No margin for error as gold rallies

In this week's market update:

• Gold prices surged above USD $1,800 per troy ounce (oz) this week, with the precious metal now up 10% for the month

• Silver put on an even stronger showing, rallying by 5%, with the gold to silver ratio falling below 80 for the first time in months.

• Equities, oil, and cryptocurrencies also rose modestly, while the USD index continued to decline, down 1% for the week

• Bond yields also continued their recent decline, with 10-year yields in the United States and Australia now closer to 3.5%, down circa 50 basis points from the level they were sitting at a month ago

• Heightened expectations that the US Federal Reserve will adopt more dovish monetary policy as we head toward 2023 have driven the recent rally across most asset classes, as recession warnings continue to build

Three reasons to be bullish gold

It’s been another positive week for the precious metal complex, with gold rallying above USD $1800oz, up 3%. The move has seen gold claw back almost all of its year-to-date drawdown in USD terms (indeed, it’s now positive on a rolling 12-month basis), which is quite the result given the strength of the US dollar itself, and the move higher in real yields that we have seen for most 2022.

Silver also pushed higher, rising by 5% toward USD $23oz, with the gold to silver ratio falling below 80 for the first time since April this year.

The move in precious metals was mirrored across broader financial markets, with equities rallying (S&P 500 +1% and ASX 200 +2% over the past five trading days), commodities rising, and even cryptocurrencies attracting a small bid, though Bitcoin still remains mired well below USD $20,000 per coin.

The likelihood of a slower pace of tightening from the US Federal Reserve continues to be the main catalyst for the rally in most assets, with US Federal Reserve Chair noting this week that; “It makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down. The time for moderating the pace of rate increases may come as soon as the December meeting.”

Back to gold specifically, and it now sits more than USD $150oz, or 10% higher than the low’s seen barely a month ago in early November (silver is up 14% over the same time period), with this strong rally reinforcing the belief amongst many investors that we have now entered a new bull market in precious metals.

UBS added to the positive narrative building around gold, with an update from earlier this week noting three structural reasons favouring the precious metal. These reasons, extracts of which are edited and include below, are as follows.

1. Long-term investors and central banks continue to gradually build gold allocations, continuing a trend that has been in place for over a decade, with net buying on track for another record year. This buying, driven in part by the desire of central banks to diversify dollar-denominated reserves, is unlikely to end anytime soon.

2. A likely uptick in institutional demand, with gold holdings in these portfolios currently quite low as a percentage of overall assets. UBS noted that for now, if held at all, gold is likely mostly held for diversification and portfolio protection reasons, rather than expectations of outright material price appreciation. This implies more resilient core positions and scope for allocations to grow.

3. Strong physical demand, which this year at least, has been a key factor affecting the relationship between gold and real rates.

Crucially, the rally that we have seen in precious metals over the past month has now seen gold push above its 200-day moving average, which is sitting just below USD $1,800oz. Credit Suisse had noted that gold may have needed further time to consolidate, and even re-test downside targets, before pushing beyond the USD $1800oz barrier.

Now that that hurdle has been cleared, the potential for more short-term upside is obvious, with technical charts suggesting the metal could head toward USD $1900oz, with a return to net buying by gold ETF investors and speculative investors adding to the recent momentum.

Medium term, the outlook is even brighter, as both gold and silver are set to benefit as investors seek an alternative to a share-market that could fall a lot further, as we highlight below.

Everyone’s bearish – no one has sold

Investor sentiment has soured across the course of 2022, as a major drawdown in equity markets, a crash in cryptocurrencies, and the worst bond market pullback in decades has led to notable losses across most portfolios.

Based on various surveys, sentiment today is about as bad as it was at the height of the Global Financial Crisis (GFC), which can be seen in the red line on the chart below.

There are two main differences though between the GFC era, and today.

The first of those is that the drawdown in markets was much more severe in the GFC, with the S&P 500 falling by approximately 50% between October 2007 and March 2009. At its low point this year, the market was down closer to 20%. That’s painful, but nowhere near as bad as what transpired fifteen years ago.

The second key difference is that equity allocations in investor portfolios today haven’t declined by anywhere near as much they did when the GFC hit, which the black line on the above chart also highlights.

As a result, while sentiment surveys suggest most investors are bearish, they remain invested, even if they have delivered and reduced margin debt. At a proper market bottom, investors have typically panicked and sold out.

Consumer recession in play

The odds of a recession hitting in 2023 continue to build, with a range of forward-looking indicators suggesting that at the very least we’ll see a marked economic slowdown in the next twelve months.
 
In Australia, this is very tightly linked to developments in the local housing market, with higher inflation, and the 275 basis points (2.75%) of interest rate hikes that the Reserve Bank of Australia (RBA) have implemented this year raising mortgage repayments and crimping discretionary spending.
 
This is now starting to show up very clearly in economic data, with October retail sales in Australia falling by 0.2%, the first calendar month decline of 2022. While that is only one month of data, and one data set that, it’s likely to get worse as we head into next year.
 
That much is made clear when looking at analysis from the Reserve Bank of Australia, which suggests 15% of mortgage holders in Australia will see their spare cash flow turn negative in the event interest rates rise to 3.6%. This can be seen in the chart below.

At the very least, its clear that a consumer discretionary recession is in play for next year, with potentially negative implications for the economy and the local share-market, especially given property prices likely have further to fall.
 
That can’t help but encourage Australian investors to look at alternative assets to include in their portfolio, with those alternative assets obviously including gold and silver.

Inside the office this week

As we approach Christmas, there has been a noticeable uptick in investors adding hard assets to their portfolio. This week has brought an influx of individual and SMSF traders adding gold to their portfolios. Investors are using a variety of products to achieve this, from the higher valued ABC 1kg Gold Cast Bar, down to our ABC 1oz Gold Cast Bar which is prized for its versatility in trading.

Warm regards,

Jordan Eliseo
General Manager

ABC Bullion Australia

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