Commodities | Mar 04 2020
by Richard (Rick) Mills
Ahead of the Herd
As a general rule, the most successful man in life is the man who has the best information.
Gold has immunity, silver has ratio
On Monday Wall Street pared back losses from last week’s sell-off, the worst since 2008, but it was only the promise of lowering interest rates, the return of the “punch bowl” hearkening back to recession-era stimulus, that has temporarily ameliorated coronavirus fears and its growing threat to the global economy.
Arguably, more economic dangers than can be solved by a simple rate cut lie ahead, and gold is reacting as normal, in times of financial turmoil, by going up.
The precious metal recovered from Friday’s drubbing when it lost about $87, by climbing to within shouting distance of [US]$1,600/oz. At the close of trading in New York spot gold was at $1,589.10 and Comex gold futures were pushing $28 higher than Friday’s close, to $1,594.80. The spot price continued to rise on the 24-hour chart and was at $1,598.30, as of this writing. [$1640/oz at time of publication.]
On Friday as stocks were falling, US Federal Reserve Chair Jerome Powell tried to quiet the market by saying the Fed is ready to act if conditions warrant. His comments were widely interpreted to mean another reduction in interest rates from the current range of 1.5% to 1.75%. Other heads of central banks made similar comments, setting up the stock market rally that came Monday.
[Tuesday brought and emergency -50 point cut.]
Despite poor global and US economic data, including a weaker-than-expected reading in the ISM manufacturing index and a record-low reading in China’s purchasing managers index (PMI) equities “closed up strongly on the hope that fiscal and monetary stimulus is on the way,” said Kathy Lien, managing director of FX strategy at BK Asset Management, in a note quoted by Marketwatch.
Market fear around the coronavirus has sunk the yield on the 10-year Treasury bond to new lows, as investors flock to the safety of Treasuries (and gold), raising their prices, causing yields to plummet. On Friday the yield on the benchmark 10-year note dropped to a record 1.16%. Following news over the weekend of China’s PMI manufacturing data sinking to 35.7 (the services PMI was even worse at 28.9), against expectations of 45, the 10-year on Monday slumped to a new record of 1.13%. (PMIs under 50 represent an economic contraction).
[Tuesday down to 0.90% before rebounding to 1.01%.]
As of Monday the coronavirus has afflicted 80,000 people in China and caused almost 3,000 deaths. Outside China, there have been more than 7,000 cases in 60 countries, and over 100 have died from it. These numbers are very out of whack, looks like if you get it in China you have much less chance of dying then if you get sick outside China. Hard for me to believe that.
As it continues to spread, some medical experts say the containment phase has passed and that Covid-19 is inevitable. That would mean living with the respiratory virus in our communities, much like the flu and managing its potentially fatal diagnosis.
“This is spreading throughout the world and it will continue to spread throughout the world,” Isaac Bogoch, an infectious disease physician at Toronto General Hospital, told CBC.
Amesh Adalja, an infectious disease physician and a senior scholar at the Johns Hopkins Center for Health Security, said, “It’s not something that we can prevent from happening in the absence of a vaccine. It’s not containable in the way that those viruses were. So this will become endemic.” He added:
“This is going to become like some of the other coronaviruses that we have. There are four of them that cause disease every year. This is likely to become the fifth coronavirus at that capacity.”
Meanwhile the economic fallout from Covid-19 continues to worsen. The OECD issued a report saying that the coronavirus outbreak could ding global economic growth by half a percentage point, putting it at 2.4%, in a best-case scenario.
PMIs not only in China have been seriously whacked due to the virus’ impact on supply chains. According to Zero Hedge the global manufacturing sector has suffered its steepest contraction since 2009. Out of 31 nations for which data was available, 15 saw their output contract. They include China, Japan, Germany, France, Italy, South Korea and Australia.
So far we have mostly seen the effects of the virus on the supply side, such as Apple warning its earnings will be down because of disruptions in China, but we are also starting to see demand destruction.
Goldman Sachs says the world is facing the biggest commodity demand shock since the financial crisis, as the outbreak and its effects spread from Asia and the Middle East to Europe and the United States.
