Precious Metals Quarterly

Transcription

1 Special report for Strategic Wealth Preservation and its clients. The Next Bull Markets In Precious Metals Read more, visit: 26 January 2018 CPM Group expects the prices for gold, silver, platinum, palladium, and rhodium to rise sharply, in ways similar to upward spikes seen in and again from 2007 into 2011, at some point. We do not expect these spikes to occur in In fact, unfortunately for investors seeking immediate capital appreciation, CPM sees prices as most likely moving sideways to slightly higher for most of these metals this year. However, at some points in the next five to ten years, prices seem likely to spike sharply higher once again for all of these metals. The price spikes will be caused by different developments. For gold and silver, some combination of gathering economic, financial system, and political issues seems most likely to lead to the next bull market. After all, such potent mixtures of external events were behind the past bull market spikes to sharply higher prices, in the 1960s, at the end of the 1970s, and again a decade ago. For the platinum group metals, it seems more likely that further significant declines in South African PGM mine production while the auto industry is still producing almost exclusively (more than 90%) petroleum-based vehicles will lead to the next bull market. CPM Group has been writing for a few years now that it considered the gold and silver markets to have reached cyclical bottoms in prices in late 2015 or early 2016, and that these markets were in the early stages of what should be expected to be multi-year bull markets. Further, CPM has stated several times that it expected gold and silver prices to rise sharply at some point over the next three to 10 years, with the potential for gold to reach record levels surpassing those seen in 2011 and CPM has been expecting gold and silver prices to reach new record levels in the period for a few years. Updating our supply and demand fundamentals, along with our view that economic and political conditions will spur even greater investment demand for gold and silver in the next seven years than we earlier had expected, we have increased our targets as to how high gold prices might go in the next bull market. already one-fifth lower than it was a decade ago, is likely to fall further over the next decade in advance of any major decline in PGM use in auto catalysts, leading to tighter supplies and consequently higher prices. Triggers CPM Group s long-term price projections are predicated on a mix of trends in each commodity s fundamentals with a macro-economic view of the economic, financial, and political environment that affects and determines those trends in supply, demand, investment demand, inventories, and other market segments. Our present view of the global economy and consequently commodities markets and prices has imbedded in it the view that there could be a short, shallow recession perhaps limited to the United States in late 2018 or 2019, followed by an anemic recovery in economic activity for a few years, with a much more significant global financial crisis and economic downturn possibly emerging around Timing recessions and financial crisis is more art than science, although there are a number of economic and econometric tools that help time issues visible on the horizon. As a result of these economic projections, our expectations are that gold and silver prices could rise sharply at some point in the coming decade, when a number of economic, financial, and political constraints combine to lead investors to move more forcefully into these precious metals, at least for a year or two. We note that investment demand for gold and silver already is at historically high levels, although down from the levels that took gold and silver prices to record levels in We do not see current levels of investment demand and prices as peaks, however. Rather, they are viewed as the new bases from which both investment demand and prices will rise further the next time the economic and political environment inspires investors to rush even more dramatically back to gold and silver. Similarly, our expectations of higher PGM prices for at least a time in the coming decade is predicated on a detailed analysis that suggests South African PGM output, Contact Strategic Wealth Preservation - Cayman Islands: info@swpcayman.com / Telephone (345) /

2 26 January 2018 Page 2 What Will Happen Given such strong projections, it behooves CPM to explain what we think may cause the next period of increased, out-sized investor buying of gold and silver. Historians write about the causes and occasions for events to unfold. There can be many causes, but some event or set of events serve as the occasion that triggers the larger event to occur. This paper focuses on the potential catalysts for the next round of sharply increased investment demand and prices. It seems most likely that it will be some combination of financial and economic events. There may be one development that serves as the trigger or occasion of the change, but it is likely to be the culmination of many financial and economic trends that lead up to both that causative event s occurrence and the subsequent effects across markets: Gold, silver, stocks, bonds, and other financial assets. We cannot foresee the specific mix of events that leads to a reversal of the present focus on stocks and relatively stable although high levels of investment demand for gold and silver. However, we are pretty sure that much of the bases for the inevitable spike in investment demand and prices for gold and silver will rest in the debt market. The debt markets public, private, corporate, and personal, nationally and globally have not improved since the Global Financial Crisis. They have gotten more problematic. Where in the wide world of debt the cracks first appear is a key question, one the answer to which no one knows. As discussed below, most likely the cracks will appear in smaller, less protected financial arenas. There are nonetheless certain hot spots in financial markets that are likely to participate in the next spasm of financial market credit