The Warning Signs Keep Building

Until last nights price action, gold and silver had remained largely stuck within its recent trading range, and on track to a record a flat monthly return for September.

However, after a sharp fall overnight (seen on the chart below in green), the yellow metal is currently trading at USD $1184oz, whilst silver is at USD $14.40oz, with the yellow metal now down close to 1% for the week.
 

In Australian dollar terms, the two precious metals are trading at AUD $1643oz (gold), and AUD $19.90 (silver), with the Australian dollar currently sitting at USD $0.721, having bounced since the middle of September.

Whilst price action has by and large remained relatively subdued over the last few weeks, there has been plenty of activity in financial markets, headlined by the Federal Reserve, who hiked rates at a meeting earlier in the week.

As you can see from the chart below, the hike was fully ‘priced in’ by the market prior to the Fed meeting, which helps explain the non-response in the gold market in the 24 hours afterward, though removal of the word “accommodative” from the Fed statement had many analysts interpreting this as a hawkish move by the Fed.
 

Shorter-term, gold is now at a critical juncture, and must hold support around USD $1180oz, less the door be opened to a retest of the USD $1160 levels we saw a few weeks back.

At this point, the market is still waiting for a decisive catalyst, though short-term momentum and the path of least resistance is to the downside. On a more positive note for bulls, any short covering by already stretched speculative investors should help support prices.

The chart below provides a useful update on positioning in the gold market at present, with positioning amongst large speculators still net short (as it has been for just over a month), whilst commercials are net long.

 
It goes without saying that this is a fairly unusual set of affairs, with speculators almost never net short, whilst commercials are almost never net long.

It gives us great confidence that we are close to an end in this corrective cycle for gold, even if it will take some time for prices to meaningfully turn around and power higher.

Warning Signs – but no one is worried

Over the last several months, many analysts and commentators have warned about the pending yield curve inversion in the United States, and why that suggests a US recession may arrive in the next year or so.

David Rosenberg, the chief Economist of Gluskin Sheff is amongst those making those noises, pointing not only to the yield curve, but topping formations in US equity markets (see chart below), emerging market debt to GDP levels which have skyrocketed post GFC, and a potential US corporate debt challenge, with close to USD $1 Trillion in debt coming due in 2020, 2021 and 2022, a near tripling from current levels.
 

Alarming as these statistics are, this week we came across a more “person on the street” indicator that we see as yet another warning sign for the US economy, which, in all fairness it has to be said has been performing far stronger than most commentators would have expected over the last year or two.

The chart below was posted in article in the Wall Street Journal on September 25th, and comes from a recent Gallup Poll. It shows the percentage of Americans who are stating that economic problems are amongst the most important challenges they and the nation faces.
 

As you can see, according to the chart, at present, very few Americans seem worried about the economy right now, a huge change from early 2009 when nearly 90% of Americans saw the state of the economy as the most important problem facing the nation.

Whilst this chart might seem like ‘good news’, its worth pointing out that the last two times so few Americans were worried about the economy was in late 2006/early 2007 (one wonders if Ben Bernanke and Hank Paulson were amongst those surveyed back then), right before the GFC struck.

Go back even further, and you can see that around the year 2000, very few Americans were worried about the economy, perhaps not surprising given the government was running surpluses, growth was strong and Wall Street (especially the NASDAQ) was flying.

Of course we all know that time period culminated in a huge stock market crash, and coincided with the beginning of the 10 year bull market in gold that saw prices rise from under USD $300oz to almost USD $2,000oz.

Another interesting observation regarding the US economy comes in the table below, which plots current readings across 30 or so economic indicators in the United States.

As you can see, most of the readings that are particularly strong right now are “soft” economic indicators, based on sentiment, rather than “hard” indicators, which are typically based on actual data.

None of this of course guarantees a US recession anytime soon, but the warning signs are there, and warrant close attention in the months ahead.

For more on this line of thinking, we’d suggest you read the latest short blog from one of our favourite commentators, Bill Bonner, titled “It Feels Like 2007 All Over Again”.

Zombies

Long time readers of ABC Bullion market updates will be aware that we have long warned of the unintended negative consequences of zero interest rate policies (ZIRP) and quantitative easing (QE).

One of those consequences has been the rise of so called “zombie” companies, which are defined as companies that are at least 10 years old, yet are unable to cover their debt service costs from profits, in other words the Interest Coverage Ratio (ICR) is less than 1x for at least 3 consecutive quarters.

Markets first started paying attention to zombies decades ago, when they first came to prominence in Japan, after the great bust they suffered, though zombies are now a global phenomenon and are prevalent in Europe and the United States.

According to the latest quarterly review from the Bank of International Settlements, which you can access here, the percentage of companies that qualify as zombies has hit an all time high, which can’t help but limit the future growth potential of the economy.
 
Furthermore, the prevalence of these companies is a major impediment to normalising rates around the developed work (notwithstanding the actions of the Fed over the last two or so years), as it is only ultra accommodative monetary policy that has allowed these companies to survive.

A final cause for concern is the relationship between these zombie companies and the banks that fund them. Obviously the loans that these zombie companies have are “assets” on the balance sheets of the banks who’ve provided them credit. Unwilling to call in their loans and/or write them off, there is clearly significant pressure on banks to roll over the debt they’ve provided to zombie firms, or find other means of accommodation.

The BIS themselves are pretty clear on the problems these companies represent, noting that; “zombies weigh on economic performance because they are less productive and because their presence lowers investment in and employment at more productive firms.”

This is yet more evidence that whilst ZIRP and QE stimulated short-term economic performance in the developed and developing world, the price for said stimulus will be paid in the years to come.

House Prices to Continue Falling

Before finishing this weeks market update, we wanted to share the following chart, which comes from this article in Business Insider.

As you can see, the chart, which was produced by Macquarie Bank, shows national dwelling price growth on an annualised monthly basis, using a range of property price indicators.

What is interesting is that not only are prices falling, but the pace of the falls appears set to accelerate, with Melbourne being the primary cause of this acceleration.

On an annualised monthly basis, property prices in our second most expensive city are now falling at more than 10% a year, something we haven’t seen since the worst of the GFC.

It is shaping up as a very unhappy Christmas for leveraged property investors, who are not only going backwards due to paltry yields their investments are generating, but now also seeing the value of their investments decline.

My view is that we are comfortably on track for a 15% decline minimum in Sydney and Melbourne, and anecdotally are seeing apartments near where we live in Rozelle (inner Western Sydney) being discounted by 5% plus in order to try tempt buyers out of the woodwork.

Over time, we expect to see this feed through to slower economic growth, slower employment growth, a deteriorating budget position, lower rates from the RBA, and a falling dollar.

Until next time,
Jordan Eliseo
Chief Economist
ABC Bullion

Disclaimer
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