Weaker Crypto Stronger Gold

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Weaker crypto could hold the key to stronger gold. Recent price action would seemingly suggest that investors are in the market for alternative asset classes that may provide a hedge against rising inflation and a weaker dollar. Investors may have more choices today, however, on where to put that cash to work.

 

The rapid and sharp rise seen in Bitcoin in recent months could be indicative of what investors are thinking. The digital currency saw a rapid run higher, marching from under $20,000 per coin to over $60,000 per coin in a matter of months. Although the rally may be largely dismissed, there are those that feel the buying in Bitcoin and cryptos represents a changing of the guard when it comes to alternative asset classes.

 

As the price of Bitcoin climbed steadily, the value of gold languished sideways. Obviously, there could be multiple reasons for this. It does seem odd, however, that as capital flowed into crypto it did not show a significant flow into gold. After hitting a peak recently of over $60,000, the Bitcoin market has reversed course and has dropped some 40% from the high. During this decline, the price of gold has garnered strength and the yellow metal could be on its way to previous all-time highs or beyond. To the layperson, it may seem as if capital is now flowing into gold as it flows out of crypto.

 

If selling pressure in cryptos remains in place, buying pressure in gold could mount. Investors are hungry for an asset that can protect them from rising inflation and dollar weakness, and the gold market has a very long history of being a reliable store of value and protector of wealth. That trend appears set to continue as inflationary pressures steam up and as the Fed keeps rates low and policy loose. Investors may, at times, seek out Bitcoin or other cryptos. These asset classes do not have gold’s history, however, and cannot be held in the hand like gold bullion. They may, therefore, lose ground to gold in the race for capital and the yellow metal may rise while cryptos move sideways or decline.

 

Slow and steady often wins the race. That anecdote may prove to be the case when it comes to gold and cryptos. The long-term investor is likely more concerned with the asset’s long-term capabilities and rapid price ascents are not overly impressive. Smart investors also understand that markets do not typically go straight up or straight down. The more rapid and aggressive the move higher in Bitcoin or cryptos is, the more likely the market may come back down at some point to back and fill. This tendency can lead to many buyers getting caught buying at or near the highs, right before the market corrects. As these buyers look to exit the market, the sell-off may intensify driving prices even lower.

 

The relationship between gold and cryptos is a new one and may be worth watching in the future. Until proven otherwise, it would appear that gold is the superior asset class for wealth protection and long-term investors may find it far more suitable compared to cryptocurrencies.

Gold Pops as Jobs Stop

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The yellow metal is not only holding firmly above the $1800 level but is now adding additional momentum. Gold prices are sharply higher in early am trade as the jobs data for April was grossly disappointing.

 

The U.S. reported that the nation added just 266,000 jobs for April, with the unemployment rate at 6.1%. The jobs added figure is a big miss from consensus estimates which were looking for 1 million jobs added last month. Non-farm payrolls for March were also revised lower from a previous reading of 916,000 to 770,000. The April unemployment rate ticked slightly higher from 6 to 6.1%.

The huge miss in April jobs data should effectively quell the notion that the Fed may have to hike rates sooner than anticipated. The employment data instead paves the way for the Fed to keep its foot on the gas pedal.

 

The idea of ultra-low rates and QE staying in place for some time to come should have a bullish effect on gold and certainly appears to be showing that effect on Friday. The combination of weaker economic data, lower treasury yields and rising inflationary measures could all fuel further upside in gold. The market may, in fact, pose a challenge to recent all-time highs in the weeks ahead. The metal could even move well beyond that level into fresh all-time high territory.

 

The gold market does have some obstacles in its path that it will need to overcome. Economic strength may become an increasingly important barrier to higher gold as the weeks go by. Competition from alternative asset classes, such as crypto, may also become increasingly measurable. Despite these issues, however, the gold market stands to benefit from the combination of factors that have driven it higher in recent months. Dollar weakness, inflation, easy money policies and more are all bullish factors for gold that could send prices sharply higher from recent levels. Good things come to those who wait, and that saying may never be more true than it is concerning the gold market.