The bank’s head of global commodities research, Jeff Currie, notes that disruptions to demand for oil and other energy products will likely be unrecoverable, whereas for other commodities like steel and aluminum they could just be deferred.
On the other hand, gold has “immunity to the virus” and has outperformed other safe-haven assets like the Japanese yen or Swiss franc, said Goldman, via Bloomberg.
In a Feb. 28 report, Currie said China has lost an estimated 4 million barrels a day of oil demand, compared to 5 Mbod in 2008-09, and that 45% of container vessel sailings from Europe to Asia were canceled in the four weeks following Chinese New Year.
On Monday Oxford Economics downgraded China’s annual growth projections this year to 4.8% – the worst in decades.
Some economists think the coronavirus is so dangerous, it could cause the next recession. However, Harvard economic prof Kenneth Rogoff, writing for Project Syndicate, says unlike the two previous global recessions this century, the new coronavirus, COVID-19, implies a supply shock as well as a demand shock:
[W]hen tens of millions of people can’t go to work (either because of a lockdown or out of fear), global value chains break down, borders are blocked, and world trade shrinks because countries distrust of one another’s health statistics, the supply side suffers at least as much.
Rogoff thinks the effects of this will cause massive deficit spending to shore up health systems and prop up economies, which will push up inflation. Price increases will be exacerbated by supply pressures – akin to the gasoline shortages of the 1970s – and a sustained retreat behind national borders, owing to a COVID-19 pandemic (or even lasting fear of pandemic), on top of rising trade frictions, is a recipe for the return of upward price pressures. In this scenario, rising inflation could prop up interest rates and challenge both monetary and fiscal policymakers.
US economy sickens
Reading between the lines, Rogoff is clearly talking here about the United States. The trade war between the US and China has already hit global growth (which in 2019 was only 2.9%), and now comes along a pandemic – what once seemed like a 15% chance of a recession starting before the presidential and congressional elections in November now seems much higher, he writes.
Wouldn’t that be ironic for Donald Trump? He’s been bragging since he took office about how he alone is responsible for making the US economy great again, principally by trade warring with China. The coronavirus which starts in China causes a pandemic that takes down the US economy, and with it, Trump’s re-election chances. Karma’s a bitch.
We are seeing the predictable politicization of the coronavirus become especially virulent, no pun intended, during this election year.
There is growing speculation as to what could happen if the US enters recession before November and blame is laid at the feet of Trump, for failing to prepare for and handle the pandemic. Could Trump lose the election to Bernie Sanders who is proposing a radical medical system overhaul?
A charge from Democrats that Trump proposed budget cuts to the Centers for Disease Control and Prevention was denied by administration officials. However according to [US] ABC News, the president did propose in his 2021 budget, 10 days after the WHO declared coronavirus a public health emergency, a 16% reduction in CDC funding. ABC News adds:
In fact, all of Trump’s budget proposals have called for cuts to CDC funding, but Congress has intervened each time by passing spending bills with year-over-year increases for the CDC that Trump then signed into law.
Republican attacks on Democrats re Covid-19 have been beyond the pale. Witness Donald Trump Junior appearing on Fox News saying “For them to try to take a pandemic and seemingly hope that it comes here and kills millions of people so that they could end Donald Trump’s streak of winning is a new level of sickness.”
Not a word was uttered by Trump in response. No stern rebuke to Don Jr. for comparing Democrats to Pol Pot, Hitler or other architects of genocide. At a rally on Friday Trump accused Democrats of politicizing the coronavirus, calling it “their new hoax” after the Russian investigation and impeachment. Quoted in The Guardian, Trump said,
“We are doing everything in our power to keep the infection and those carrying the infection from entering the country. We have no choice,” Trump said at the Coliseum and Performing Arts Center. “Whether it’s the virus that we’re talking about, or the many other public health threats, the Democrat policy of open borders is a direct threat to the health and wellbeing of all Americans.”
