Gold to rally as recession risk mounts

In this week's market update:

• Precious metal prices were bid again this week, with the USD gold price last trading at $1,929 per troy ounce (oz), up 1% over the past five trading days

• Silver was also higher, up 2% for the week, though remains unable to break above USD $24oz, a level that has proved important resistance, with silver now unchanged over the last twelve months

• Risk assets have all continued to rally, with US equities up 4% for the week, oil holding strong above USD $80 per barrel, while Bitcoin is up 9%, last trading above $23,000

• Bond yields were relatively stable, with 10-year bonds in the US and Australia rising by 8 and 14 basis points respectively

• Break-even inflation figures moved higher across the week, with the 10-year rate rising from 2.12% to 2.29%.

Record gold demand as precious metals to outperform

Precious metal prices have remained on solid footing over the past week, though are yet to decisively break above USD $1,950oz (for gold), or USD $24 oz (for silver), with the market trading in a relatively narrow range.

While the medium to long-term drivers of gold on balance remain bullish, the potential for a short-term correction remains, which we’d expect to be well bought, with physical buyers showing a continued appetite to build their holdings.

This is evidenced through multiple channels, including recently announced sales figures by the Royal Mint in the United Kingdom, who saw a record year in 2022, with gold sales up 25% year on year, while silver sales were up by almost 30%.

Andrew Dickey, The Royal Mint’s director of precious metal investment, commented on the demand levels, and more importantly, the outlook for this year, noting that; “many financial experts are expecting this momentum to continue, which will promote a level of confidence in investors of precious metals following IMF warnings of a recession. Evidence shows that previous recessions have had an impact on the gold price increasing, with the metal historically deemed a 'safe haven.' Other factors affecting demand include a slowing of the cycle of interest rate hikes by central banks, their continued purchasing of vast quantities of gold and crypto disappointment."

Short-term we should also see a pick-up in demand out of Hong Kong, with jewellery sales poised to jump by up to 30%, with an easing of COVID related restrictions, and the return of tourists from mainland China contributing to this positive outlook.

The jewellery component of gold demand, while not highly correlated to short-term price movements, is an often under-reported factor when it comes to the gold market, with more attention typically focused on ETF flows futures market positioning, physical bar and coin, and central bank demand.

Of those four components, it's only the last two that have impressed in the last twelve months, with ETF holders reducing exposure until recently, while positioning in the futures market remains modest by historical standards.

This diversity of gold demand bodes well in terms of the medium to long-term outlook, and was a  topic that World Gold Council Chief Market Strategist - North America Joe Cavatoni addressed in a recent conversation with Jill Malandrino on Nasdaq TradeTalks.

From our perspective, it’s gold’s performance as a risk off asset that will likely be of most interest this year, with the chances of a US recession, and further weakness in US equity markets highly probable in our view (see more below).

Should the come to fruition, history would suggest gold will be well bid, and will not only rise in absolute terms, but especially in relative ones, with the below table from Schroders suggesting that on average, gold has outperformed US equities by 37% in recessionary periods.

While gold hasn’t always outperformed during recessions, which the above table makes clear, it normally does, and may well do so again in the near future.
This was something Schroders themselves alluded to, noting that:

One observation we would make is that when the policy responses to US have been particularly loose / accommodative, the gold price performance has been most explosive. This was the case in 1973 (when Arthur Burns was Federal Reserve governor) and was also the case in 2008 and 2020.
We think policy responses to future US recessions will also be highly accommodative and involve a return to combined fiscal / monetary support. This is because extremely high aggregate debt levels and large deficits mean the risk of a recession morphing into something much worse will remain far too high for policymakers to risk.

That is a compelling reason to consider including an allocation to gold in a portfolio today.

Bathtubs, rent increases and the Australian dollar

The Australian dollar (AUD) has staged an impressive rally over the past month in particular, rising by 7% in USD terms, and now trading above USD $0.71. While some commentators think this is the start of a new bull market in the local currency, we wouldn’t be so sure, especially as fears of a global recession build (see next session), with the AUD still trading within in a broader downtrend.

