Is Gold too Boring?

“Bull Markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria.” – Sir John Templeton

Gold prices are treading water this week, currently trading at USD $1,316oz, whilst silver is just below USD $16.50oz. For local investors, prices are sitting at AUD $1,692oz for gold and AUD $21.16 for silver, with the currency sitting just below USD $0.78.

The relatively narrow trading ranges that gold remains stuck in, has seen volatility within precious metals return to levels last seen at 2001, which you can see on the chart below.

Precious metal bulls will note that 2001 was right around the start of the secular bull market in gold and silver, so there are many that will undoubtedly take this as a positive sign.

To that end, we were reminded of the great investing quote from Sir John Templeton above, as we think it’s highly relevant for gold today.

Back in 2011, when gold in USD peaked, there was euphoria towards precious metal prices, even if as a percentage of total investor portfolios, gold holdings remained quite low.

At the time, surveys of retail investors in the United States suggested gold was the best way to store wealth, whilst hedge funds had never been more aggressively long the precious metal.

This can be seen in the chart below, which shows hedge fund net positions from 2006 to 2015, with the record high position in 2011 clearly evident.

It was in hindsight quite obvious that the market needed to take a breather, even if most people weren’t prepared for gold to tumble all the way back down toward USD $1,050oz by the end of 2015.

At that point, everybody was pessimistic about gold, with numerous priced predictions suggesting gold was on its way back below USD $1,000oz, and set to underperform for years to come.

The image below, which comes from a mid July 2015 report I wrote titled “The Death of Gold…….or Not!”, which is still the most widely read article on precious metals, sums up the mood toward precious metals at the time.

In short, we were at a point of peak pessimism toward gold, with hedge funds, and the like, all but abandoning the yellow metal. Unsurprisingly, this time period pretty much marked the low in the corrective cycle for precious metals, with gold up around 25% in that time.

Today, referring to Templeton’s quote above, we are at the sceptical part, with the majority of the market still unconvinced of the need to own precious metals.

The scepticism is driven by a number of factors that include:

• Expectations of further rate hikes by the Federal Reserve, which increase the opportunity cost of owning gold

• Expectations of higher growth in developed markets which should allow companies to grow earnings

• Still low inflation across the developed world, with little need to hedge against the loss of purchasing power in financial assets

On top of all of that, market participants still have extremely high levels of faith that central banks have their back, and will continue to support financial markets.

Given this narrative, it’s understandable why so many investors are still reticent to invest in bullion.

Shiny new alternatives like Bitcoin have also been a factor, especially at a retail level. This is best witnessed through the premiums being charged for popular bullion coins like the American Eagle and Buffalo.

As you can see from the chart below, they have plummeted in the last year or so, evidence of the tepid demand for physical metals, even though prices are up by circa 25% since that 2015 low.

From an investment perspective, there are two ways to interpret this. Short-term, even though positioning in gold, and especially silver markets looks encouraging, and there are numerous catalysts that could send gold higher, uncertainty remains, and we could see another move lower.

From a medium to long-term perspective, the status of the gold market is highly encouraging, as a ‘boring’ market that investors are sceptical about is almost always a lot cheaper to buy into, irrespective of the asset class.

Bitcoin – The Hits Keep on Coming

Whilst investor interest in Bitcoin has declined over the last month or so, no surprise given the more than 50% correction from its December 2017 highs, there are still plenty of interesting developments in the cryptocurrency space.

In the news this week, we’ve seen that Google will, effective end June, remove advertising for all cryptocurrencies, including Bitcoin and any new initial coin offerings (ICO).

Regulatory scrutiny continues to build, with the SEC recently releasing a statement regarding “potentially unlawful online platforms for trading digital assets”, whilst there were also further concerns regarding the hacking of digital currency exchanges.

Price wise – the market is down another 11% for the week, with Bitcoin trading around USD $8,400 per coin, having at one point fallen through the USD $8,000 mark.

One sign that there is still far too much enthusiasm and bullishness in the sector, is the continual ‘get rich with crypto’ marketing that we see across social media, email marketing, etc.

This week, I’ve been invited to join multiple webinars which will apparently help me “profit from the next crypto boom”, whilst there are is still a never ending stream of coins promising to be “the next Bitcoin”.

The hype isn’t limited to the coins either, with advertisements like the one below offering Bitcoin ‘mining farms’, which also promise to be incredibly lucrative.

One can’t help but be sceptical that a ‘plug and play’ mining farm that supposedly generates 100,000 GBP in profit is on sale for just 7,000 GBP. Especially given it apparently has a 100% profit to turnover ratio, meaning the electricity must be free, I suppose. 

Bottom line to all of this: This is exactly the kind of garbage you see either at, or very near the top of a market cycle. No one falls for this trash at the bottom of a bear market.

Australia – Rate Cuts on the Cards?

This week, Macquarie Bank joined the long list of Australian banks abandoning calls for rate hikes in 2018. Up until now, they were of the view that the RBA would follow the Federal Reserve in August of this year, but have now pushed that back to early 2019.

There are three fundamental reasons for their change of heart:

• A review of other advanced economies, where official unemployment rates can fall to very low levels without much of a lift in either inflation or wages

• The low current level of inflation in Australia, and the lack of likely catalysts to send it higher

• A slowdown in the housing market, and growth in investor lending, which should allay financial stability concerns

We agree with all the sentiments Macquarie have expressed, though of course we believe real inflation rates are already substantially higher.

Interestingly though, despite Macquarie joining the “RBA on hold for longer” crowd, markets are still overwhelmingly of the view that the next move for the RBA is up. The chart below shows that a rate hike is now fully priced in for May 2019 at the latest, and possibly as early as February.

As we’ve stated in numerous market updates recently, we are still of the view that this is too optimistic an outlook for the Australian economy, and that rates will either be on hold for a lot longer, with a continued risk they’ll end up moving lower.

In other Australian related news this week, we’ve seen the Federal Opposition announce a possible end to dividend imputation, which will most impact retirees on a 0% tax rate who are currently getting tax credits from the ATO, provided companies pay fully franked dividends.

You can read a few views on this policy at links here, here and here.

There is a lot of water yet to go under the bridge between now and the next Federal election, but at this point, should Labor win, which they almost certainly will based on current polls, then the tax status of the assets Australians have a lot of their wealth concentrated in today (primarily dividend paying shares and investment properties) is likely to become far less favourable.

Given a clouded economic outlook, and the likelihood of lower rates and a lower AUD in time, this will only act to boost the attractiveness of physical precious metals to local investors.

Until next time,
Jordan Eliseo

Disclaimer
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