Precious metals have closed out a very impressive Q1 2016, a welcome respite after what has been a tough three years for those who’ve been long in the sector. After starting the year trading at USD $1,060 and USD $13.85 per troy ounce for gold and silver respectively, the market has rallied strongly, with the two metals finishing the quarter up 16% (gold) and 11% (silver). That is based on closing prices of USD $1234 and USD $15.38 per troy ounce for the two metals.

Australian dollar investors have also benefitted, with the two metals appreciating by 11% (gold) and 5.60% (silver) respectively, the differential owing to the quite extraordinary rally in the Australian dollar, which has defied market consensus to close the quarter, trading above USD $0.75.

The strong performance over the first quarter can be put down to a number of factors, including:

• Fears over enhanced financial market volatility, especially as risk assets sold off sharply in January and early February

• A weaker than expected US Dollar, which has not gone on to new high after new high, which was largely what the market was expecting as we entered 2016

• Fears over a global economic slowdown and potential hard-landing in China

• Expectations of further easing in Japan and Europe, which have been duly delivered by the BoJ and the ECB

• A re-set of expectations as regards the path of interest rate hikes by the Fed

• Political uncertainty, be that rising fears of a Brexit, or the potential Republican nomination falling to Donald Trump

We’d also note that for the first time in years, there has been a slight (not overwhelming) sense of fear in the air, with genuine concern about the implementation of NIRP in Japan, and the potential for similar forms of extreme financial repression to engulf the entire Western world. Clearly, there are more and more people everyday who are clearly asking the uncomfortable question about just where this monetary experiment is heading.

Considering all of the above – its not surprising physical precious metals found some favour, especially when you consider how unloved and how short the market was as we closed out 2015.

ETF inflows have been robust for the entire quarter, whilst we’ve also seen continued buying from emerging markets and central banks. Indeed the buying from the ETFs has probably been the major story of the quarter, with the acquisition of gold by GLD even more significant than the strategic buying that is continuing to take place in China and Russia.

That’s according to this article from Sharps Pixley. Where author Lawrie Williams noted that for the calendar quarter, the world’s largest gold ETF had gobbled up just under 180 tonnes of the precious metal, worth some $6.6bn based on an average price for the quarter around the USD $1150 per troy ounce level.

The purchasing of bullion through these ETFs is evidence of two important trends all bullion investors should be aware of.

The first of those is that despite the fact direct physical bullion ownership is the most flexible, safest, and in the medium to long run cheapest way of owning bullion (see this article I wrote in The Australian for more on this), the gold ETFs are not the enemy of physical bullion investors, and indeed inflows into them are typically highly correlated to the gold price as per the chart below.

Secondly, and perhaps most importantly, it demonstrates the fact that whilst private sector emerging market demand and sovereign demand via central bank purchases in the coming years likely put a very stable floor under the gold price, it will require the expansion of investor demand in the developed West to push gold prices closer to the ceiling of where they could head in this cycle.

As such, all precious metal bulls should welcome the renewed investor appetite we are seeing in the Western World, and which is best evidenced in this pick up in gold buying.

We’ve also seen the bigger end of town look more favourably on the sector, with banks generally upgrading forecasts, whilst asset managers are also warming to precious metals.

On that note we were interested in an article carried in Bloomberg this week, where Richard Turnill, global chief investment strategist for Blackrock stated that “Stabilizing oil prices and a tighter labor market could contribute to rising actual, and expected, U.S. inflation,” before going on to add that the world’s largest asset manager “like inflation linked bonds and gold as diversifiers”.

PIMCO are also warming to gold, in part because they think inflation will be a surprise to the upside, with Joachim Fels, a global economic adviser for the bond giant stating that; “If you look at inflation expectations as they are reflected in the bond market we think they are too low. We still think markets are pricing in too low a profile for inflation. We don’t think inflation will move significantly above central bank’s targets, but we think that there’s a good chance that over the next 12 months or so, particularly in the U.S., that we will get back to 2 percent.”

You can read that Bloomberg article in full here.

In acknowledging the potential for precious metals, these global powerhouses of the asset management world are joining some of the higher profile players in the hedge fund and family office space, including Ray Dalio and Stanley Druckenmiller, who are even more bullish on gold, and certain of the importance of holding it in their portfolios.

On that note, let’s take a quick look at the technical picture for gold and silver as we enter Q2 2016.