constraints that consequently would lead to a major round of economic problems and a rush to gold and silver. These include the following. They may be divided into two subsets. The first are the longer term, structural problems facing the world. The second are the smaller problems, which actually are more likely to join in some combination to serve as the occasion or trigger for the next round of financial panic. Structural Issues Persistent government deficits, Ever expanding sovereign debt, The squeezing out of debt markets of more productive private sector borrowing by this sovereign debt, Probable negative consequences from the Fed s policies of raising interest rates and shrinking its balance sheet, which will constrain private sector borrowing further, Mounting private sector debt, Long-term unemployment and labor market surpluses, Inability to grow consumer demand sufficient to keep pace with production of consumer goods and services, The mismatch between pension fund returns since 2008 and their long-term obligations, which are leading to pension funds taking greater risks in order to try to regain some capital. And more Commodities Research and Consulting, Asset Management, and Investment Banking CPM Group, founded in 1986, is an authoritative commodities research and consulting company. It is independent of all producers, processors, financial institutions, and other companies having commercial positions in commodities. CPM Group has extensive experience in commodities research, trading, and finance, equipping the company to provide financial advice and consulting grounded in hands-on experience. research@cpmgroup.com Telephone

3 26 January 2018 Page 3 Possible Occasions Issues such as the hidden illiquidity inherent in the growing open interest of exchange traded products relative to the underlying assets market sizes, The disappearance of market makers, specialists, and other braking mechanisms from global financial markets, Program trading, Weakness in housing markets, in the United States, China, Europe, and other countries and regions, The perhaps unintended consequences of tax and regulatory changes, And the inevitable unforeseen events. It may seem odd to write about the next financial crisis at this time. In early 2018 volatility in the stock market, bond market, gold, silver, oil, currencies, and other markets are at or close to historical lows. In the financial markets, all seems unnaturally calm. It is natural in fact to worry at times like the present especially. The reality is that financial markets are grossly under-pricing risk, just as they did in the periods of and then At some point financial market volatility is likely to increase sharply, dramatically, and suddenly. That would be translated into a very sharp drop in stock prices, a sharp drop in bond prices, and a sharp rise in gold and silver prices. We are not writing about a 15% - 20% decline in stocks. In 2001 and the , the S&P 500 was virtually cut in half, while some other market indices such as Nasdaq declined much more. Persistent Government Deficits and Mounting Sovereign Debt Underlying all of this is the politically intractable issue of government deficit spending and mounting debt. Governments around the world are locked in a crunch between politically delivered spending commitments that are not able to be financed except through ever-expanding debt. It must be pointed out here that these entitlements include defense spending as well as the more often discussed social support programs. In the United States, the most egregious example, the government and its associates have pursued a program for six decades to make defense spending a political and social deliverable. Another key point is to note that the intractability of these economic and financial problems is rooted in the political structure of governments, especially in advanced economies. From an economic and financial perspective, many of these structural issues could be resolved with surprising ease and lack of pain for the vast majority of citizens. It is the political system that blocks even the easiest, least painful economic policy solutions from being implemented. Unsustainable government spending is viewed by politicians and their supporting financial sources as necessary to maintain social order, in order for politicians to be reelected. It has several long-term negative consequences, however. For one, it leads to ever expanding sovereign debt. This is bad in its own right, but more negatively the rise in government borrowing squeezes out lending to the private sector. Private sector lending, to corporations and individuals, is more productive economically than is lending to governments. Private borrowers tend to use borrowed money to build, buy, and expand things, which adds to the overall economic growth of national economies. Government borrowing goes into infrastructure investment in an ever-decreasing volume and share, however. More and more government borrowing goes to payments of non-productive, unproductive, or less productive programs, reducing long-term growth rates. As a consequence of this spiral, which has not been addressed effectively by any of the advanced economies governments, persistent government deficits and mounting sovereign debt are major negative developments setting the stage for and underlying future financial crises. Government debt may be the major cause of such future crises, but it is unlikely to be the occasion that triggers such crises. Other Stress Points The occasions will occur somewhere else. To figure out what combination of such factors may serve as a collective trigger, one needs to consider carefully the secondary list of trends listed above, as well as to struggle with discerning other trends not so readily apparent. The Fed s policies of raising interest rates and reducing its balance sheet in order to prepare for the next recession and financial crisis, will play an important role in the coming drama. CPM has written it feels these policies are misguided for several years now. The very acts of Fed tightening could well precipitate or contribute heavily to the emergence of the next recession and financial crisis.

