Markets Surge as Central Banks Blink

Dear Investor,

In this week's market update:

• Gold prices surged over the past five trading days, rallying by 4% to USD $1715oz

• Silver fared even better, rising by 11% to USD $20.70oz, with the gold to silver ratio (GSR) falling from 89 to 83

• Local precious metal investors also saw price gains (gold +3%, silver +10%) though these were capped by a 1% rise in the Australian dollar, which finished the week trading back above USD 0.65

• Equity markets and commodities also bounced, led by oil, which was up by 9%, with the S&P 500 and ASX 200 up 3% and 4% respectively

• Inflation expectations rose for the week, with the 10-year breakeven inflation rate now sitting at 2.22%, up from 2.15% at the end of September

Now that’s a rally!

Financial markets staged a huge rally over the past few trading days, as investors treated recent central bank activity as a sign that the rapid pace of interest rate increases deployed across developed markets in 2022 may soon ease.

Australia in many ways set the tone for this, with the Reserve Bank of Australia (RBA) electing to raise interest rates by just 0.25% to 2.60% at their latest policy meeting held on Tuesday 4th October.

While some economists had predicted such a result, three quarters of forecasters surveyed by Bloomberg had expected a more substantial interest rate hike.

While it remains to be seen whether the RBA decision is mimicked worldwide (Paul Krugman for one has warned of a slowdown in economic activity, suggesting the Fed should ease back on the speed of rate hikes, while other data suggests inflation pressures remain significant), or if the RBA is now an outlier of sorts, it was no surprise that markets staged the rally the have in recent days.

Firstly, they had they seen significant falls in the prior month, with the S&P 500 down 9% during September.

Markets had also reached an extremely oversold position, evidenced through charts like the one below, with the blue line suggesting the S&P 500 had reached an oversold level similar to those seen in major bear market bottoms seen back in the early 2000s, and again when the Global Financial Crisis hit.

Source:  @CalebFranzen via @CallumThomas

Given this backdrop, markets were primed for a rally, which is exactly what transpired, with equity markets seeing their best two day rally since 2020, which was of course in the aftermath of the COVID-19 induced sell off.

Commodities also surged, with oil up 7%, and trading back near USD $90 per barrel, though this was in part driven by the news that OPEC are looking to cut production levels by up to 2 million barrels per day, despite pressure from The White House.

Cryptocurrency prices also saw an uplift, with Bitcoin (BTC) reclaiming USD $20,000 per coin, though some crypto traders still see further downside ahead, with warnings of a decline toward USD $14,000 per coin. If that were to happen, it would put BTC down 70% for the year, and a full 80% below the all-time high hit in late 2021.

Last but by no means least, the last five trading days have been particularly kind to precious metal investors, with gold at one point rallying by the better part of USD $100oz, to trade at USD $1715oz at the time of writing.

Silver also increased by 11% in USD terms and is sitting back above USD $20.50oz with the GSR falling from 89 to 83.

Where to next for gold and silver

While the rally over the past five trading days will have pleased precious metal bulls, it remains too early to call a definitive change in direction.

The US dollar, which has pulled back over the last week, remains in an uptrend, while inflation expectations are still incredibly low.

And while current sentiment readings (very poor) and futures market positioning (net short for managed money speculators), are likely bullish over the medium to long-term, they do indicate that over a shorter time frame, precious metals have some work to do to break the bearish trend they’ve been in since early 2022.

Below we look at three charts which provide a feel for where the precious metal market currently sits.

• Watch out for a top in real yields

The chart below shows the USD gold price, as well as the real yield on the 10-year US treasury bond. While there are other forces that drive the gold price, there is no doubt that lower real yields have tended to be good for the gold price, while higher real yields act as a headwind.

Source: ABC Bullion, US Treasury, LBMA

The chart highlights the fact that since the start of 2022, real yields have soared, increasing by over 2.50%, from -1.04% to +1.54% where they sit today, noting that they went as high as 1.68% by the end of September.

This surge has of course been a major driver of the circa USD $200oz (and 20%) correction we’ve seen in the USD gold price since it hit an intra-year high in early March this year.

All things considered, a case can be made that gold has held up better than one might expect given this surge in real yields, with the precious metal trading closer to USD $1100oz last time real yields were this high.

If we’ve now seen the top of this surge in real yields, then a major obstacle to higher gold prices will have been removed.

• Gold and moving averages

The chart below shows the USD gold price, as well as the 50 day (50 DMA) and 200 day (200 DMA) moving average for the precious metal, dating back to the end of 2015, when gold entered a new bull market in USD terms.

Source: ABC Bullion, LBMA

The chart demonstrates that while gold is still some distance below its 200 DMA, it is basically back in line with its 50 DMA.

The chart also highlights the lack of froth in gold market today, as in periods like August 2020 and March 2022 (when gold was trading at more than USD $2,000oz) the precious metal was trading well above both its 50 and 200 DMA, which is often a warning sign.

This can be seen in the table below, which shows spot prices, 50 and 200 DMAs and the percentage gap between these prices, for both gold and silver, at various points over the past two plus years.

Source: ABC Bullion, LBMA

As you can see, back in August 2020, gold and silver were trading at 26% and 60% above their 200 DMAs respectively. Today the situation is totally different.

• Gold to silver ratio

The chart below shows the gold to silver ratio (GSR) over the last fifty plus years, from the end of 1969 onward.

Source: ABC Bullion, LBMA

At a current reading of 83, the GSR still sits well above its long-term average, which is closer to 59. This suggests silver remains cheap relative to gold. The chart also highlights that the movement in this ratio back toward 100, which occurred over the past few months, has run out of legs, which suggests silver may be set for a period of outperformance.

This would likely be bullish for the entire precious metal sector, given periods of outperformance for silver often occur during precious metal bull markets.

Given the various data points, we’d say the short-term outlook for precious metals remains mixed, with the medium to long-term view looking more positive.

Summary

As a final comment, we’d note that while the overall of precious metal prices remains uncertain, it does seem clear that volatility will remain.

Rather than being something to fear, that can be something for investors to embrace, a subject we discussed in a separate blog post this week, alongside a look at gold’s lack of credit risk, and its correlation to equity markets.

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