Government’s Financial Repression Toolkit

Precious Metals Commentary

This week, gold had another crack at the $1,550 level on the back of negative manufacturing index figures, the continuing saga that is Brexit and commencement of tariff hikes.

However, the resumption of US-China trade talks and strong US employment figures overnight on top of easing tensions in Hong Kong saw profit taking in the precious metals, with gold booking a -$40 move to $1,513 and silver dropping a buck to $18.50.

The RBA’s decision to leave interest rates on hold gave the Aussie a boost, seeing it end its couple of weeks’ downward trend to below 0.67 to put on a cent and trade above 0.6810 as we write.

The Australian dollar’s strength saw local gold prices miss a run to $2,300 to currently hold just above $2,200.
 

Aussie silver also retraced to $27.10.

Platinum

We last looked at platinum in July when it was trading around $850, noting that it may have bottomed and that those who like a bit of speculative spice in their portfolio may want to have a look at it.

We were prompted to have another look at it when an ABC Bullion client purchased 12 kilograms of platinum last week. Astute timing, as Tuesday last week platinum started a run from $855 to $940 as we write, a gain of 10% in 10 days.

The initial cause for the move is being reported as an announcement by the Chinese State Council to loosen car-purchase restrictions (a large part of platinum and palladium demand is autocatalysts). Palladium did not respond to the news, only starting to move on Friday but then palladium at $1,550 is close to all-time highs of $1,615 so the market may have seen less room for palladium to move.

With platinum and palladium being somewhat substitutable in autocatalysts, palladium’s $600 or so difference to platinum has seen market talk about car manufacturers switching to platinum on the basis that palladium’s supply constraints have forecasters seeing its price remaining high. However, it would take automakers a couple of years to switch production methods, so platinum demand would not be immediately impacted.

We feel that the Chinese news probably acted as a catalyst (excuse the pun) for the market to note that platinum had been lagging behind gold and silver. Below we have charted gold, silver and platinum since gold’s breakout on 20 June (it had been rising since 29 May but 20 June was when it attracted market attention after breaking through the long-term $1,375 resistance level).
 

 
For the first month (1) gold outperformed the other two metals but they both made a small catch up during July (2). During August, silver held up with gold but platinum went nowhere. Then on the 23rd, silver made a break (3) with platinum following four days later (4). Also note that even with last night’s price drop, each of the three metals are still showing good returns in US dollars over the last 80 days with gold at 11.5%, silver at 23.2% and platinum at 18.5%.

The chart’s short timeframe makes it look like silver and platinum are extended but on a longer term basis, the current gold:silver ratio of 81.7 it is still historically high, as we noted last week. The same applies to platinum, as platinum spent most of the 2000s worth more than gold (which means a gold:platinum ratio below 1.0) so the current ratio of 1.6 is also historically high.

Platinum ETFs saw strong inflows in early 2019 after being flat for most of 2016 through to 2018, moving up 30% from 2.3 million ounces to 3.0 million ounces early in the year and adding another 70,000 ounces on this recent price move, so investor interest remains strong.

Financial Repression Toolkit

We received some emails from clients rightly indignant about the ban on cash transactions above $10,000 we discussed a couple of weeks ago. Well spare a thought for Germans. A new Money Laundering Act sets a cash threshold of 2000 Euros on precious metal transactions. At current Euro gold prices this will mean that one will not be able to buy more than 1.5 ounces anonymously.

At least the Germans are better off than the Argentineans, who have just had capital controls imposed after weeks of market turmoil (they were only abolished in 2015) in a futile attempt to shore up their currency. The new rules restrict the purchase of US dollars at $10,000 a month. As an aside, we note that a 100-year bond issued by Argentina in 2017 has since lost over 60% of its value.

If you think we are just fear-mongering and that capital controls are the sort of thing that only third world countries engage in, we would draw your attention to a 2015 International Monetary Fund paper titled The Liquidation of Government Debt (and hat tip to Dan Denning for tweeting it to our attention).

As the paper notes, advanced economies had negative real (after inflation) interest rates for half of the period from 1945 to 1980. Negative or below-market real interest rates insidiously reduce government debt to avoid the drama of default and restructuring.

The authors say that such “financial repression” may once again “be part of the toolkit deployed to cope with the most recent surge in public debt in advanced economies”. Negative interest rates are just one of the “tools” in the “kit”, which the authors say also include:

• explicit or indirect caps or ceilings on interest rates

• capital account restrictions and exchange controls

• high bank reserve requirements

• “prudential” regulatory measures requiring the holding of government debt

• transaction taxes on equities

• direct ownership or extensive management of banks

• restricting entry into the financial industry

• directing credit to certain industries

The reason we used the word “insidious” is that these financial repression tools are, as the authors helpfully note (to the no doubt central banker readers of their paper) “opaque to most voters” compared to income/sales taxes increases or government expenditure reductions and are thus “a more politically palatable alternative to authorities faced with the need to reduce outstanding debts”.

Unconventional Measures

The ABS released Australia’s latest gross domestic product (GDP) figures this week. Most just focus on the headline number, noting that it is the 112th quarter in a row of zero/positive percentage increase, or 28 years of expansion.

GDP as a measure of how an economy is performing is a flawed figure but even more so if you ignore inflation and population growth – if we let a million people come to Australia tomorrow we would guarantee our GDP will go up, but that would not necessarily mean our standard of living would be better.

We agree with Callam Pickering that what we need to look at is real (after inflation) GDP per person. Below is a chart he tweeted showing this and you can see it presents a very different picture.

As he notes, “this is the weakest growth we have experienced since the height of the GFC”. One thing that has also been weak since the GFC is personal credit, with this chart below showing a dramatic malaise since 2008 when looked at over the past 40 years.
 

With Australian economic growth slowing sharply due to the housing downturn and weak consumer spending, Shane Oliver (AMP Capital) says that the RBA will have to resort to unconventional measures as there would be little point cutting the cash rate below 0.5% or negative as “banks will be unlikely to pass it on in lower mortgage rates”.

Some of the unconventional measures Shane thinks are worth considering include:

• explicit forward guidance

• quantitative easing, i.e. using printed money to purchase public and private securities

• providing cheap funding to banks to support lending

• intervening to push the Australian dollar lower

However, Shane says that these measures have issues so suggests that a better way would be for the government to “use printed money to provide direct financing of government spending or ‘cheques in the mail’ to households”. He says while this is called Modern Monetary Theory (MMT) today, it was first suggested by economist Milton Friedman decades ago as a “helicopter drop”.

Widely read newsletter writer John Mauldin is less blasé about MMT saying that it will “produce out-of-control inflation that will essentially destroy the Boomer generation’s ability to retire with anything like most envision today” and if it is coming he will be heavily weighting his portfolio to “gold, real estate, and a few biotech companies”.

Chad Slater, investment manager at Morphic Asset Management, agrees, arguing that MMT could spark a new bull cycle in gold as MMT is likely to be inflationary and gold is one of the few asset classes that does well in stagflation, which “is most definitely bad for bonds; it is very bad for long duration assets; it is somewhat bad for equities, and it is very bad for cash”.

Until next time,
 
John Feeney and Bron Suchecki
ABC Bullion
 
If you have any questions or feedback about this week’s report, we would love to hear from you. You can contact John Feeney (@JohnFeeney10) and Bron Suchecki (@bronsuchecki) directly on Twitter, otherwise please feel free to send us an email at [email protected], or call us during trading hours on 1300 361 261.

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.