Helicopter Money Gaining Altitude

Precious Metals Commentary

Gold opened the week strongly with a flight to safety following the weekend attack which cut Saudi Arabia’s oil production by half. The market was range-bound during the week waiting for the US interest rate decision. Following the announcement that the Fed would lower its target range by a quarter of a percent, gold fell rapidly by $25 to a low of $1,481.

 
Gold tested the bottom of the $1,480-$1,550 range we discussed last week but has held up as we write, trading at just above $1,500. Silver was unable to get above $18 and is currently trading at $17.85. Its lacklustre performance relative to gold saw the gold:silver ratio getting as high as 85.3 this week, and currently settling around 84.
 

Gold and silver in Australian dollars booked small gains to $2,216 and $26.40 respectively with the help of the Aussie dollar falling below 0.68 following the US interest rate cut.
 

ABC Bullion’s Global General Manager, Nick Frappell, says in his latest technical report that for gold “the macro picture has not changed markedly, and so far, the decline in prices remains very much within a strong rising trend” with $1,478 as the immediate support level and $1,557 as resistance.

Repo Squeeze

Earlier this week there was a squeeze in overnight repo rates that raised concerns the Federal Reserve may be struggling to control money-market rates. The overnight repo market is used by banks to obtain short-term cash they need, which they do by providing “high-quality” government bonds and agency mortgage-backed securities in exchange.
 

While spikes in this rate are not uncommon (usually around quarter or year end dates), the chart above shows the significance of the move. Various theories were put forward as to the cause:

• a glut of new US government bonds appeared on the market

• big cash demands due to corporate tax payments coming due

• Treasury Sell-off last week that triggered the Growth-to-Value unwind

• large price movements in oil in the aftermath of the attack resulted in large margin calls

• Saudis liquidating positions to extract cash

The US Fed had to step in and inject $53 billion on Tuesday and then a further $75 billion on Wednesday and Thursday to bring these short-term rates under control.

Bloomberg quotes TD Securities as blaming the “scarcity of bank reserves, which are the only asset that provides banks with intraday liquidity.” Note that reserves have been declining since 2014 and are currently at $1.4 trillion. The repo rate squeeze is seen by some as an indication that $1.4 trillion is not enough given post-GFC regulations requiring increased bank liquidity.

Thus Fed Chair Powell’s comments about resuming “organic balance sheet growth earlier than thought” was not about a new round of QE but responding to this reserve scarcity issue.

Craig Pirrong, a professor at the University of Houston, says that the “post-crisis regulatory ‘reforms’ have made the funding markets more rigid” and the associated push toward centrally cleared trades rather than over-the-counter trading makes markets more tightly coupled. This results in an inter-market feedback loop where a shock in one market which results in initial stress in short-term funding markets can result in traders in other markets having problems funding their positions, feeding back into more market stress.

 
Jeffrey Snider (Alhambra Investment Partners) has been commenting on the weakened state of the global financial system, particularly offshore US dollars, for some time and considers this repo squeeze as merely another indicator of a “disorder has been building for months now” that “reveal[s] more completely the scale of the building dysfunction.”

No surprise then that gold has been stair-stepping up “for months now” finding a floor first at $1,380 and now $1,480.

Helicopter Money

Yesterday the Australian Bureau of Statistics report a very small increase (0.1%) to 5.3% in the unemployment rate for August. However, as the chart below from Westpac shows, the underemployment rate has remained above 8% for a number of years, certainly not a sign of a healthy economy.
 

The result is market expectations that the RBA will cut rates at its October Board meeting.

Alan Kohler, writing in The Australian on Monday, noted that the RBA’s 14 rate cuts over eight years has occurred with falling inflation and GDP growth. He says that with global debt levels of US$250 trillion at three times GDP the “only way this is going to be reduced without massive disruption and hardship is through inflation.”

Alan’s solution is not to engage in QE by buying debt off banks or giving the money directly to the government, but to “just give the money directly to the people – deposit cash into everyone’s bank accounts.”

And last week we thought we were joking about adding a couple of zeros of the $1,080 tax refund cheques. Just another example of how the ideas of Modern Monetary Theory (MMT) are gaining traction - or maybe we should say the money helicopter is gaining altitude.

Just in case it is not clear what this means this quote from a book called the MMT bible (Credit and State Theories of Money) should make it clear: “If savers refuse to spend, their savings should be allowed to diminish through inflation.”

What MMT proponents don’t understand is that many savers will not just sit on their hands and let their savings be “diminished” and will look to move their savings into hard assets that cannot be printed, of which gold and silver are the easiest and most liquid to get in and out of.

Battle of the Exchanges

CME announced last week that it would be launching of two new gold futures contracts on October 14 based on the Shanghai Gold Exchange’s (SGE) gold benchmark price. While both contracts reference SGE’s CNY (onshore Renminbi) benchmark and trade in kilograms (the most common form in Asian markets), one will be denominated in US dollars and the other in CNH (offshore Renminbi) .

As the SGE commented, “these two new Shanghai Gold futures contracts by CME Group marks a significant step in the internationalization of the Shanghai Gold Benchmark.” However, it should be noted that both contracts will not be physically settled, either in the US or China, and will instead be financially-settled in USD using the USD/CNH rate provided by EBS Service Company to convert the SGE gold price to a USD price.

The financial rather than physical settled nature means the new contracts are more targeted at speculators and those looking to arbitrage the price differences between Western and Chinese markets.

The chart supplied below by the CME emphasises this point, noting the much wider and more volatile discount that CME gold futures trade at relative to SGE prices (dark blue line) when compared to the premium CME gold futures trades at relative to London spot prices (light blue line).
 

While the new contracts will increase liquidity in the SGE market, the fact that there are only a limited number of entities allowed to import gold into China and that China does restrict import quotas from time to time (as we discussed a month ago) we feel means that the ability for traders without an import license to profit from the “GC – SGE spread” will be limited.

These new contracts add to the CME’s wide range of gold (and silver) contracts, which in addition to their main 100oz gold futures, include E-micro futures, E-mini futures, Kilo futures, London spot futures and cleared OTC London forwards.

CME appears to be winning the war for exchange traded precious metal business with reports that the London Metal Exchange’s (LME) gold and silver futures contracts are in doubt with the expected resignation of Societe Generale as a market maker, leaving only Goldman Sachs and Morgan Stanley as banks committed to offering tradeable prices for the LME’s contracts.
 

The chart above shows that the LME contract’s volume has failed to grow after their launch (and note that the right axis for the LME’s volumes is multiples less than CME’s Comex volumes).

While we are talking about exchange trading, we note an announcement back in May that US exchange Nasdaq was taking its exchange technology and re-engineering it to work for sports betting - partnering with horse racing clubs like the Hong Kong Jockey Club (Asia’s biggest racing club).

Nasdaq’s Head of New Markets was quoted as saying: “as [a sports betting] operator, you increasingly need more data and you need it fast, you need bets to run through your system quickly and you need to be able to handle peak times. Well, guess what? That sounds a whole lot like a stock exchange.”

With many claiming that markets these days are dominated by speculators and momentum followers rather than fundamental value investors, alternatively you could say stock and futures market sound a whole lot like sport betting operators.

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.