As coronavirus fears bite and the fallout drifts to the US (where six people have died so far), the US dollar index has fallen from 99.86 on Feb. 20 to the current 97.43. [97.19]
According to ISM data from January and February, the US gauge of supplier deliveries rose to the highest since 2018, indicating supply disruptions from Covid-19. The imports index fell the most since 2009, and new order growth slowed to 9-month lows. Here’s Chris Williamson, chief business economist at IHS Markit, for his take on the alarming figures:
“Manufacturing production and order book trends deteriorated markedly in February as producers struggled against the double headwinds of falling export sales and supply chain delays, both in turn often linked to the coronavirus outbreak.
While trade war fears have eased, helping push firms’ expectations for future growth to the highest since last April, coronavirus-related supply chain issues threaten to constrain production in coming months. At the same time, companies have become increasingly concerned that the COVID-19 outbreak will also hit demand, which is reportedly already cooling amid uncertainly leading up to the presidential election. Recent stock market volatility could also further dampen consumer spending and deter business investment.”
On Sunday Goldman Sachs projected GDP growth of just 0.9% in the first quarter and zero growth in Q2 – the worst six-month window since the Great Recession, US News reported.
Although the country is likely to narrowly avoid recession, “the situation has proven worse than we expected” and that “the downside risks have clearly grown,” according to the investment bank’s baseline scenario.
Plunging yields à rate cuts
Is there a remedy, a means of diverting course from what looks to be the Titanic global economy about to run headlong into a massive iceberg? All eyes are on the Federal Reserve for what should by now be a familiar solution to economic troubles: cut rates. [Which it has.]
Goldman expects the Fed to cut interest rates four times between now and the end of the second quarter, maybe even before the March 17-18 meeting of the Federal Open Market Committee (FOMC). [It did.] The influential bank justifies gloomy outlook on global growth for 2020 slowing from 3% to around 2%.
Remember, when growth in other countries falters, even though the US is doing fairly well, for now, as the world’s biggest economy, any slowdown affects American suppliers, big time.
The upshot will likely be a 50-basis-point rate cut by March 18 [done], followed by another 50 bp in the second quarter, for a total of 100 bp in the first half, Which means that the US Fed Funds rate will be just above zero as the US enters the second half, and has a high chance of tipping negative around the time of the election notes Zero Hedge with barely-disguised glee.
The CME Group’s FedWatch tool also suggests there is virtually a 100% chance that the central bank will launch a 50-point interest rate cut by mid-March.
There may even be coordinated monetary easing for the first time since the financial crisis, with the central banks of Canada, the UK, Australia, New Zealand, Norway, India, South Korea, the EU and Switzerland all acting in concert to slash rates to get economic growth moving again, Goldman forecasts.
On Monday Trump weighed in on the rate cuts, blaming Fed Chair Jerome Powell for being too slow to react (ie. to lower rates) and arguing that the central bank has put the US at a disadvantage during the outbreak. The Fed cut rates three times in 2019 as a reaction to slowing global growth and concerns over not high enough inflation. That was before the coronavirus.
Paper vs physical gold
Getting back to gold, the takedown on the gold price we saw last Friday may be puzzling to some, considering that gold normally does extremely well during stock market corrections. Roland Manley over at Bullion Star gives a comprehensive account of what happened and why. Without getting into the minutia, we can say that gold’s price movement is currently more driven by the “paper” markets ie. gold ETFs and gold futures, than by the “physical” markets ie. gold bars/ coins and gold jewelry.
Indeed Manley points out that there is a disconnect between the paper and the physical gold markets, evidenced by the fact that gold went down last week in the face of unprecedented demand for the physical metal, according to Bullion Star.
It’s also interesting to note, as Bloomberg does, that Over the last few weeks, gold buyers [gold shops that buy used jewelry] have seen a frantic push by individuals racing to sell their little-used jewelry in the U.S. and Europe amid worries that the extraordinary price rally fueled by the coronavirus since the start of the year may soon run its course.
We know that gold scrap accounts for about 30% of global supply. We also know that mined gold in 2019 was basically flat. The world’s mines cannot meet the current demand for gold without recycling jewelry. With scrap gold supply rising by an estimated 2.5%, due to jewelry owners “cleaning out their safes” to capitalize on high prices, will it offset the amount of physical gold buying?