Technical Update

with John Feeney

The pullback we saw play out last week in Gold took a breather this week, due to a short-term bounce on the back of a Yellen driven USD sell-off. There is still a very large build up of Commercial Short positions on the COT chart that is contributing to the weakness and questionable outlook for USD gold for now.

Gold in AUD sits around $3 per ounce lower than last week’s market update, currently around $1,607 per ounce. We had a look at the USD gold chart last week, so this week we’ll take a look at the shorter-term daily AUD gold chart below.

We are not in oversold territory, but averaging into these areas around $1,600 on AUD strength seems a lot safer buying than the recent spike of $1,750. We are still above the 100 and 200 day moving averages for AUD gold and well within the uptrend shown two weeks ago on the weekly chart.

The MACD is approaching oversold levels, but is still yet to signal a swing in momentum. If MACD can break through the signal line, which it may possibly do in the near future, this will likely signal a buy sign. This is mostly a result of a potential topping in the AUD, with the charts signalling the Pacific peso is overbought at around 0.77c.

We very much expect some sort of pullback in the AUD soon, which will support AUD Gold and Silver prices.

The silver chart for AUD is starting to look really nice, with long period of consolidation around the $20 per ounce spot price. It is forming a healthy base around this price and bearing in mind an overbought Australian dollar, we continue to like these levels of $20 per ounce or $650 per kg on spot.

What is an Australian investor to do (apart from buy gold, that is)

At ABC Bullion, we’re always looking to include interesting charts and analysis in our market updates, particularly if they are relevant for Australian investors, even if they aren’t directly gold related.

And before finishing this report with a look at why economics truly is the dismal science these days, we wanted to share some interesting charts and tables, to do with equity market and the Australian dollar.

The first of these is below (kudos to Romano Sala Tenna from Katana Asset Management who produced it, link here)

which shows the consensus dividend yield, and the return including franking credits, on offer for the big 4 banks. Now we have written in the past about the dangers we see ahead for the banks, including extra capital requirements, the likely uptick in home loan arrears, the broader plateauing of private sector credit demand and the potential shock should there be any nationwide decline in housing prices.

In short, we think they are great businesses – but not necessarily great investments at current valuations. But, when we put ourselves in the shoes of your everyday retiree or SMSF trustee, who needs income in their portfolio, can we really be surprised if they’re attracted to these stocks?

After all, compared to your standard term deposit, there is now an 8% yield differential between what you will earn owning stock in these blue chip companies, versus what you’ll get lending other owners of the stock the money in the form of a term deposit.

The second story was to do with which stocks on the ASX are performing best, something particular relevant when the overall picture has been very unrewarding for the last year or so, with the market down some 15%

In an article carried by Macrobusiness, we saw that UBS had some research out with a very interesting graph looking at the evolution of price-earnings ratios not for the market as a whole, but for high P/E and low P/E stocks. The graph is included below.

UBS noted that; “The rise in P/E dispersion over the last couple of months coincides with a waning of both market performance and earnings growth. The concomitant rerating of “high P/E” stocks during this period makes some sense in that in a “lowgrowth regime” the market will pay a higher premium for growth, particularly when it is perceived to be defensive and sustainable growth, as opposed to cyclical growth.

It is an interesting development, and one that highlights clearly why just ‘owning the market’ is not always a successful strategy. Indeed its one we feel could come under considerable pressure in the years ahead, as equity market behemoths struggle to maintain profitability and increase sales in what we feel will be a substantially weaker macro-environment.

You can read the Macrobusiness article here.

Finally, a chart on what is next for the Australian dollar, which is of course highly relevant to any client of ABC Bullion and indeed any precious metal investor in Australia.

AMP Capital included the following chart, in an article that suggested the Q1 rally in the AUD will likely prove short lived, with further downside ahead.

Commenting on the rally, AMP noted that the market was very short the AUD heading into the start of the year, but that since then, things have been more positive; “with commodity prices bouncing back (from their recent lows oil is up 50%, copper is up 15% and iron ore is up 45%), the Fed sounding more dovish and delaying rate hikes which has pushed the $US down generally and Australian economic growth holding up well. The combination of a more dovish Fed and better Australian data has seen a widening in expected interest rate differentials between Australia and the US, which makes it relatively more attractive to park money in Australia. So with more positive news on Australian export earnings and the relative interest rate in favour of Australia, speculators and traders have closed their short positions and the Australian dollar has rebounded.”

