What Backs a Dollar?

Precious Metals Commentary

This week saw a significant pullback in precious metals prices, with gold dropping 2.9% to USD$1,468 and silver dropping 5.5% to USD$17.10 per ounce, mainly on the back of thawing tensions between China and the US, with both agreeing to start reducing tariffs ‘in phases’. US stocks popped higher to new all-time highs once again, and it seems investor risk appetite is back on the table with the S&P 500 climbing to 3,085 in a buy everything frenzy, regardless of valuation.

With the Australian Dollar holding above 0.689 US cents we are trading a full $65 per ounce lower than last week for gold with silver $1.34 lower than last Friday. A very decent sized pullback for those waiting on lower prices to top up.

It makes sense for gold to see such a sharp pullback, as we have to be conscious of the fact that a large component of the rally up through USD$1,400-$1500 was due to fears of escalating trade wars impacting on US economic growth. From a monetary policy point of view, the longer trade wars went on, the more pressure there would have been on the Fed to lean towards an easing bias, which is of course bullish for gold. As tensions dry up and things get resolved, we see some of this coming back out of the froth in the gold price.

So a healthy pullback from the highs for now, and we still have support for gold in the low USD $1,460 range, so will be interesting to see how things hold up from here.

Once again our favourite longer term technical indicator has finally dipped into the buy zone and that is the Australian dollar gold price weekly chart Williams Oscillator. When timing top ups only do so when in the oversold zone at the -80 level as you tend to avoid the highs and average into medium terms lows. We usually only get a few spots a year when the weekly chart is oversold, and the last spot was April at $1,790 AUD. Theory goes, one can wait until the indicator moves back above from oversold levels to be safe but we prefer to dollar cost average into these zones.

You can see looking back over the years all of the oversold spot provided a good point to top up and we tend to mention this indicator in our market updates every time we reach this zone.

(*Look for the Wm% oscillator at the bottom on the chart when it is below the -80 line to signal oversold)

Sound Money

We were both amused and concerned with the results of a survey performed by a crypto mining firm asking Americans “what is the US dollar backed by?”

Amused that nearly one third of people thought money was still gold backed, and at the 7% of cynics who said “nothing”. It is worth noting that even under a gold standard, money was not 100% backed by gold.

It is concerning, however, that the survey shows few understand money at all, including the surveying firm themselves, as they say that “the US Government” is the correct answer.

The fact is that the majority of money these days is created by banks, not the government, and that money is therefore mostly backed by the loans banks hold. To the extent that these loans are sound and the borrowers work to repay them, then a country’s money can be considered “sound”.

How sound are the assets of the banks is the question of course.

In simplistic terms, the price of gold can be considered as a measure, or vote, by the population as to how confident they are in the banking system, as gold is still the go-to asset if one is concerned about a financial crisis.

One other interesting result from the survey was that while 30% of respondents said they hardly ever used cash, 76% of people opposed the idea of replacing paper banknotes with digital-only money.

It would seem people are well aware of the dangers of going totally digital, both from a privacy point of view as well as computer system failures.

Economy Splutters

An interesting statistic came across our Twitter feed this week: monthly new car sales have declined year-on-year for 19 months as of October, according to the Federal Chamber of Automotive Industries (FCAI).

We pulled the figures from the ABS and FCAI to create the chart below and it is clear that car sales have hardly recovered since the financial crisis.

Sales have pretty much stalled since 2012 as indicated by the purple arrow. More concerning is the turn down indicated by the red arrow, which started in early 2017, approaching a 20% drop.

The FCAI noted that sales were down across all buyer types – private, business and government. An October fall of 11% in light commercial vehicle sales (a sign tradies are doing it tough) and 18% in heavy commercial vehicles is not encouraging.

Tradies are probably aware of the continuing fall in new residential building approvals and the resulting weak residential construction activity, as noted by Chris Watling of Longview Economics.

Chris expects further softness in housing, after what he says recently has been just a “relief rally” and that “once housing weakness resumes, then Aussie rates seem destined to reach their effective lower bound with QE likely to follow”.

The bad news continues with the Sydney Morning Herald reporting that retail sales have flatlined, falling 0.1% in September an 0.2% down on the year.

Those figures are worst annual result since Australia's last recession and doubly concerning given the RBA’s interest rate cuts, which were supposed to add $3 billion a month to household disposable incomes, and the $7.2 billion of tax cuts.

