Precious metals rocket as yields collapse

In this week's market update:

• Gold prices soared over the past five trading days, rising by 5% as the collapse of Silicon Valley Bank (SVB), and one of the sharpest declines in bond yields on record saw the precious metal rise above USD $1,900 per troy ounce (oz).

• Silver has also rallied, up 8%, last trading near USD 21.7oz, with the gold silver ratio (GSR) now sitting at 88, down from 91 five days ago.

• Equity markets have seen a spike in volatility, though the S&P 500 has eked out a minor gain, while the ASX 200 has fallen 5%. European shares have also suffered, with trading in bank shares at one point suspended, with fears Credit Suisse is on the verge of collapsing.

• Bonds experienced one of their most volatile weeks in fifteen years, with the scale of the moves in yields (both to the downside, and then upside) last seen when the Global Financial Crisis hit some fifteen years ago. Across the course of the week, 10 year bond yields fell by more than 0.30% in the United States, and 0.20% in Australia.

• Markets have begun to price in significant levels of monetary easing by central banks, though with inflation remaining stubbornly high, it is far from certain this will occur.

Well, that was quick!

Precious metal prices soared this week, with gold trading back above USD $1900oz, while silver rose toward USD $22oz, up 5% and 8% respectively over the past five trading days. Price action in the two precious metals has seen the gold to silver ratio (GSR) fall to 88, down from 91 last week.

For local currency investors, the news has been just as positive, with gold soaring toward AUD $2,900oz, while silver is back again approaching AUD $33oz.

The proximate cause of the huge rally in precious metals was the collapse of Silicon Valley Bank (SVB), which was essentially shut down by California regulators late last week, with Signature Bank also collapsing in the last few days.

While some commentators believe SVB was just the first domino to fall in terms of the pressure set to hit regional banks, it was an did have some specific factors that contributed to its downfall, including its reliance on deposits from one main sector (tech).

It was also unusual in the way it managed risk, or didn’t manage risk depending on how you look at it, with the below chart (sourced here) highlighting how much of an outlier it was compared to other major banks.

It’s also worth noting that policymakers reacted swiftly, with the Federal Deposit Insurance Corporation assuring all depositors at SVB that their money is both safe and accessible.
This has led to the bizarre scenario where SVB itself is now marketing that “deposits held with SVB are among the safest of any bank or institution in the country”, which will may rate a mention in any future studies on moral hazard.

While it remains to be seen how things play out in coming weeks, there is no doubt the collapse of SVB, and the reaction from policymakers caused chaos across financial markets.
Equities and crypto were volatile as expected, though the bigger move was in the bond market. Yields on both short and long-term government bonds plunged, though some of this was no doubt driven by speculative investors covering huge short positions in US debt securities.

So significant has the price action been that markets are now expecting up to 100 basis points (or 1%) of cuts by the US Federal Reserve in the next twelve months. This is a far cry from where we were just one week ago, when CitiGroup noted that they “now expect a 50bp rate hike at the March FOMC meeting (rather than 25bp) with a terminal rate of 5.5-5.75% (up from 5.25-5.50%). The 255k jobs and 0.5%MoM core CPI we project in our final forecast are likely enough to provoke the 50bp hike.”

A similar situation has been observed in Australia. Up until a week ago, markets were pricing in a peak in the cash rate somewhere north of 4%, which implied the Reserve Bank of Australia (RBA) had up to three more interest rate hikes it was set to deploy in the coming months.

Today, the market is pricing in a peak for the cash rate of closer to 3.60%, which is where rates are already sitting.

Given the inflation backdrop (more on this below), it will be fascinating to see how both the US Federal Reserve and the RBA respond. Many are concerned that bringing rate hikes to an end will be seen as what it is, a sign of panic from policymakers.

As a result, it is not clear that central banks are going to step back from their current tightening path. It’s even less clear that it would be a good thing for markets if they did, as we explore below.

Be careful what you wish for

There is a growing school of thought that while markets have been volatile to say the least in the past week, the collapse of SVB, the bailout of depositors that followed, and the expectation that central banks will soon pivot to easier monetary policy will be bullish for risk assets, including shares.

The argument is logical enough, in that if higher rates have been one factor pushing share markets lower over the past year, then surely lower rates will help push markets higher.
Unfortunately, history debunks this theory, with the below chart (sourced here) highlighting what happened to the S&P 500 when the Fed began easing monetary policy just over twenty years ago, in the aftermath of the NASDAQ crash.

Rather than rallying, equities fell by the better part of 40% while the Fed was in the middle of one of its most aggressive rate cutting cycles.

This was also around the time that gold begun a circa decade long bull market.

While no one has a crystal ball, it would not surprise to see history repeat.