This price strength is the primary driver of the largely stable Australian dollar gold price, which is trading around AUD $2,700oz, unchanged over the past month, while silver is still trading for just under AUD $24oz.

Part of the explanation for the Australian dollar rally in the past month is just general USD weakness, with the USD index (DXY), falling by 2% over the same time period.
There are other factors at play though, including stubbornly high inflation in Australia, with the latest figures suggesting consumer prices (up 7.8% in the year to end December) are rising at their fastest pace since 1990.

These inflation figures are all but certain to lead to another interest rate hike by the Reserve Bank of Australia (RBA), at their next policy meeting, with cash rate futures now suggesting a peak in interest rates of almost 3.75%, which we will hit in August this year.

Many think rates may have to go higher than that, with economist Steven Miller for one noting that “a policy rate well in excess of the 3.60 per cent previously implied by domestic interest rate markets may be a more optimal path to long-term sustainable growth in activity and employment.”

One factor that will almost certainly contribute to higher inflation rates (and therefore pressure on the RBA to maintain tighter monetary policy settings) is the situation in Australia’s rental market.

Data from CoreLogic suggests rental increases topped 10% for the year, a record high, with ramped up levels of immigration certain to keep upward pressure on rents going forward.
As it relates to the overall inflation rate in Australian, very few of these rental increases have yet fed through, with the rental subcomponent of CPI up by just 4% for the year. The reason for this is that while data like CoreLogic looks at newly signed rental contracts, the Australian Bureau of Statistics look at all rental contracts when calculating CPI.

The below bathtub analogy explains.

The water in the tub represents all rents being paid by households, while the water entering the tub from the tap represents new rental agreements. The CPI series is measuring the overall temperature of the bathtub whereas an advertised rents series measures the temperature of the water flowing into the tub. It will take some time for the flow of water to change the overall temperature of the water in the bathtub.

As a result, expect rental price pressures to be problematic for some time to come, interest rates to remain higher than they otherwise might, and downward pressure on property prices and overall economic activity in Australia to intensify.

In due course, that will put downside (not upward) pressure on the Australian dollar, with the current stabilisation in Australian dollar gold prices likely an opportunity for long-term accumulators.

Leading in to a US recession

Data out of the United States continues to suggest that a recession is imminent, despite the just released GDP data for Q4 2022 which showed growth of 2.9% (vs market expectations of 2.6%), and helped fuel a modest rally in stocks.

Despite that positive result, forward-looking indicators paint a more sober picture, perhaps best visualized in the below graph, which shows the US Conference Board Leading Indicators Index (LEI) (purple line on graph), and US recessions shaded in grey.

The index has fallen to levels lower than its current reading in the past, which indicates there could be more downside to come. More concerningly, even if it were to stabilise at current levels, a recession would likely be the base case scenario, given it has never been at these levels without the economy tipping into recession.

Interestingly, the stock market doesn’t tend to bottom until after the LEI does, with PMI data out of the United States, which continues to deteriorate, another reason for caution when it comes to the outlook for stocks this year.

A final hurdle worth mentioning in this update is the challenge that already higher interest rates will pose for corporates.

While we know higher interest rates at best cause many mortgage holders to cut back on discretionary spending, and at worst cause some homeowners such significant stress that they are forced to sell their houses, the challenge for businesses can be just as profound.

Indeed, this year, it’s likely to be particularly problematic, given the unprecedented percentage of bonds that mature in less than one year, which is captured in the below chart.

All this debt will need to be refinanced, causing a significant cash-flow crunch for affected corporates, given the spike in the funding costs that we’ve seen in the last twelve months since central banks began to tighten policy rates.

Inside the office this week

Gold and silver remain well bought across our client base at ABC Bullion, with new investors adding the precious metals to their portfolio for the first time, while long-standing clients have been adding to existing holdings. 50 gram ABC Bullion gold cast bars are particularly popular in the office, as is our signature 1kg ABC Bullion silver cast bar.

The ABC Bullion 1kg Silver Cast Bar.

Warm Regards,

Jordan Eliseo
General Manager

ABC Bullion Australia

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