Stagflation and the case for gold in 2023

In this week's makret update:

• Gold prices have started the new year on solid footing, with the precious metal up 1% to USD $1832 per troy ounce (oz).

• Silver is softer, off 3% in USD terms, last trading above USD $23oz, with the gold to silver ratio (GSR) rising from 76 to 79 over the past five trading days.

• Equity markets have been relatively stable at a headline level (despite high profile pullbacks for companies like Tesla), while currencies are also calm, with the US dollar index up 1%.

• Commodities have continued to sell off, with oil off 6% in the past five trading days, while inflation expectations and bond yields have also fallen, as recession risks continue to build.

What goes up must come down?

Gold prices have risen in the first few trading days of 2023, though a pullback in the past 24 hours has seen the precious metal give up most of its earlier gains, with silver, which is now -3% over the past five trading days, also impacted.

Equities and crypto markets are relatively unchanged so far, with the bigger moves being seen in commodity markets, where oil is again falling, as recession risks continue to rise, with recent ISM data out of the United States suggesting manufacturing output declined for a second straight month.

It’s not just the US either, with global manufacturing and services PMI data suggesting GDP will contract, while recession probability indicators are at their highest levels since 1968, as per a recent World Gold Council update which touched on the range of factors that will likely impact gold this year.

While heightened changes of a recession add to the potential risks in equity markets (given earnings will inevitably be hit), and in property markets as more would be homeowners either lose jobs and/or face heightened financial stress, investors are more focused on what it means for monetary policy.

A pivot, from hawkish to dovish policy is now priced into markets, with the below chart from @CharlieBilello suggesting two more hikes from the Fed by the end of March. Rate cuts are then expected to come through by late 2023, with policy expected to ease as far out as January 2025, fully two years from now.

If the Fed does indeed follow that path, then investors will expect most of the rest of the world to follow suit, with the below chart from @CallumThomas highlighting how synchronised monetary policy has been over the last twenty years (the pandemic era in particular), irrespective of whether we are looking at developed or emerging markets.

It’s worth noting that the last time we saw a shift from almost all central banks tightening policy to almost all central banks easing policy was back in the Global Financial Crisis, between 2007 and 2009.
 
That proved a perilous time to be an owner of risk assets, with equities plunging by more than 50% in some parts of the world.
 
Safe haven likes gold and other precious metals flourished in this period.

The new bull market in precious metals

If central banks do indeed pivot to more dovish policy at some point in 2023, then it would not surprise to see even stronger gold outperformance relative to risk assets than we saw during the GFC era.

Several factors support this hypothesis"

• Inflation, while almost certainly set to ease this year, remains at problematic levels today, whereas it was almost non-existent in the aftermath of the GFC. A recession combined with uncomfortably high inflation (Stagflation in other words) would likely be the perfect environment for gold and silver to soar.

• Commodities, despite being a relative shining light in 2022, are coming off a decade of underperformance relative to risk assets.

• Bond prices are falling meaningfully for the first time in a generation, with risk-free return now turning into return-free risk, in real terms in particular.

• Governments debt to GDP ratios are far higher than they were fifteen years ago, likely constraining the potential for a fiscal response to support economies through a period of low growth/recession, unless said fiscal response is financed through quantitative easing.

Indeed gold is already beginning to show strong outperformance relative to a portfolio of traditional assets, evidenced through the chart below, which was produced in this article by @TheDailyGold, and shows the performance of gold against a 60% stocks 40% bond portfolio.

After putting in place what looks like a double bottom in late 2018, and again in late 2022, this ratio has begun to head higher, with history demonstrating clearly that gold is capable of putting in a multi-year run of outperformance.
 
If history repeats, then we’d also expect silver to flourish in such an environment, especially considering how cheap it remains relative to gold today.

What to expect in Australia

Australia is obviously not immune to developments in the northern hemisphere, with rising recession risks also at play domestically. This can perhaps best be visualised through consumer confidence (or lack thereof today) data, with the chart below highlighting how pessimistic Australian’s are today.

This is not surprising considering the state of the housing market, where prices not only continue to fall, but properties are taking much longer to sell, with data from SQM suggesting the number of properties on sale for more than six months rose by almost 15% last year.

Distressed property sales will also continue to rise, with just over $475 billion of fixed rate loans (many of which were taken out at or near pandemic era lows) set to reset to much higher rates this year.

While this data suggests the Reserve Bank might want to hold interest rates steady for some time, to see just how significant a headwind to the economy this poses, it may not be that simple. For while confidence indicators suggest Australian’s are worried as it relates to the outlook for the economy, they have so far kept their wallets open, with pre-Christmas spending up 8.6%, while boxing day sales were up 15%.

Inflation is still way above the levels the RBA are comfortable with, and while property prices are falling, they are still significantly higher than they were pre-pandemic.

Given this, it’s perhaps not surprising that markets still expect the RBA to be in tightening mode for most of 2023, with the cash rate currently expected to peak at just over 3.90% in September this year.

Inside the office this week

It’s been a busy start to the year in the ABC Bullion Sydney office (other state showrooms open on Monday 9th), with clients adding to their gold and silver holdings. 50-gram ABC Bullion Gold Cast Bars have been particularly popular, as have our signature 1-kilo ABC Bullion Silver Cast Bars.
 
We have also seen a surge in customers activating ABC Bullion Gold Saver accounts, with the start of a new year a motivator to set up a bullion savings plan that allows investors to gradually increase their holdings of gold and silver.
 
 
Warm regards,

Jordan Eliseo
General Manager
ABC Bullion Australia

The ABC Bullion Team

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