Precious Metals Quarterly

Transcription

1 Precious Metals Quarterly Special report for Strategic Wealth Preservation and its clients. A Year For Accumulation CPM Group expects gold prices to consolidate over the course of the second and third quarters of 2018, with a higher probability of breaking out to the upside in the fourth quarter of this year and beyond. In the medium term gold prices are expected to move modestly but steadily higher in 2019 and beyond, eventually moving more quickly toward record levels at some point in the next five to 10 years. These price expectations are based on the reality that there are various global economic, financial, and political problems looming large on the horizon. It is not clear how far distant they are on the horizon, however. They could pose threats to global financial stability at any point: It could be five to seven years from now, as CPM currently expects, but in reality a new global financial crisis just as easily could erupt yet this year. What is clear is that there are massive unresolved issues that will need to be dealt with at some point. Equally clear is the fact that specific gold and silver supply and demand conditions are lining up to be supportive of sharply higher metals prices when these external factors cause investors to decide collectively that they should have more, not less, of their wealth in gold and silver. Given the uncertainties facing the world and the lack of clarity as to when this all unfolds, 2018 looks like an ideal year for investors to accumulate precious metals before prices begin trending higher. During 2017 investors were well aware of various political and financial market threats that could upend global Read more, visit: 12 April 2018 economic growth. Most of these were perceived to be on the distant horizon last year, however. Furthermore, with interest rates and inflation low, and equity markets steadily racking up ever higher new record levels with historically low volatility, investors felt secure putting off adding gold and silver to their portfolios for a time. Some investors had been building hedges against such potential problems but most had been focusing on the rising equity markets. Ultra low interest rates, ultra low volatility, and a generally healthy global economy made it easier to ignore the potential risks and threats to the global economy. As the markets progress through 2018 and into the years beyond this complacency and the environment that fostered it are more likely to change. Already investors were jolted early in 2018 with a sharp spike up in equity market volatility and some sharp downward moves in stock prices. The changing global monetary policy landscape coupled with the long-in-the-tooth growth cycle in the United States, Europe, China and other major economies suggest further financial instability going forward. With little fresh ammunition to bolster the U.S. markets further, the U.S. economy looks most at risk of recession. Give that the U.S. still accounts for around a quarter of global GDP this would have negative ramifications for the rest of the world as well. At present the risks are bubbling under the surface. Investors are aware of them but the risks have not materialized sufficiently to stimulate heavier investor interest in gold and silver. This is causing a mean reverting pattern in precious metals prices at elevated levels. Investors are Strategic Wealth Preservation (SWP) is an international precious metals dealer and secure storage provider headquartered in the Cayman Islands. The company has sales offices located in Canada and Germany, offering our clients support in English, French and German. Contact Strategic Wealth Preservation: info@swpcayman.com / telephone 1 (345) /