4 26 January 2018 Page 4 So, the Fed s policies are likely to be a factor. They most likely will not be the trigger, however, since they are so obvious and important that almost the entire world s financial sector is focused mightily on these. The occasion is more likely to appear in an overlooked corner of financial markets, just as the collateralized debt obligations built on shoddy U.S. mortgage industry practices served as the occasion in 2007 a part of financial markets that many participants were unaware even existed until it became a problem. In searching for overlooked corners of financial markets that have unsustainable structures, the departure of market makers, the rise of electronic, mechanical trading, and the mismatch in liquidity between ETFs and the underlying asset markets all pop to the front of consciousness. Indeed, the mismatch between ETF open interest and the volume of underlying assets is very similar to that which existed, and exists again, in the U.S. mortgage and housing market. Back in the period before 2007 there were economists and regulators who expressed concern over the enormous volume of CDO assets relative to the size of the underlying asset markets. Bankers continued deprecated such concerns, saying that such derivative volumes could be netted out, reducing the size of the imbalance to manageable ratios. The counter argument that such netting only worked if it was simultaneously was written off in the bankers testimonies as being an issue that only nonpractitioners found worrisome. In the final event, it was exactly the fact that netting is not simultaneous that started the GFC. Bad government responses, primarily by the U.S. Treasury, compounded that problem. All of this points to the idea that the next financial crisis and recession will begin in some esoteric, overlooked corner of the global debt market, or maybe several such corners. ETFs, taking an ever-growing proportion of investor funds, is a good candidate, as is the nature of electronic financial markets. The growing imbalance between the size of the ETF derivatives markets open interest or outstanding obligations, on the one hand, and the sharply less liquid markets for many of the underlying assets, poses enormous risks for the overall financial market. Just as the liquidity and credit crunch in the CDO market led to a freezing of global credit that caused a plunge in all asset values, a seemingly minor liquidity event in a series of ETF derivatives could trigger a similar global financial crisis in the future Year In Review Gold Gold prices continued to rise for the second consecutive year in Gold prices rose 14% by the end of 2017 from the end of 2016, on a Comex nearby active futures month settlement price basis. Gold s performance during 2017 was in line with CPM Group s expectations at the beginning of 2017 as can be seen in this quote from our January 2017 Precious Metals Advisory. The road ahead is likely to be bumpy. While prices are not expected to skyrocket during the year, they are expected to rise. Meanwhile, to cautiously use a term CPM normally derides, the downside seems fairly limited. The uncertainties and risks facing the global economy, financial markets, and political structures cannot be overemphasized. The strength in gold prices during 2017 added to CPM Group s conviction that gold prices bottomed out in December The rise in gold prices during 2017 was against several odds, making the increase in prices even more meaningful. Some of the headwinds that gold prices battled included a generally improving global economy, record levels in equity markets, and a normalization of U.S. monetary policy. Gold performed well given these conditions, with political factors underpinning prices. Silver Silver s price performance was relatively lackluster during 2017, with prices rising at half the pace of gold prices. Silver finished 2017 at $17.14, up from $15.98 at the end of On an annual average basis, silver prices fell slightly to $17.09 in 2017 from $17.14 in This is compared to a 9.3% increase in 2016 from the previous year. The lackluster performance of silver over the course of 2017 was in sharp contrast to that in the previous year when shorter-term trend-following investors, alongside longer-term investors, purchased the metal and drove prices sharply higher. Silver prices started 2017 on a strong note. The metal was unable to hold onto its gains, however, taking an especially hard beating toward the end of the year when institutional investors on the Comex build large short positions in the metal and drove prices down sharply. While gold was able to withstand a lot of the economic headwinds, silver, its more volatile cousin, saw prices respond more dramatically. While global political turmoil throughout 2017, prevented prices from declining signifi-