Someone who isn’t concerned is AMP Capital’s Shane Oliver, who says he “not so fussed about the global outlook”. While he acknowledges that:

• global debt is at record levels relative to GDP;

• quantitative easing and negative interest rates haven’t worked;

• negative interest rate debt is causing distortions in valuing assets and risking asset bubbles;

• rising inequality driving populist backlash; and

• geopolitical tensions as we move from a “unipolar world” to a “multipolar world”;

He gives several reasons why he thinks the global economic cycle will turn up next year. We are not convinced and below we address those reasons we particularly disagree with.

“the key is to compare debt against assets and here the numbers are not so scary because debt and assets tend to rise together”

This statement ignores what we mentioned earlier, which is what is the quality of those assets? As banks create money when people borrow, and people buy assets with that borrowed money, banks need to be careful that they aren’t fuelling bubblish behaviour. With home prices above 10 times incomes (compared to historical ratios of 3 times), we think it isn’t unreasonable to be concerned about asset values.

“debt interest burdens are low thanks to low interest rates”

This does get closer to what really matters, which is ability to service (and repay principal, as quaint as that may be in these days of interest only loans). Sure, interest burdens are low, but what happens when rates rise?

“positive valuation boost to assets like shares and property that low inflation and low interest rates provides”

With rates at historical lows, isn’t that boost all done for? And isn’t the other side of the coin a negative valuation bust as rates rise?

“all of the rise in debt in developed countries since the GFC has come from public debt and the risk of default here is very low because governments can tax and print money”

We don’t know about you, but we aren’t comforted by knowing the government won’t default by increasing our tax rates and taxing us indirectly via inflationary money printing. It is a fact that you won’t default if you can take money from someone else to pay back your debt, but it is hardly fair.

“inflation does start to rise quantitative easing can be reversed gradually by central banks”

When things go bad, they often go bad quickly, so we are sceptical central banks will have time to leisurely reverse QE to nip inflation in the bud. We don’t seem to remember much calmness and gradualness going on around the global financial crisis ten years ago.

Inflation is Regressive

Talking of inflation, a study we came across this week found that the inflation rate for low-income families is higher that the rate high-income families experience.

The London School of Economics found that the prices of the products purchased by the bottom 20% increased faster than the prices purchased by the top 20%, with low-income families having an inflation rate at least 0.44% higher.

While that may not seem like much, that difference compounds over time, increasing the rich-poor gap.

Jim Bruce, director of a documentary on the Federal Reserve, summed it up by asking if there was a “policy more regressive than the Fed radically intervening in financial markets for 10 years to create a wealth effect (which provides a firehose of $ to top 1% and a slow drip to bottom 50%) in hopes of raising inflation (which hurts poor the most)?”

Penniless at 100

Newsletter writer and advisor Marcus Padley had an article out this week talking about how negative after inflation returns mean that retirees will have to give up on the idea of living off the income from their investments and will need to spend down their capital, likely leaving nothing for their children.

He calls it the “Penniless at 100” plan. It is hard to disagree that this appears to be the unfortunate reality for most savers at this time.

However, it seems Marcus thinks that this as a good thing, as he talks of “ingrate children are going to have to make their own money” and a story about his next-door neighbours who lived in abject poverty but whose “wealthy daughter pocketed $999,000” when their home was sold after their death.

We don’t think there is anything wrong with wanting to leave something to the kids. The only way society progresses is if people create and pass on wealth rather than “eating their seed corn”.

Spending down one’s capital is the same as early pioneers who cleared land, established homes, reared animals and planted crops, then in their retirement ate all their animals and crops and burned their homes bit by bit to warm themselves as they lived out their last days in a tent, and told their ingrate children they can go build their own farm, from scratch.

It is nonsense and a backward step, but is what low/negative interest rates are effectively forcing people to do.

As we said at the beginning of this update, gold is your way to vote on, and exit from, such monetary system until common sense re-establishes itself.

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.

Disclaimer
This publication is for educational purposes only and should not be considered either general or personal advice. It does not consider any particular person’s investment objectives, financial situation or needs. Accordingly, no recommendation (expressed or implied) or other information contained in this report should be acted upon without the appropriateness of that information having regard to those factors. You should assess whether or not the information contained herein is appropriate to your individual financial circumstances and goals before making an investment decision, or seek the help the of a licensed financial adviser. Performance is historical, performance may vary, and past performance is not necessarily indicative of future performance. Any prices, quotes, or statistics included have been obtained from sources deemed to be reliable, but we do not guarantee their accuracy or completeness.