Gold to go how high next year?
08 December 2022
In this week's market update:
Gold prices eased marginally this week, falling 1% in USD terms, as the market consolidates the recent push above USD $1,800 per troy ounce (oz).
Silver continued to strengthen, up another 4%, now trading back above USD $23 oz, with the gold to silver ratio now approaching 75, with silver now outperforming on a 1 week, 1 month and 1 year basis.
Equity markets were soft, with the S&P 500 and ASX 200 off 3% and 2% respectively, as markets eagerly anticipate next week’s US Federal Reserve meeting.
Commodities were the big movers of the week, with oil prices crashing by 12% (they are down 20% in the last month), now trading back near USD $70 per barrel.
Fixed income markets continued to rally, with the price of US 10-year bonds up another 3% (15% for the month), as yields continue to decline.
Cryptocurrency markets remain relatively calm, with Bitcoin up 2% for the week, having found support above USD $15,000 coin for now.
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Precious metal prices were mixed last week, with silver continuing its recent rally, now trading back above USD $23oz, while gold had a small pullback (-1%), consolidating the recent spike that saw it push back above USD $1800oz five trading days ago.
The continued strength in silver, and relative to stability of gold compare favourably to moves in risk assets, and across the broader commodity spectrum. Equity markets down 2% over the last week, while oil prices in particular were smashed, down more than 10%, with crude on the verge of falling below USD $70 per barrel.
As we head toward the New Year, the case for gold, and precious metals more generally, continues to strengthen, given:
Economic data points continue to display fragility, with a sharp slow down if not outright recession on the cards in 2023. In Australia this is showing up in a deteriorating outlook for the services sector, with sales, new orders and employment data all pointing to lower output next year, while the decline in house prices is accelerating.
China is again adding to its gold reserves, the first time in three years it has reported an increase in holdings, with total reserves now sitting just below 2,000 tonnes.
Speculative positioning in the gold futures market has turned positive, while outflows from gold ETFs have almost stopped, as evidenced in the chart below from the World Gold Council
Preliminary data for the first few days of December 2022 shows a return to inflows into gold ETFs globally, potentially bringing to an end the seven straight months of net selling we have seen from this sector of the gold market.
This remains a key indicator to watch as we head into the new year, with the potential for gold ETF inflows to combine with already robust physical and central bank demand, which would almost certainly have bullish price implications.
Speaking of bullish price implications, and it would be remiss not to reflect on recent musings of Credit Suisse analyst Zoltan Pozsar, who is one of the most respected analysts when it comes to understanding and explaining how the monetary plumbing that keeps capital markets functioning works.
Pozsar noted that talks of a $60 per barrel cap on the price of Russian oil by EU, G7 and other countries including Australia, (a subject discussed here) translate to an effective price of 1 gram of gold per barrel. He also hypothesized a scenario where gold could be trading beyond USD $3,500oz.
While hypothesis is the key word, the price target mentioned by Pozsar is not that different from that of Saxo bank, who in their latest annual outrageous predictions publication, discussed the potential for gold to soar toward USD $3,000oz, with markets finally beginning to realise, and price in a future where inflation doesn’t prove to be transitory.
Silver to outperform
While the stars are beginning to align for gold, a very good case can be made that silver will be the precious metal outperformer going into next year.
We’ve already seen that outperformance begin to shine through in the last month, with silver up 11% vs 7% for gold, with the gold to silver ratio (GSR) falling from 81 to 77 over this time period.
Indeed, since the peak in the GSR at more than 115 back when the pandemic hit, silver has been the clear winner, up 66% since the end of March 2020, vs 11% for gold.
Silver’s strong run may have a way to go, with the following table a timely reminder of how strongly it has outperformed a rising gold price in precious metal bull markets.
Gold and silver returns during precious metal bull markets
Source: ABC Bullion, London Bullion Market Association
Gold has historically been the safer of the two, in that it’s not as volatile, has smaller drawdowns, and has been the more reliable portfolio diversifier. It’s also substantially more liquid.
But there can be no denying silver’s ability to outperform, with Bloomberg writer Ed Van Der Walt noting in a recent article some of silver’s potential benefits vs gold.
A picture tells a thousand words
The return of inflation has been one of if not the key themes dominating financial markets in 2022, with large parts of the developed and developing world now dealing with the fastest pace of consumer price rises in decades. This is neatly encapsulated in the below picture, produced by the team at Visual Capitalist, which shows that almost half the world is dealing with at least double-digit inflation.
While it would be easy to say that this inflation spike has been primarily driven by the loose monetary and profligate fiscal policy that we saw throughout the pandemic, there is no doubt supply chain factors, the war in Ukraine, and energy price spikes have been major contributors.