5 26 January 2018 Page 5 cantly below levels seen in 2016 the relatively healthy economic environment kept a lid on prices. Continued strength in the equities markets played a part in weighing on silver prices throughout Platinum Platinum moved in a relatively tight range during 2017, with prices capped by softer fabrication demand and sufficient South African mine supply. Over the course of 2017 institutional investors were mixed on Nymex platinum as they increased both their gross long positions and gross short positions in the metal. As a result the levels of gross longs and gross shorts were at historically high levels at the end of What is clear is that investors are more interested and active in platinum futures than they were in the past, and that this interest is manifested on trading both sides of the market. Meanwhile, investors were net buyers of platinum ETPs last year, helped by buying of two South African platinum ETPs NewPlat and AfricaPlatinum. Most key auto markets recorded strong growth in commercial vehicle sales during 2017, with the European market reporting robust growth during the January- November period. While less positive sentiment on the decline in diesel s market share in the European passenger vehicle market persisted, such a decline has been gradual to date. Nearly half of all new cars still run on diesel in Europe. In the fifteen European Union countries, diesel s market share fell from 52.1% to 49.9% between 2015 and One thing that could be overlooked is that hybrid vehicles and heavy duty diesel cars still use platinum, palladium, and rhodium auto catalysts, helping underpin demand from the auto sector. Palladium The price of palladium soared over the course of last year, up more than 55% to $1, at the end of 2017 from $ at the end of On an annual average basis, prices averaged $867.4 last year, an increase of 41.3% from an annual average of $614.0 in The palladium market has been in a multi-year surplus over the past decade, although this surplus is much smaller than that in the platinum market and is narrowing. From 2016 to 2017, the palladium market has tightened significantly due to a combination of lower mine output, soft scrap recovery and rising fabrication demand. The emergence of new investors, those who never had participated in the palladium market, on top of a tighter physical market added to the upward pressure on prices. As a result, palladium prices repeatedly hit multi-year highs and eventually traded at a premium to platinum prices for the first time in history. Over the course of 2017, institutional investors on the Nymex significantly increased their gross long positions in palladium, and when they did so, they also built up some fresh short positions in the metal, although the pace of their short building was much slower and milder than that in their long-building. At the end of 2017 institutional investors gross longs were at historically high levels while their gross shorts were at historically low levels, suggesting palladium prices will be vulnerable to massive liquidation and/or short building if there is a turnaround in investor sentiment in Investors remained net sellers for the full year of 2017 of their holdings in palladium ETPs, with a big part of the selling occurring in two South Africa-based palladium ETPs, Standard Bank palladium ETP and ABSA palladium ETP. The U.S. Mint began sales of palladium coins in September last year. Theoretically, the introduction of a palladium coin would help draw attention to palladium from investors new to this metal, and that a limited mintage could lead investors who are unable to secure U.S. Mint palladium coins to turn to other palladium coins and investment bars, further increasing investor demand for palladium. Nonetheless, a total of 15,000 ounces of palladium were sold in September only for 2017, suggesting tepid investment demand for palladium coins in a rising price environment. Demand indicators from the auto sector, the largest enduse market for palladium, were mixed during Auto sales in China continued to register strong year-on-year growth, while consumer purchases of automobiles in the United States declined after sales hit a record in Global semi-conductor sales, on the other hand, rebounded strongly last year after a decline in the previous year. Rhodium Rhodium prices more than doubled at the end of last year from the end of 2016, boosted by continued tightness in newly-refined rhodium supply relative to fabrication demand. Investors and dealers took note of the degree to which metal was not readily available from producers to meet the orders, encouraging them to hold on to their own stocks and wait for somewhat higher prices before selling more. On an annual average basis, rhodium prices averaged $1, last year, up 59.8% from an annual average of $ in 2016.

