Markets give thanks as Fed to pivot?

In this week's market update:

• Gold prices were steady this week, continuing to consolidate the gains from early November that pushed the price back above USD $1,750 per troy ounce (oz).

• Silver continued to rally, rising 3% over the last five trading days (+14% for the month), with the gold to silver ratio (GSR) falling to 81.

• Equities nudged higher, with the S&P 500 up by 2% for the week, while the ASX also rose modestly.

• Currency markets were relatively calm, with the Australian dollar continuing to trend higher (+1% for the week), while the US dollar index fell by a similar amount.

• Commodity prices on the whole were stable, though oil continued to ease, down 5% for the week and now back below USD $80 per barrel.

• Bond yields continued to ease, with US 10-year bond prices up 3%, while cryptocurrency markets steadied, with Bitcoin trading in the mid $16,000 range.

Awaiting a catalyst
Financial markets continued to trade in a relatively tight range, as markets await a fresh catalyst as head into the final month of the year.

Gold and silver, which have staged impressive rallies since the lows seen in early November, have also traded in a narrower range over the last fortnight, though silver’s continued outperformance bodes well for the sector.

Analysts are mixed in their view on where the precious metal heads in the short-term, with ANZ noting that gold would need to push beyond USD $1,800oz to confirm a bullish trend. ANZ still see a risk that gold could fall back to test support closer to USD $1,700oz at a minimum, with a chance downside levels closer to USD $1620oz (which we’ve already approached in 2022), could again be tested.

Credit Suisse seem to share a similar view, noting that a push beyond USD $1,800oz is critical to maintain the recent upward momentum, but that if it happens, they’d expect gold to move even higher, potentially pushing up toward the USD$1,880oz level.

Saxo Bank appear somewhat more optimistic, noting that while gold still faces headwinds, we’ve potentially moved into a new environment for the precious metal, with traders and speculators now likely to ‘buy weakness’ rather than ‘sell strength’, with the USD $1,735oz level a potentially critical demarcation line in terms of this behaviour.

They also point out the continued lack of buying interest from investors who use ETFs for their gold allocations, with this segment continuing to cut exposure, even as gold surged higher in early November.

Futures market participants however have responded, with speculative investors betting the gold price will fall reducing their positions by almost 50% in the first two weeks of the month, while those betting prices will rise have modestly increased their bets.

These developments in captured in the chart below, produce by Saxo.

We are sympathetic to the above views, noting that while gold could ease in the short-term, it does appear that the market has reached something of a turning point, and that investors are more likely to be adding to gold positions going forward, rather than reducing them.

There are multiple factors driving this, not least of which is the increased likelihood that the US Federal Reserve (the Fed) will soon need to pivot, or at least ease the severity of the interest rate increases that it has implemented in its attempt to curb inflation this year.

Indeed, most forecasters now expect the Fed to raise rates by just 0.50% at their next meeting, with David Meger, director of metals trading at High Street Futures noting that: “The idea that (the Fed) are getting close to being done (with rate hikes) early next year is a positive underlying environment. Knowing that the bulk of those interest rate hikes are already factored into the market, I would say there is no longer a dark cloud of interest rate hikes looming over the gold market.”

We agree with that sentiment, though we’d note that over the medium term, gold often does well in environments interest rates rise, as evidenced in the table below, which is from a recent ABC Bullion blog titled; “Gold to soar alongside rising interest rates”.

Table: Periods of interest rate rises, and USD gold price moves

Nevertheless, there is no doubt that for now at least, most market participants see higher rates, which increase the opportunity cost of owning precious metals, as being bad for gold.
As such, any indications that rate rises either won’t be as severe as previously anticipated are a likely catalyst for higher gold and silver prices, which is no doubt feeding into the more optimistic view that investors have toward precious metals right now, as per some recent research from BMO.

Gold’s strategic role
For strategic investors, the value of gold, and the role it can play in a portfolio, is becoming more evident every day.

Societe Generale recently published commentary which helps explain one of the reasons why gold can be so valuable, noting that systemic risks are a common feature after rounds of monetary policy tightening (i.e., what central banks have been doing this year), with Societe Generale economists noting that allocations to gold can help stabilise overall portfolio volatility.

This attribute of gold can be important for all investor types, from retail investors through to SMSF trustees, family offices and institutionally managed funds, with the latter client base starting to look more closely at the way they have allocated to alternative investments (basically anything that’s not equities, bonds, or cash).

In the last twenty plus years, institutionally managed funds have notably increased their exposure to alternative investments, from private equity, to hedge funds, to unlisted infrastructure.
The Centre of Retirement Research, located in Boston, recently published commentary which noted that while these alternative assets may have lowered overall portfolio volatility in the last twenty years, they likely haven’t helped overall portfolio returns.

In time, findings like this should encourage institutional investors to look at gold more favourably, as gold has

1. Outperformed nearly all mainstream asset classes over the last twenty years, and indeed has beaten most assets with the exception of equities since the early 1970s

2. Is much more liquid than the vast majority of alternative assets, turning over in excess of USD $150bn per day. That liquidity provides important flexibility to investors that can help both manage risk, and capture returns.

3. Has a more than 50-year track record in the modern investment era of being negatively correlated to falling risk assets, and positively correlated to rising risk assets

4. Has zero credit risk when held in physical form, minimising this risk factor at an overall portfolio level

5. Has incredibly low execution and storage costs, whereas most alternative assets are at the high end of the fee spectrum.

6. Is incredibly simple to monitor and manage, whereas many alternative assets require specialist skills, which are expensive, to manage effectively.

Many of these positive attributes are already well understood by gold and precious metal investors today.

We expect demand for the precious metal to increase as more institutional money comes to see gold in a similar light.

Odds on for a recession
While financial market commentators are often more focused on the US Fed, and US financial markets, developments in of Asia are also critical to the health of the global economy.
 
In that regard, news this week that parts of China may be re-entering COVID related lockdowns, or something similar to lockdowns, with cases hitting a daily record, represent another hit to the outlook for growth, and to sentiment.
 
They also have potentially negative implications for inflation, depending on any supply side disruption they may cause.
 
It needs to be remembered too that this is occurring in an environment where a recession in the United States in 2023 is becoming a base case, with the most recent Philadelphia Fed survey of professional forecasters (a series that dates back to the 1960s) suggesting that more forecasters are predicting a recession will hit within the next year than at any point in history.
 
This can be seen in the chart below, courtesy of @biancoresearch.

While one could be tempted to look at this data and take a contrarian view, (essentially “if more people than ever think we’ll have a recession, we probably won’t have one”), the chart, which shows actual US recessions in grey lines, indicates that with this series at least, the experts are often right.
 
At the very least, data like this is likely to encourage investors to reassess their portfolios and make sure they are robustly structured to withstand the potential volatility to come in a recessionary environment where both rates and inflation are at multi-decade highs.

This should be very positive for gold, and broader precious metal demand.

The ABC Bullion Team
This week has seen clients turn their heads towards gold coins and ABC’s Gold Tablet Range, with investors adding to their hard asset allocations. Whilst SMSF trustees and clients with larger portfolios tend to allocate to cast bars in larger sizes, like the ABC Bullion 1kg Cast Bar Gold, smaller denomination coins and tables are also an excellent addition to clients portfolios, especially when investing with a more modest budget.

Warm regards,
 
Jordan Eliseo
General Manager
ABC Bullion Australia

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