Gold looks solid

Given the recent news flow, asset markets, including gold and silver, are likely to remain volatile in coming weeks. For those with a longer-term view though, events of the last week combined with the broader macro environment only reinforce the case for precious metals in a portfolio.

After all, while declining at a headline level, inflation remains stubbornly high, rising by 0.4% for the month of February (6% year on year) in the United States, with core inflation coming in higher than estimates.

With service cost inflation continuing to gather steam (see chart below sourced here), there seems little chance that the Fed will hit its inflation target of between 2-3% inflation any time soon, a scenario that would only become more problematic if they do indeed stop hiking rates, as some in the market now expect.

That’s helpful to the case for gold and silver over time.

We are also starting to see a return of inflows into gold ETFs, with almost 14 tonnes of metal flowing into these products on Monday of this week. As per Krishan Gopaul of the World Gold Council, that’s the highest level of daily demand in almost three years, with this segment of the market primed to add upside momentum to precious metals given investors in these products have either largely sat on the sidelines, or indeed been reducing holding in the last two years.

Moving forward, there is considerable scope for Western investors to add to their gold exposure, with Ronald Stoeferle of Incrementum noting that asset allocators still tend to have little or no exposure to gold, a situation that hasn’t changed meaningfully since 2017. That means there is substantially more potential for holdings to increase rather than decrease.

Chinese demand is also strong, with gold withdrawals from the Shanghai Gold Exchange topping 169 tonnes in February. That is up 30 tonnes from the prior month, and is 76 tonnes higher year on year, while the People’s Bank of China continue to accumulate, with their total gold reserve now sitting at 2,050 tonnes of the precious metal.

That central bank acquisition by the PBOC dovetails in with a final point worth noting when it comes to the outlook for gold. And that is that gold’s share of central bank reserves is only growing, having risen from below 10%, to almost 14% of total reserves since the early 2000s.

That increase in gold reserves has come in part at the expense of FX reserves held in USD, which can be seen in the below chart (sourced here from TD Securities).

Strong physical demand (see next section) combined with robust central bank acquisitions and a return to buying from gold ETF investors sets the metal up nicely for the coming months, with long-term investors likely to be well rewarded.

Inside the office this week

It’s been one of the busiest weeks of the last three years at ABC Bullion, with near record volumes in both gold and silver. Inside our office, 50-gram ABC Bullion gold cast bars, silver coins, and 1kg ABC Bullion silver cast bars remain our most popular products, while online, pool allocated metals, and 1 oz ABC Bullion gold bars are doing a brisk trade, as investors add bullion to their portfolios.

We also continue to see good two-way trade, with a large number of investors also taking advantage of the price spike to liquidate part of their precious metal portfolio.
As a final comment, we thought we’d share an article from Yahoo finance, with references hedge fund legend Ray Dalio, and the importance of teaching kids investment skills. The article talks about gold, and why gold coins, given their tangible nature, can be a great asset to buy for children, noting that “Unlike stocks or mutual funds, gold coins are tangible, making it easier for children to grasp the concept of investing.”

We’d echo those thoughts and have noted a number of parents and grandparents buying both gold and silver coins for their children or grandchildren, as well as activating ABC Bullion Gold Saver Accounts, so they can build a precious metal portfolio over time.

The ABC Bullion 50g Gold Cast Bar.

Warm Regards,

Jordan Eliseo
General Manager

ABC Bullion Australia

Disclaimer: This document has been prepared by Australian Bullion Company (NSW) Pty Limited (ABN 82 002 858 602) (ABC). The information contained in this document or internet related link (collectively, Document) is of a general nature and is provided for information purposes only. It is not intended to constitute advice, nor to influence any person in making a decision in relation to any precious metal or related product. To the extent that any advice is provided in this Document, it is general advice only and has been prepared without taking into account your objectives, financial situation or needs (your Personal Circumstances). Before acting on any such general advice, we recommend that you obtain professional advice and consider the appropriateness of the advice having regard to your Personal Circumstances. If the advice relates to the acquisition, or possible acquisition of any precious metal or related product, you should obtain independent professional advice before making any decision about whether to acquire it. Although the information and opinions contained in this document are based on sources we believe to be reliable, to the extent permitted by law, ABC and its associated entities do not warrant, represent or guarantee, expressly or impliedly, that the information contained in this document is accurate, complete, reliable or current. The information is subject to change without notice and we are under no obligation to update it. Past performance is not a reliable indicator of future performance. If you intend to rely on the information, you should independently verify and assess the accuracy and completeness and obtain professional advice regarding its suitability for your Personal Circumstances. To the extent possible, ABC, its associated entities, and any of its or their officers, employees and agents accepts no liability for any loss or damage relating to any use or reliance on the information in this document. It is intended for the use of ABC clients and may not be distributed or reproduced without consent. © Australian Bullion Company (NSW) Pty Limited 2020.