It’s hard to say but according to Manley’s analysis, the gold price fall last Friday was not connected to the physical gold market.
Gold-silver ratio soars
It’s also interesting to look at how gold and silver are doing in relation to each other, during periods of safe-haven demand.
We can use the gold-silver ratio to find out how silver prices compare to gold, since the precious metals have roughly the same amount of above-ground supply – 6.1 billion ounces, and around the same level of 0.999 fine bullion used for investments – 2.5Boz.
The gold-silver ratio is the amount of silver one can buy with an ounce of gold. Simply divide the current gold price by the price of silver, to find the ratio.
On June 12, 2019, the gold-silver ratio hit a 26-year high by breaking through the 90-ounce mark – meaning it took over 90 ounces of silver to purchase one ounce of gold. The higher the number, the more undervalued is silver or, to put it another way, the farther gold is pulling away from silver, valued in dollars per ounce.
For the past several weeks the gold-silver ratio has stayed around 86-88:1. Since the coronavirus outbreak though, the gold-silver ratio has rocketed to a new record of 95:1.
This is so far out of whack from the historical ratio of 54:1, that silver is on sale.
The question precious metals investors need to ask themselves is, with the world having become a much more dangerous place with the coronavirus spreading and all the other hot spots, like Syria, North Korea, etc., still in play, will gold move down to adjust to a more normal ratio, or will silver prices head up?
Silver is expected to do well this year through a combination of higher industrial and investment demand, and tightened supply owing to mine production issues and output cuts.
At this point we see every reason to believe that the trade deal is on hold – with supply chains so messed up it may not be long before US-China trade grinds to a complete halt, the border to China shut – global growth is falling, the US dollar is tanking, bond yields are dropping (when yields go below 2% it’s time to buy gold because the real yield interest rates minus inflation is 0%), and interest rates are going to be further cut, meaning this an extremely bullish time for gold.
The gold-silver ratio keeps going up and it’s only a matter of time before silver corrects, because imho, gold is going higher.
Northern Syria hot zone
We all know that gold is the world’s oldest safe haven and investors move their investments into bullion when they no longer trust equities and bonds. The coronavirus is certainly driving most of the safe-haven gold demand these days but we can’t forget geopolitics.
Buried in the headlines over the election and the coronavirus is a hot war breaking out between Syria and Turkey in northern Syria. Last week, The National Post reported Turkey has deployed “swarms of killer drones” to strike Russian-backed Syrian government forces, in retaliation for the killing of 33 Turkish soldiers. Remember Turkey is a NATO ally and any attack on one NATO member is considered an attack on all its members:
The tactic threatens to bring NATO member Turkey into direct confrontation with Russia, adding to strains in relations between Erdogan and Russian President Vladimir Putin as they prepare to meet this week in an effort to ease tensions over Syria. The two leaders have worked together to try to end the Syrian civil war, despite backing opposing sides, but have repeatedly stumbled over who should control the northwestern Syrian province of Idlib that borders Turkey.
Russia dominates the skies over Syria as part of Putin’s military support of Syrian leader Bashar al-Assad, deploying advanced S-400 missile-defence systems to secure the air space while its warplanes aid Syrian forces battling to take the last rebel stronghold in Idlib. Turkish forces back the rebels and Ankara says it fears a fresh exodus of refugees flocking into Turkey if Idlib falls to Assad.
Erdogan is reportedly urging US and NATO to halt the Syrian-Russian offensive in Idlib. On Friday the USS Dwight D. Eisenhower, a carrier strike group, crossed the Strait of Gibraltar and entered the Mediterranean, accompanied by multiple support ships. The US Navy says the presence of the USS “Ike” is for “conducting operations in the US 6th Fleet to support maritime security operations in international waters, alongside our allies and partners” but the timing is certainly suspicious.
Could the Trump administration’s decision to pull troops from northern Syria have anything to do with this latest conflagration that threatens to engulf a NATO ally?
Australian summers lengthening
We know we can’t draw a direct line between gold prices and climate change but we find it of interest to note right now, amidst all the other safe haven demand for gold, a headline regarding Australian summers heating up.
