The How and Why of Gold and Silver

Precious Metals Commentary

A largely uneventful week for precious metals except for a large AUD/USD move to a new 52 week high of 72.6 US cents. Gold finished the week lower at US$1,928 and silver held up at $26.95 pushing the gold:silver ratio down to 71.6.

Traders were obviously focused on the Jackson Hole event this week which would have Fed Chair Jerome Powell deliver a speech on monetary policy, unemployment, and inflation. The Fed has had an inflation target of 2% for what seems an eternity now, so a change in language this week confirmed the new mandate will be to let inflation run higher than 2% to help stimulate the US economic recovery post COVID.

Everyone trading gold was overly excited about the new comments with gold getting as high as $1,975 before being heavily sold off back to $1,920. Somewhat of a buy the rumour, sell the fact trade as more waffle from Powell on keeping rates lower for longer isn’t exactly new news.

This week the US government was rated the worst on a poll of how well they handled the coronavirus crisis. Only 18% of those polled said the US is more united now than before the virus and this is evident in what we are seeing across the country with rioters fighting amongst each other now as well as with police.

The US is in a state of crisis with unemployment above 10%, underemployment over 16% and the economy contracting 31% this year, all whilst retail traders push US stocks to all-time highs; it is a bizarre year thus far.

The strength in the AUD continued this week leading to local gold and silver prices trading close to the lowest prices of the month. The USD index is down 7% since May this year which is helping the Aussie higher and we also have strong iron ore prices contributing to recent gains.

We haven’t been too bearish on the AUD/USD in recent times as we remain bearish on the US Dollar given the state that they are in currently. This trend in the AUD is keeping a lid on precious metals prices for now with the rally not looking too overcooked just yet but averaging into metals during periods of AUD strength in recent years has been a good strategy.

Westpac economist Bill Evans is bullish enough to suggest the AUD could trade as high as 80c by the end of 2021, but that may be a tad overly optimistic when you consider the problems with household debt and the risks to an Australian banking crisis (not something an economist at a major bank would mention though).

Although we could see the USD weaken further, we think the boost to precious metals prices should outweigh any AUD strength in the longer term, and short-term spikes in the FX should provide some good spots to average into the metals over time for local investors.

The How and Why of Gold and Silver

On Wednesday Bron gave a webinar on gold and silver in conjunction with Zadel Property Education that attracted over 400 viewers. The main presentation went for about 50 minutes and covered:

• The Rational Case for Gold

• The Irrational Nature of Gold

• The Four Types of Gold Investor

• What, Who and Where of Buying and Storing

• Gold or Silver, or Both?

The Question & Answer session that followed went for 1 hour, such was the interest in precious metals, with a lot of focus on tax issues and confiscation, which we will cover below.
Zadel have kindly made it available to the public and you can watch it below or click here to watch it in a new window.

For those who don’t have 2 hours to spare, below we will cover some of the highlights.

Bubbles

The first chart Bron started off with was the gold bull market chart we wrote about on 7th August, but updated with the recent sell offs we had on the 11th and 19th (marked in the circle in red). While gold is down a bit over 7% in US dollars, the chart shows that the correction so far hardly registers when looking at the move since it bottomed in 2016.

Given how modest the bull market has been to-date, compared to the 1970s, the claim by US asset manager Carillon Tower Advisers that “gold is bigger bubble than tech” and that it has become disconnected from fundamentals is laughable.

While gold certainly has bubble phases, Bron noted that this is not unique to the metals and showed how the main bubble stages in the graphic below apply to many different markets and times like the cocoa bubble of 1977, the uranium bubble of 2007 and, of course, the NASDAQ tech stock bubble in 2000.

The Carillon Tower Advisers view ignores the fact that asset price rises have not just been driven by loose monetary policy but also increased borrowing that in the main has not been used to fund productive enterprises but instead for consumption and speculation.

Debt

The Global Financial Crisis in 2008 highlighted this and it is our view that the underlying debt-saturation issue has not been addressed. As we have been noting for a long time, when there are more voters who are borrowers than savers, governments will seek to ease their debt burden by lower rates and inflation. This is the core of the case for gold and silver.

The day before Bron’s presentation the RBA released a research discussion paper on “How Risky is Australian Household Debt?” which concluded that Australian “banks appear resilient to a severe downturn”, which is not surprising as the RBA wouldn’t admit it has allowed an unstable situation to develop.

The paper is a response to the fact that Australia’s debt to income ratio is quite high compared to many other countries. The RBA say that one of the key factors behind the high ratio is the fact that rental housing is mostly owned directly by individuals while in many other countries rental housing is owned by corporations, the government or not-for-profits. The chart below shows that relationship.

The RBA models the impact of an economic shock on this high debt level and says that due to moderate loan-to-valuation ratios and debt being held mostly by wealthier households that the impact will be modest.

We tend to be skeptical of economic models as they cannot include all the factors driving individual decisions and they also tend to ignore feedback effects, let alone the issue of the validity of the inputs/assumptions in the model.

The RBA do note that their model doesn’t “account for the increase in debt over the past four or five years” (people using their home as an ATM?) and that “a large but plausible fall in asset prices could lead to a substantial fall in consumption”. That latter point is what concerns us, as it can create a downward spiralling feedback loop where businesses contract, unemployment or income is reduced, belt-tightening by households and repeat.

Tax

There were a lot of questions after the webinar about tax. We have found that some people think that precious metals are treated differently for tax purposes, or don’t attract tax at all. While gold and silver do not attract GST (as long as it is of the right purity and from a recognised manufacturer like ABC Bullion) they are treated by the ATO like any other investment asset.

So, for example, as long as you are not carrying on a business of trading precious metals, normal capital gains tax rules will apply. There was some discussion about the application of “personal use assets” (an asset used or kept mainly for personal use or enjoyment) rules to precious metals.

Our view is that it would be a stretch to argue that you bought bullion for personal enjoyment only and you should seek professional advice before not declaring any capital gains on sale of your precious metals.

Confiscation

The other issue that came up was on the chance that Australia would go back to a gold standard and/or confiscate gold. Our view is that a gold standard is highly unlikely as it puts handcuffs on governments and central banks with regards to money printing.

With a “flexible” fiat monetary system we don’t consider the probability of gold confiscation to be high ad governments don’t need gold to pay for things. The only likely scenario in our view is if there was a world war, in which case countries would likely only trade with each other in exchange for gold, as a country’s fiat currency would not be honoured if they were invaded and occupied, as well as the fact that in war a currency is often inflated to pay for the costs of war.

For those interested in the history of gold confiscation in Australia and the “suspension” of Part IV of the Banking Act 1959 (the law by which it was illegal to own gold in Australia in the past), Bron’s personal blog posts from 2008 here and here cover it extensively.

Until next time,

John Feeney and Bron Suchecki
ABC Bullion
 
If you have any questions or feedback about this week’s report, we would love to hear from you. You can contact John Feeney (@JohnFeeney10) and Bron Suchecki (@bronsuchecki) directly on Twitter, otherwise please feel free to send us an email at [email protected], or call us during trading hours on 1300 361 261.

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