6 26 January 2018 Page The Year Ahead Gold As we head into 2018, CPM Group expects volatile global political developments, but economic and financial markets to continue to move steadily forward as they have through most of the past year. At some point economics and financial markets are expected to become more volatile, but it may be late 2018 or beyond before that happens. In such an environment gold prices are expected to tread sideways to slightly higher. Gold prices should be expected to move sideways to higher, providing an opportunity for investors to increase their gold holdings. CPM projects gold prices will rise about 2.3% to $1,288 on average in 2018, rising modestly during the year. CPM Group s expectations are for gold prices to rise at an accelerated pace during 2019 and to rise to new record annual average prices between 2021 and Gold prices are projected to rise over the next five to ten years based on a combination of economic, financial, and political factors stimulating increased investment, continued central bank buying, and a decline in mine production after The next twelve to eighteen months could provide the best opportunity to increase gold holdings in a portfolio before the market begins to rise at a strong pace. Silver Silver prices are forecast to average $17.75 in 2018, up 3.8% over While growth in silver prices are forecast to outpace growth in gold prices during 2018 the relative value of silver is expected to continue lagging that of gold. At the end of 2017, the gold to silver ratio stood at 77. This ratio is expected to decline over the course of 2018, to 72.6 on an annual average basis. This is still well above the historical average of 56, however. Given the forecast for higher gold prices in the medium term, the present relative discount of silver prices to gold suggests that there could be a significant upside potential for silver when prices begin to move. CPM Group does not expect this more aggressive move higher in silver prices to occur until at least Given the historic volatility of silver prices, silver prices should be and can be expected to rise sharply higher very quickly. A combination of this volatility, near 30% premium in the 2018 projected gold-silver ratio to the historical ratio, coupled with improving fundamentals are all factors that make silver a compelling investment at present levels. As in the case of gold, CPM Group believes that 2018 would provide a good buying opportunity for silver investors. Not only is the metal relatively undervalued, but there also are several fundamental reasons (supply and demand) coupled with lurking political and macroeconomic problems for investors to purchase silver at present levels. Investors are forecast to add million ounces of silver to their holdings on a net basis during Platinum Group Metals As discussed at the start of this report, CPM expects platinum and palladium prices to be relatively subdued during 2018, with the potential for a multi-year sharp spike higher in prices at some point over the coming decade. While gold and silver prices are seen as rising in a similar fashion in the long run due to investors pouring into these metals as alternative stores of value and hedges against a host of economic and financial issues that may come home to roost in the years ahead, PGM prices are expected to rise more on fundamental trends: Lower South African production in the next several years preceding any major decline in fabrication demand for these metals from the auto industry. Expectations of seasonal price strength in the precious metals complex should help support platinum and palladium at their present levels in the first quarter of Prices of the two metals are expected to continue to depart from each other for the rest of the year after moving in different directions in 2016 and 2017, reflecting different fabrication demand trends and varying investor interest in the two metals markets. Platinum Platinum prices are likely to move sideways with limited downside over the course of On the upside, prices may be capped by ongoing adverse fabrication demand trends, which have been in place for the past few years. It is worth noting that these less-positive trends are wellknown to platinum investors, and are priced into the metal market. On the downside, prices should be supported by an expected slowdown in mine supply growth starting 2018 and several years thereafter. In the meantime there could be occasions throughout 2018 when announcements of supply disruptions, whether they are coming from labor issues or production curtailment, and/ or financial stress from South African mining companies could help stimulate bouts of investor interest in the physical metal, pulling prices higher at any given time. In addition, spillover effects from the price movements of gold, possibly stemming from global political issues and

7 26 January 2018 Page 7 potential economic and financial uncertainty, also could push platinum prices higher at some point during On an annual average basis, platinum is forecast to average $960 this year, up 0.9% from an annual average of $952 last year. Optimism surrounding the prospect of electric vehicles (EVs), which do not use PGMs, intensified during 2017, which to some extent played a part in keeping platinum prices in a range over the course of last year. Such positive sentiment has its merit in that prices of lithium-ion batteries are declining and that advances in technologies are helping increase EVs driving ranges and reducing recharging times. However, what one may miss is that positive developments in areas including battery price, driving range, recharging time, battery size, and battery safety, have not reached to a point where EVs are becoming as economical and practical as cars