2 12 April 2018 Page 2 buying metal when signs of risks materialize but sell when the risks are not realized. As in the equity markets, the result of these investor buying and selling habits are to keep gold and silver prices in narrow channels, for now. This will eventually change. As mentioned above, possibly the normalization of monetary policy will help to expose the problems more clearly. Rising Interest Rates Are Not Necessarily Bad For Gold Interest rates globally are on their way up due to a combination of central banks working toward normalizing monetary policy and, in the case of U.S. Treasury interest rates, a reduction in demand and increase in supply of U.S. Treasuries. Investors for U.S. Treasuries are shifting away from U.S. Treasury bills and notes to a more diversified portfolio of government and corporate debt, just as the Fed is reducing its demand for new Treasuries as it shrinks its balance sheet not buying replacement Treasuries as the ones it holds mature, returning the dollars to the Treasury instead. Thus demand for U.S. Treasuries from both the real market and the Fed is declining just as the Treasury is starting to double, triple, and ultimately quadruple the volume of Treasuries it needs to sell in order to finance the enormous increase in uncovered federal spending and deficits. This reduction in demand for Treasuries just as the government wildly increases the supply is a major factor pushing interest rates higher. It is not one entirely in the control of the Treasury or the Fed. The prospects of rising interest rates ultimately is bad for overall economic growth and raises the prospects of a recession, which should be beneficial to gold demand as an hedge against the accompanying turmoil in traditional assets. The increase in interest rates is negative for gold as well. However, changes in monetary policy around the world coupled with increases in U.S. interest rates, for the reasons mentioned above, are likely to have a significantly greater negative impact on equity, bond, currency, and real estate markets than they are expected to negatively affect gold. While the interest rate increases may act as a mild headwind for gold prices, there are numerous factors that are expected to support gold prices and help them rise in spite of an increase in interest rates. Some of these factors include the following. Asset reallocation in light of financial market turmoil away from stocks and bonds to cash and portfolio diversifiers such as gold. Relative value: The fact that stocks, bonds, and real estate have been inflated by the ultra low interest rate environment of the post financial crisis era, while gold is still around a third below its 2011 record. A U.S. dollar that is not likely to rise meaningfully despite an increase in interest rates because The increase in U.S. interest rates already is factored into the value of the currency Ballooning twin federal fiscal and trade deficits and an improvement in other major economies around the world. Real interest rates are not expected to rise to the point that they would have a serious negative impact on gold prices. While inflation also is not expected to rise at a rapid pace even as it is increasing from recently low levels. This should help to keep real interest rates in check. 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 Precious Metals Quarterly At present real interest rates are negative. Studying the relationship between median returns on gold in different real interest rate environments, it is clear that the price of gold has performed best when real interest rates were between negative two and positive one. Monthly data over the past 50 years was used for this study. The monthly average London PM fix was used for the gold price meanwhile three-month Treasury bills less CPI were used for real interest rates. Major central banks around the world are unlikely to aggressively raise interest rates in an attempt to get ahead of inflation, especially because of the outsized risk this has of precipitating a recession. Central banks are unlikely to try and get ahead of inflation, and if nominal interest rates are being raised in response to higher inflation, real rates, which is what matters to gold returns, are not likely to deviate significantly from their present levels. 12 April 2018 Inflation Inflation is forecast to rise in the short to medium term, but only moderately. CPM Group does not expect inflation will rise in an uncontainable fashion to significantly higher levels (hyperinflation). Regardless of CPM group s views on inflation, market participants are likely to respond to any signs of strength in inflation as a reason to purchase gold as an inflation hedge. Since 2017 for the first time since the Great Recession, the global economy is growing in unison. This has bred renewed discussions regarding inflation. There are various tailwinds to inflation: A healthier global growth picture since 2017 a strengthening jobs market relatively stronger oil prices late-stage fiscal stimulus in the United States limited upside for the U.S. dollar and the potential for trade wars While these factors are expected to act as tailwinds to inflation in the near to medium term there are various headwinds to these factors which are expected to prevent inflation from spiraling out of control. These headwinds are: A U.S. economy, now in its eighth year of expansion, more than any other major economy is ripe for a pull back and could break the collective growth in the global economy that has been in place since U.S. growth needs to battle a slowing auto market, commercial real estate market, possibly a slower residential real estate market, continued increase in government debt levels, and other capacity and financial constraints. Page 3 The jobs market is no doubt strong, but there still are some soft spots. For example, in the United States the level of underemployment is still above the average prior to the Great Recession. Furthermore, the increased use of technology continues to weigh on employment growth rates and wages. Oil prices also are higher relative to levels in recent years but have limited upside potential from current levels. Higher prices have typically tended to result in increased supply from the United States. Oil demand is hurting from the greater efficiency in the use of fuel. Some supporters of strong US inflation also believe that the late stage fiscal stimulus will boost both spending and hiring. The timing of the fiscal stimulus is unusual, however, given how late in the growth cycle it has been introduced. It is likely to have a more positive impact on stocks values than on jobs and spending. And finally, if the European and Japanese central banks deem their economic growth to be sustainable it could cause them to join the Fed in normalizing monetary policy, albeit very gradually, which should further prevent any chances of inflation getting out of control.