Indeed, as the Visual Capitalist team noted,
Since October 2020, an index of global energy prices—made up of crude oil, natural gas, coal and propane—has increased drastically. Compared to the 2021 average, natural gas prices in Europe are up sixfold. Real European household electricity prices are up 78% and gas prices have climbed even more, at 144% compared to 20-year averages.
While markets are still pricing in a rapid fall in inflation (the table at the top of this update shows that the 10 year breakeven inflation rate in the United States is just 2.26% right now, having fallen over the last twelve months), we may be in for a rude shock, with historical precedent suggesting it will take until at least the middle, and possibly even latter part of this decade for inflation to recede to the 2-3% levels that most policymakers tend to aim for, either implicitly, or explicitly through stated mandates.
Indeed, research emanating from within the Federal Reserve system also warns of a long battle to tame inflation, with Robert G. Valletta, associate director of research and senior vice president at the Federal Reserve Bank of San Francisco, noting in an early December research note that the bank “project that inflation will continue to recede gradually but not reach the Fed’s 2% average goal for another three years or more.”
The research note went on to make two additional points, both of which have potentially positive implications for precious metals, given their role as an inflation hedge, and as portfolio diversifiers.
The first point was that the San Francisco Fed judged the risks to the inflation forecast as “weighted to the upside”.
The second point had to do with projections of economic activity, with the research note stating:
Although we expect continued growth, we view the risks to economic activity as weighted to the downside. Recession signals from financial markets are now sounding the alarm, most notably the inverted spreads between yields on long-term and shorter-term Treasury bonds.
Inflation risks weighted to the upside. Economic activity outlook weighted to the downside.
That’s a tough environment for risk assets to flourish, but one where you’d expect precious metals to catch a sustained bid.
What should central banks do?
The research note published by the San Francisco Federal Reserve neatly encapsulates the conundrum central banks face as we head into 2023.
Tighten monetary policy much further, and you all but guarantee a recession. Refuse to tighten, and you risk inflation expectations becoming unanchored, and run the risk of setting the economy up for a multi-year period of high (as in +5% per annum) inflation, which will destroy real wealth.
This is of course not purely a US phenomenon, with the Reserve Bank of Australia (RBA) facing the very same challenge as it attempts to calibrate optimal monetary policy settings.
Interestingly, there has been a notable increase in media articles and opinion pieces essentially arguing that the RBA should ignore high inflation, or at least treat it as the lesser of two evils (i.e., high inflation is preferable to a recession and/or full-blown house price crash).
Indeed, some institutions are openly questioning whether the RBA should increase its inflation target, with the Australian Council of Social Services (ACOSS) warning there will be massive job losses if rates continue to rise.
Many of the articles stating that the RBA, and other central banks around the world should tolerate higher inflation often highlight that central banks can’t control many of the items driving inflation right now, like energy prices, and other supply chain issues, and that rate hikes are therefore pointless.
While there is a large element of truth to the argument that many of the inflationary forces at work today can’t be directly impacted by monetary policy, it’s wrong to argue higher rates can’t still influence demand across the economy, and therefore overall inflationary pressure.
There are two other things worth noting on this phenomenon.
Central banks have always only had limited direct influence over inflation. This is not a new phenomenon. If one argues they can’t control inflation, don’t given them an implicit or explicit inflation target.
In the low inflation era between the GFC and the pandemic, there were multiple forces at work (think technology, demographics, record private debt levels), all of which central banks have minimal to no control over, and all of which were deflationary. There were precious few articles or think pieces in that era stating zero interest rates were pointless. Indeed, quite the opposite, with central banks encouraged to put their foot to floor as it were so as to offset those deflationary forces and keep consumer prices rising.
As we head into next year, the battle to control inflation while limiting the economic fallout from higher rates will be the number one factor many market participants are watching.
And while predicting which month the Fed might stop hiking, or what precise level inflation will end 2023 at will keep financial commentators busy, from an investment perspective, it’s best to keep it simple, and focus on wealth preservation through what looks certain to be another difficult year for markets.
Speaking personally if nothing else, it gives me great comfort to be holding a sizeable allocation to precious metals through such an environment.
Inside the office this week
As we close out the year, clients continue to increase their precious metal holdings with sales of ABC's 50g Gold Cast Bar and ABC's 250g Cast Bar particularly robust. Clients continue to use gold and silver for a variety of reasons, from portfolio diversification, to protection against inflation, with this time of year also seeing a notable uptick in gifting, with items like silver coins particularly popular in this regard.
Warm regards,
Jordan Eliseo
General Manager
ABC Bullion Australia
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