with conventional engines that use gasoline or diesel. CPM Group thinks it GOLD remains to be seen whether battery EVs will become the go-to technology in the next decade or so. It could very well be the case, but then the transition from automobiles with conventional engines to EVs lies beyond the coming decade. Therefore, EVs are not an immediate and medium-term threat to uses of PGMs in automobiles. CPM Group s analysis also has suggested that a decline in diesel market share is a gradual process and is unlikely to result in a sharp drop in the use of platinum in auto catalysts in diesel cars in the next few years. The platinum market is far more likely to suffer from falling mine output before it suffers from sharp reductions in platinum use in auto emission catalysts. Platinum investors are presently factoring in the less bullish factor from the demand side, and are yet to begin to price in the supply-side slowdown that could occur in the medium term. Since South African platinum supply is likely to fall sharply before auto use declines on a long- SILVER $1,900 P $1,800 $1,700 $1,600 $1,500 $1,400 $1,300 $1,200 $1,100 $1,000 $900 Actual $800 $ $40 $36 Projections $32 $28 $24 $20 $16 $12 Actual $ PLATINUM PALLADIUM $1,900 P $1,800 $1,700 $1,600 $1,500 $1,400 $1,300 $1,200 $1,100 $1,000 Actual $900 $ P $1,150 $1,050 $950 $850 $750 $650 $550 $450 $350 $250 Actual $

8 26 January 2018 Page 8 term basis, the platinum market is likely to experience a period of several years of tight supply of newly refined metal relative to fabrication demand, which could push platinum prices sharply higher. Such a move may be a few years away, however. The price of platinum has limited downside from present levels, which should allow investors a good entry point to benefit from the healthier future supply and demand fundamentals in the metal s market. Palladium Palladium prices are expected to extend last year s strong performance in early 2018 as investors tend to build on an existing trend. Expectations of seasonal price strength in the precious metals complex in the first quarter also should help support palladium prices at elevated levels. However, an expected slowdown in the U.S. and Chinese auto markets, an increase in palladium secondary supply, and large investor inventory may weigh on prices later in the year. Palladium prices could come down from their elevated levels but should be expected to remain higher than 2017 levels on an annual average basis. The annual average palladium price is projected to be around $953 in 2018, representing a 9.9% increase from last year. On the upside, continued congestion on the Nymex palladium futures contracts should provide upward momentum to prices in the near term. Palladium prices may need some fresh bullish catalysts to rise significantly higher after having risen more than 55% at the end of 2017 from the end of When palladium prices begin to decline in a sustained way, possibly after the first quarter of 2018, investors could begin purchasing palladium coins, although such investor buying is expected to only offer some underlying support to prices instead of propping up prices significantly higher considering While palladium fabrication demand from the auto sector, the largest end-use of the metal, is likely to slow down in 2018, the total volume is forecast to be still high due to the sheer size of the U.S. and Chinese auto markets. This is expected to provide strong downside support to prices. Palladium may have more downside risks than upside momentum in the medium term. The main reason behind the price rally in palladium last year was that a group of new, trend-following investors that had never had exposure to palladium entered the market and bought the metal in a quick fashion on expectations of further price increases. This very group of investors could easily exit the market when palladium prices start to decline in a meaningful way and/or the tight conditions in the palladium market start to ease in a sustained fashion. Rhodium In the first quarter of 2018, decent demand from automobile and chemical sectors and continued tightness in the physical market are expected to help rhodium prices extend the strong performance last year. Seasonal price strength in the precious metals complex in the first quarter also may provide further positive cues to prices. Prices could come off later in the year, weighed down by a projected slowdown in two key auto markets, the United States and China. Investors, including those investing in rhodium ETPs, also may take profits on higher prices, temporarily pushing prices lower. That said, prices should be expected to remain higher than 2017 levels on an annual average basis, helped by tighter market conditions and ongoing positive investor sentiment toward palladium and rhodium. About Strategic Wealth Preservation (SWP) Strategic Wealth Preservation (SWP) is a fully-integrated precious metals dealer and secure storage provider specializing in the acquisition and secure storage of precious metals for individuals, companies, trusts and wealth management professionals on behalf of their clients. We offer global vaulting solutions in the Cayman Islands, Toronto, New York, Miami, London, Frankfurt, Zurich, Lichtenstein, Hong Kong, Singapore and Australia. We have partnered with major US wholesalers and mints to create highly liquid two-way markets for precious metals trading within our vaulting locations. We also hold the distinction of being an approved storage facility for precious metals held within self-directed Individual Retirement Accounts (IRAs) for American citizens and are the approved distributor of the Royal Mint of England and Perth Mint of Australia. Our website, is an excellent resource to learn more about our company s services.