice regarding its suitability for your Personal Circumstances. To the extent possible, ABC, its associated entities, and any of its or their officers, employees and agents accepts no liability for any loss or damage relating to any use or reliance on the information in this document. It is intended for the use of ABC clients and may not be distributed or reproduced without consent. © Australian Bullion Company (NSW) Pty Limited 2020.