4 12 April 2018 Page 4 Trade Tariffs Tariffs of any sort tend to create inefficiencies and typically tend to drive inflation higher. The imposition of U.S. tariffs on imported steel and aluminum would create a bit of both and have already resulted in China imposing import tariffs on various items imported from the United States. As of this writing the U.S. Chinese trade disputes are threatening to grow worse. Trade tariffs also further reduce any willingness on the part of countries around the world to trust or cooperate with the U.S. government, which further erodes economic growth and raises the risks of economic recession and financial market distress sooner rather than later. If these tariffs are limited to this initial round, there will be limited damage to the U.S., Chinese or global economy. If these trade tensions escalate they could initially lead to inflation and eventually lead to recessions. From the precious metals point of view both of the negative consequences of increased trade tariffs is positive. Both gold and silver are used as inflation hedges and are also used as portfolio diversifiers for periods when economic problems result in a decline in value of traditional assets like stocks and bonds. Factors Expected to Influence Global Gold and Silver Investment Demand During 2018 A variety of factors work individually and collectively in influencing the level of investment demand for gold and silver. These factors include but are not limited to investors purchasing the metal as an inflation and currency exchange rate hedge, a safe haven asset, a form of savings, and a portfolio diversifier. The extent to which these various factors are positive or turn positive as criteria for buying gold in the minds of investors, and the intensity of those investor convictions, determines the direction, trends, and levels for the price of gold. Investors were not purchasing gold as an inflation hedge during Buying gold as an inflation hedge is likely to regain importance in the near term as inflation concerns revive globally. While CPM Group expects inflation to rise moderately in the short to medium term, it does not view inflation as a major concern or becoming uncontainable (hyperinflation) in the short, medium, or long term. Many others in the financial markets are growing more concerned about inflation, however, and are writing extensive notices about the risks of rising inflation in their newsletters and reports to investors. Regardless of CPM s views, markets are likely to respond to any signs of strength in inflation as a reason to purchase gold as an inflation hedge. This trend is likely to gain further traction if the market views the Fed and other major central banks as unlikely to raise rates aggressively enough to contain inflation. Investor interest in gold as a safe haven asset was and is expected to be mildly positive during 2017 and 2018, respectively. This is not to say that investors think that the problems in the world are over, but there are not fresh factors that would drive investors toward wanting to purchase gold the way they did during and immediately after the global financial crisis. The depth and breadth of the problems faced by the global economy in were the largest in scale since the Great Depression. This jolted investors around the world, causing a sharp run up in gold as a safe haven. At the time investors were willing to purchase large volumes of gold even as gold prices rose. They chased the gold price higher. Investors still remain concerned about the long term condition of the global economy, but they have stepped back from being in crisis mode as was the case between 2008 and While conditions grew more stable after 2011, many intractable financial and economic issues remain unresolved. Some have grown worse, and some are expected to rekindle investor and market unease in 2018 and beyond. Investors meanwhile have come to accept that it will be several years before major economies around the world work through the large fundamental imbalances created since the early 1980s, such as structural fiscal deficits and the consequent inexorable rapid rise in sovereign debt in major countries, and global trade, current account, currency and political imbalances. The duration to correct these problems has already to a great extent desensitized investors toward these problems. Over the past several years Investors have become increasingly accustomed to these economic problems, treating them as the new normal, which is likely to result in gold s role as a safe haven taking somewhat of a backseat in the near term. That may be a misreading of the nature of these problems. While these imbalances have persisted for many decades longer than the financial market Cassandras have prophesized, that does not mean there are no limits to the amount of debt that markets will accept and that these issues will not cause severe economic dislocations at some point in the years ahead. Ironically, just as the fear trade buying of gold has been subsiding since 2016, the factors that ought to encourage caution and fear have been gathering energy. Currency market volatility was in 2017 and is expected to be in 2018 a factor that is supportive of gold investment demand. A normalization of monetary policy by many of the large central banks around the world is likely to contribute to the expected increase in currency market volatility, along with rising interest rates, and trends and developments in individual countries that affect their relative ratings in the minds of investors. Furthermore, if various major central banks are at different stages of the loosening cycles the currency market volatility can be expected to intensify.

5 12 April 2018 Page 5

6 12 April 2018 Page 6 Investors purchasing gold as a form of savings are expected to continue doing so. Demand for this purpose had a moderately positive effect on gold investment demand during 2017 and is expected to continue to do so in The improvement in prices during 2016 from the depths of 2015 and the expectation that prices could be sustained around levels seen in recent months may give some investors greater confidence in shifting some part of their wealth and investments toward gold as a form of savings. Investment demand for gold as an alternative investment and a portfolio diversifier has been positive in 2017 and is expected to remain so in Prospects of higher gold prices in the future, relatively stable prices during 2018, and the relatively stretched valuations in equity and bond markets are expected to keep investors interested in the metal as an alternative asset and portfolio diversifier. Demand from investors for gold as a commodity, basis its supply and fabrication demand fundamentals, improved during 2017 from 2016 and is expected to remain mildly supportive of investment demand during There is still an ongoing increase in mine supply, albeit at a slower pace than before, which is expected to weigh on investment demand for gold as a commodity this year. in the medium term this is expected to change, with mine supply expected to decline for several years in response to the lack of capital investment in exploration and expansion of mines. This decline is expected to coincide with stronger investment demand and central bank demand a situation that should be extremely positive for gold prices in the medium term. From Fear To Greed There has been an interesting shift in the composition of the gold investor market during There has been a noticeable shift away from investors who bought gold for capital preservation purposes, as a safe haven asset or an alternative currency, toward investors who were buying gold in expectation of capital appreciation because they expected gold prices to rise. Financial types might say it was a shift from beta investors to alpha seekers. Another way to say it: More gold has been bought out of greed than fear in the past year and a half or so. As a result, gold coin sales fell, while gold ETF investments, and futures and options trading have risen since The irony of this development is that while some of these investors who purchased gold as a hedge against potential economic problems have backed away from making these purchases simply because they got tired of waiting have decided to back away at a time when the stars are lining up for a strong gold bull market. Not only are there unresolved long-term macroeconomic problems and political developments that are coming to roost but gold s own supply and demand fundamentals are evolving to create a tighter market. While there has been a recent shift in sentiment and temperament of gold investors there continues to be strong net demand for gold on a global basis. In 2017 investors purchased around 19 million ounces of gold on a net basis, which was in the top 25% of net purchases by investors between 1950 and If you exclude the enormous bull market between 2002 and 2012, 2017 saw the thirteenth highest level of investment demand. Net global investment demand for gold is forecast to rise in 2018 to a little more than 20 million ounces. Investors of gold coins are likely to return to the gold market when they see a more sustained increase in gold prices. This could be a strategic error, however, as these investors might have to chase gold prices higher to build or rebuild their inventories.