Going forward though, AMP are less optimistic for the local currency, noting that interest rate differentials are likely to narrow (we agree, as we see the RBA cutting at least twice in 2016), whilst they expect continued weakness in commodity prices, even if the worst of the price declines is clearly behind us. On a 12 month basis, AMP Capital see the AUD falling as low as $0.60 vs. the USD. We are not sure it will fall that low in such a short time period, though we’d note that were it to happen, it will push gold prices in Australian dollars above $2000 per troy ounce.

You can read the AMP Capital article in full here.

Dot Plots and Word Counts: Why Economics is Truly the Dismal Science

Before finishing this week’s report, we couldn’t help but share an interesting piece of ‘research’ from Deutsche Bank, which we came across this week. Indeed it inspired the title for this week’s market update, with the reference to the entire study of economics, which is often referred to as the ‘dismal science’.

Firstly we want to clarify that we are not in any way attempting to impugn Deutsche Bank (a company I once worked for), nor the analyst who produced the chart, as it so very clear is relevant to financial markets and their likely movements in the coming months and years.

The chart is below, and as you can see, according to the research by Deutsche, the number of times that Janet Yellen has mentioned the words ‘China’, ‘Dollar’ and ‘Global’ in her economic outlook speeches has been in something of a bull market. Indeed her references to these topics have basically quadrupled since May of last year.

Clearly, conversations at the water cooler or in the roundtables of the Marriner Eccles building have been taken in a distinctly global direction of late, indicative of the extra attention the Fed is paying to economic and financial market developments beyond the shores on the United States.

In many ways, the fact that Deutsche felt compelled to produce this chart reminds us of the obsession and analyst hyperbole that follows any update to the now infamous Fed ‘Dot Plot’, which the market invariably reads as the Fed’s forecast for the expected trajectory of interest rates going forward.

So ridiculous has this become that you’ve even got analysts trying to work out who are the hawkish and dovish members of the FOMC, with the following image from MarketWatch a good representation of this.

If this is financial news – is it any wonder autobots are replacing the role of real journalists, spitting out copy based on an algorithm rather than any real thinking. Indeed when you think about it, if the algos can dominate the actual trade on the market, why shouldn’t they dominate the market commentary itself?

Sadly, in a world where ‘money’ is but the plaything of central bankers, we do not doubt for one second that this ‘analysis’ is relevant, for markets move almost purely based on their interpretation of the likely changes in Fed (and central banks as a whole) policy. We wish to merely observe on how sad a reflection on the state of the economic profession, and indeed the global economy it is.

Speaking personally, I’d much rather if we as an economics profession could focus on employment levels, capital investment, corporate profitability, growth in private sector incomes, household debt to GDP ratios or global trade.  But today, these statistics are a combination of either;

• Gross misinterpretations of the overall trend (buybacks boosting EPS)

• Distorted (unemployment decreasing due to plummeting participation rates)

• Outright depressing; think capital investment or global trade volumes

Instead, the economics profession has been reduced to word counting and analyzing dots on a plot, which have been put there by academics and PHDs who, as well intended as they may be, have had little to no experience in the private sector, where the prosperity most of us take for granted is truly generated.

Even the academics themselves are starting to question how useful their plotting really is, and whether those in the investment world should really read as much into it as they seemingly do. Narayana Kocherlakota, who until last year was the president of the Minneapolis Fed recently stated that there were major problems with the market interpretation of the ‘dot-plot’, noting that;

“The dot plot has two big perception problems. The first is the belief that it reflects officials’ interest-rate forecasts. It doesn’t. Rather, it shows what each participant thinks the Fed should do, based on his or her individual forecast of how the economy will evolve and what the optimal response would be.”

The second problem, according to Kocherlakota is that; “investors tend to see the dot plot as a commitment about the trajectory of rates”, when it is clearly a representation of the expectations of FOMC members, which obviously change with the daily ebb and flow of financial and economic data.

Some would argue the devolution of the economics profession is a suitable representation of the global economy itself, which in no meaningful way has recovered from the nightmares of 2008 and 2009, and which is slowly but surely awakening from the dream that our unelected monetary overlords truly overpower the market forces they should never have trifled with.

There are many chapters left to write in this book, but until we reach its conclusion, it remains prudent to hold onto your precious metals exposure.

Until next week

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.