Gold - Time to Break Out?

Gold prices have rallied this week, with the price of the yellow metal currently trading near USD $1,350oz. Silver, which has slightly lagged gold since the beginning of this bull market cycle in early 2016, was an even stronger performer.
 
A powerful move higher Wednesday night Australian time saw the ‘little cousin’ of the precious metal sector add close to 4% for the week, with the gold to silver ratio declining to 78:1.
 
A solid move higher in silver is a sign that all precious metal bulls have been looking for, as it tends to outperform in rising precious metal markets.
 
It is also something we’ve been expecting for some time, and indeed we commented in recent weeks about the fact we are now using our ABC Bullion Gold Saver exclusively to add to our silver positions right now (rather than acquiring more gold) in anticipation of rising prices.
 
The elevated gold to silver ratio, which at 80:1 is about as high as its been at any point since the early 1990s, was the primary reason we really expect silver to outperform in the coming years, as is the extreme positioning amongst money managers.
 
To that end, the chart below, which comes from a great precious metal market update from ING (available here) shows both the gold to silver ratio (orange line) and net money manager positions in silver, going all the way back to 1997.

It shows quite clearly how elevated the gold to silver ratio has been recently, and the fact that money managers are now net short silver, something that hasn’t happened for over 15 years.

They’re both great signs for those looking for a cheap point to enter a market, and this outlook, plus the historical price moves in silver (and gold) from previous periods that mimicked todays scenario, gives us some comfort that should the rally in silver we’ve seen this week gain traction, the gains in the coming years could be quite significant.
 
In terms of financial flows, over 800,000 ounces of silver have flowed into silver ETFs this month, whilst bar and coin demand, which was very low in 2017, appears to be recovering, with some bullion dealers reporting huge upticks in sales in recent weeks.
 
What about the Miners?
 
Gold miners are the other area of the precious metal complex that often outperform in rising precious metals markets, though they bring with them a different set of risks and implementation difficulties relative to the physical metals themselves.
 
Nevertheless, it’s insightful to look at the performance of the miners, especially relative to the broader stock market, as they provide an indication of the overall health of the precious metal market.
 
To that end, there are encouraging signs in this space too, with a handful of ETFs which invest in the junior end of the precious metal mining sector looking much healthier on the charts.
 
This can be seen in the chart below, which comes from a great update from Jordan Roy-Byrne, which you can find here, highlights the fact all three are showing signs of breaking higher.

As the author states_; “The juniors have trended lower since February 2017 but are now threatening to break trendline resistance. Since December 2017 the juniors have traded in an increasingly tighter and tighter range which indicates a break is coming very soon. Also, note how the 200-day moving averages are flat and no longer sloping lower. That reflects a mature correction and the potential for a new uptrend if the juniors break above resistance in a strong fashion.”_

Will Gold Follow?

It’s no surprise that with the outlook for silver and precious metal miners looking healthier, gold is also well placed. The ‘ceiling’ around USD $1,360oz still needs to be cleared decisively before more investors will deploy money into the sector but with the market skewed to the upside and inflationary pressures in the United States building, optimism is warranted.
 
The positive outlook for the sector is gaining attention from some of the world’s most high profile investors, research houses, asset managers and brokers, with Goldman Sachs recently re-iterating their bullish outlook on the sector, whilst UBS executive director Wayne Gordon, writing in the April 2018 edition of the Crucible (published by the SBMA), not that he expects higher prices in the long term too, noting three key catalysts;

• Broad US dollar weakness

• Higher inflation and moderate tightening by the Fed this year

• Greater volatility in equity and fixed income markets

David Rosenberg of Gluskin Sheff is also bullish on the broader commodity complex, whilst Jeffrey Gundlach of Double Line Capital is particularly focused on gold.
 
Gundlach, one of the world’s most respected fixed income investors who vies with Bill Gross for the title of “bond king”, recently stated that the yellow metal is on the verge of a “thousand dollar breakout”, which, should it eventuate to the upside, would take the yellow metal well above USD $2,000oz.
 
Commenting on the current state of the market, Gundlach noted that; “Gold is negatively correlated with the dollar. We see that gold broke above its downtrend line. But now we see a massive base building in gold. Massive. It’s a four-year, five-year base in gold. If we break above this resistance line one can expect gold to go up by, like, a thousand dollars.”

The below chart, which comes from a recent Double Line update to investors, highlights clearly the base that has built in gold over the past few years, as well as the 200 day moving average that gold is now sitting comfortably above.

Their update also included this great chart of the USD over the past 40 years, which shows clearly that the dollar tends to move in cycles that often last 5 to 10 years. The strength in the dollar from 2010 to 2016 is evident, as is the weakness we’ve seen creep in over the past year or so.

There are many analysts out there that expect the USD to rally in the months ahead, and they may well be right, but the charts at the very least suggest the weakness in the greenback may last for years.

This will undoubtedly be gold bullish should it come to pass.

Gundlach and Rosenberg aren’t alone, with a whole host of analysts at the recent Strategic Investment Conference hosted by Mauldin Economics bullish on the yellow metal.

One of the most interesting takes came from Louis Gave, of Gavekal Research, who stated that the world is on the verge of a profound and once in a generation shift from a deflationary boom to an inflationary boom.

Gave included the following chart, which looks at the ratio between gold and bonds. According to Gave, “over a four year period, bonds should always outperform…when they don’t, when bonds underperform gold, that’s the market giving you a very important signal.”

That chart is telling us that gold is outperforming bonds. If history is any guide, that outperformance may last for decades.

You can read more about the analysts at the Strategic Investment Conference, and their views on gold here.

A quick word on Debt!

Regular readers of our ABC Bullion market updates will know we frequently warn about the continued rise in debt levels across the developed, and developing world. We are not anti-debt in any way, but for many years have worried about the poor return on investment generated on the dollars, euros, yen, etc. that are being borrowed around the world.

This week we came across a great table from the team at Mauldin Economic (full article here), worth sharing which highlights this very trend, which looks at how many cents of additional output are generated for every dollar we borrow, both in 2007 (around the time the GFC hit), and again in 2017.

The table looks at this metric across the globe as a whole, as well as China, Japan and the United States as individual nations.

As you can see, whilst in 2007 the global economy was generating $0.37 in additional output for every $1 being borrowed, the number had dropped to $0.31 by last year, with countries like the United States and Japan seeing a decrease of around $0.04 or $0.05 per $1 borrowed over this decade.

The most worrying statistic, particularly for Australian’s, is the staggering 45% decrease in the effectiveness of debt deployed in the Chinese economy, with every $1 borrowed now generating just $0.33 of additional output, down from $0.61 a decade ago.

This isn’t sustainable, and is one of the key reasons why China is so keen to alter the nature of their growth away from the fixed asset investment that has been so beneficial to Australia in the last 15 years.

This change, as well as the unsustainable trajectory for debt and growth across the developed world remain major challenges to tackle in the years ahead.

Until next time.
Jordan Eliseo

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.