Data released Monday by the Australia Institute, a think tank, shows summers Down Under over the past five years are, on average, 50% longer than they were in the mid-20th century.
“Our findings are not a projection of what we may see in the future,” said Richie Merzian, climate and energy program director at the Australia Institute. “It’s happening right now.”
The finding is especially potent, considering Australia just experienced a devastating bushfire season that burned nearly 12 million hectares, killing 33 people and an estimated 1 billion animals native to Australia, Reuters said.
We know from our research that a key aspect of global warming is that when the planet warms, dry areas get dryer, summers become longer and winters shorter. That may seem like good news to those in the northern hemisphere but it can only means more bad news for drought-stricken areas amid the global fresh water crisis we have written on extensively.
I said it recently but I’ll say it again. We are moving closer to gold's Minsky Moment. Things are happening to cause instability in the global economy, including a worsening coronavirus, a slowdown in manufacturing, a denting of the largest economies, and a shooting war in Syria that threatens to involve NATO members.
We know that the US stock market is a bubble and all bubbles pop. The volatility over the past few days may not be a pop but it’s definitely a correction.
We also know that much has been done by the Trump administration to fray existing alliances and to inflame tensions with trading partners-turned-adversaries, namely China, the European Union and even its two NAFTA “amigos”, Canada and Mexico.
China, Russia, Turkey and others, are already moving away from pricing trade in US dollars and buying US debt through Treasury purchases. Central banks have been stocking up on gold.
Will the rest of the world follow and punt the US$ as the world’s reserve currency? Long-term, we at AOTH think so. Short-term, we see everything that is happening right now to be very good for gold and silver.
Consider: the dollar is falling and bond yields have hit the skids. 2% is the number that sways investors into bullion from other asset classes because the net yield is close to zero or negative. Well, the 10-year Treasury has fallen to 1.1%, so with inflation running at 2.5% we are clearly in negative territory. Why buy a negative-yielding T-bill when you can buy gold that last year gained 18%?
Interest rates are already low but are going lower; expect at least two rate cuts in the next two weeks, maybe four by the end of the second quarter, if Goldman Sachs is correct. Gold being a non-yielding asset, low rates are always good for bullion.
Donald Trump has throughout his presidential term rallied for a weak dollar and low interest rates to fix the trade deficit. He’s personally taken credit for the booming stock market, which is mostly due to stock buybacks, enabling record insider selling. Remember share repurchases artificially inflate earnings per share. They benefit management at the expense of company growth and ultimately, shareholders.
Trump appears to be getting his low dollar but he’s also going to get a stock market crash. Why? Because we know the coronavirus is hurting supply chains, it’s killing global growth, and its effects are being felt in the US, reflected in weak manufacturing data and the lower dollar. As US corporate earnings drop, so will share prices, and most importantly, there won’t be extra cash for stock buybacks. Without buybacks there is nothing to prop up the stock market. Poof.
How about bonds? At yields above 2%, investors have been piling into US Treasuries as a safe haven amid coronavirus fears and other geopolitical tensions. They are attractive in comparison to the trillions of negative-yielding sovereign debt sloshing around. But with a number of interest rate cuts predicted, bonds are starting to look like a poor investment. If foreign investors slow or stop buying US Treasuries, as Russia has done and China did last May, the United States is in real trouble. Without purchasers of US debt (Treasuries) the US has no way of financing its annual deficits and $23 trillion pile of debt, without printing money. Printing money on a large scale causes hyperinflation.
A worsening US economy will turn investors away from bonds and Treasuries. The dollar will fall and commodities will rise, including gold and silver, pushed higher by investment demand for ETFs and physical metal.
Which is the better buy, gold or silver? The gold-silver ratio is currently at 95 and rising as both silver and gold keep climbing on virus fears. However the ratio is far higher than its historical average of 50-60:1, meaning either gold must fall or silver must rise. Gold’s going higher, imo a lot higher, but I’ve still got my money on a 2020 run on silver.
Richard (Rick) Mills
Richard is the owner of Aheadoftheherd.com and invests in the junior resource/bio-tech sectors. His articles have been published on over 400 websites, including:
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