 

Today’s follow through price action would seem to confirm yesterday’s rally in gold and could attract further buying interest. The real test, however, is likely to come in the $1850-$1870 area. This area marks not only previous resistance, but also the market’s 200-day moving average. Some attempted selling may be expected, but the bulls may simply punch through this region like a knife through warm butter. If that is the case, more buyers are likely to flock to the market as resistance is cleared, setting the stage for additional upside gains. The bulls this week have regained control of gold on the daily chart, and the market may again be viewed as a buy the dips asset until proven otherwise.

 

Even long time gold detractor Warren Buffet has suggested that gold may be a worthwhile investment in the current environment. Buffet purchased shares of Barrick gold last summer and sold them in the fourth quarter. He was also recently quoted discussing inflation and the effects it is having on his companies and investments.

The Tax Man May Cometh

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The stock market declined on Thursday as news hit the wires concerning Biden tax proposals. The Dow Jones Industrial Average declined by over 300 points, while the tech-heavy Nasdaq lost nearly 1% on the day.

 

The equity plunge on Thursday begs the question of how stock markets may react to a more aggressive tax policy by the new administration. Some analysts suggested, however, that if aggressive tax legislation had a chance at being passed, the market would have dived by thousands of points, not hundreds.

 

The threat of the tax man is likely to become an increasing focal point or markets in the months ahead. Although the idea of higher tax rates can seem daunting and is unliked by most, if not all citizens, the higher tax rates are likely to only affect a few of the wealthiest Americans and corporations. As far as markets are concerned, it is a case of not k knowing that may be far worse than the actual legislation that is eventually proposed. That not knowing could fuel market volatility and could end up driving buying in precious metals as investors seek out a perceived safe haven for their capital.

 

Thursday’s equity performance could very well be the tip of the iceberg when it comes to fear based selling. Markets have continued their ascent for some time now, with little standing in the way of higher stock prices. The threat of the tax man could be the primary catalyst to end the current equity bull market and fuel an about face in markets. If that proves to be the case, the gold and metals markets could stand to benefit significantly.

 

The gold market has been range bound for some time now and could be just waiting for the next major catalyst to fuel a breakout in either direction. The bulls have bought up any significant dips to the bottom of the trading range while the bears have thus far limited any sustainable upside. Things could be set to change, however, if the bulls are able to maintain trade above the $1800 level on a closing basis. That level could hold the key to higher gold, while the $1700 area below could set the stage for a fresh leg lower.

 

The metals have benefited from a weaker dollar, easy monetary policies and other factors in recent months. Given the current geopolitical and economic backdrop, it is difficult to imagine a scenario in which gold does not continue its ascent to the upside. These factors, combined with rising inflation and the threat of an equity market reversal, should be enough to drive gold back to all-time highs or beyond. Good things often take time, however, and the recent sideways action in gold could be indicative of a brewing breakout that may come at any point.

 

A stock market reversal or collapse could be the final straw for the gold bulls. Such rice action could pave the way for sharply higher gold and could set the stage for fresh all-time highs to be made in the weeks or months ahead.

The Fed Has Spoken

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The U.S. Federal Reserve made no changes to monetary policy today as expected. The central bank did, however, increase both its growth and inflation outlooks. The Fed reiterated that interest rates are not going anywhere anytime soon, and that no increases will be seen prior to the end of 2023.

 

The potential for rates to remain at zero for another couple of years has injected buying interest in the yellow metal today, and gold has now pushed into positive territory following the Fed announcement. Although the Fed has suggested that growth and inflation are likely to pick up more steam, it also cited some key issues that could potentially pit a damper on things going forward. The Fed cited the ongoing viral pandemic as a major contributor to overall economic activity and said that it poses a major risk to the economic outlook.

 

The rate of inflation forecast by the Fed may now exceed its desired 2% annual target. Recent projections suggest that price pressures could rise by as much as 2.4% by the end of the year before falling back towards 2%. The rapid rise in inflationary pressure could keep gold and other hard assets well supported in the months ahead, despite the potential for strong equity market performance.

 

The Fed appears ready and willing to follow through on its previously discussed plans to allow inflation to run a bit “hot” before raising rates to slow things down. The notion of ultra-low rates with a weaker dollar and massive stimulus spending may give more investors reason to consider gold in the near future, especially in the face of rising inflation.

 

Fed Chairman Jerome Powell will be giving a news conference following today’s decision on interest rates. No major surprises are expected, and Powell is likely to continue to telegraph the fact that the economic recovery remains far below the pace necessary for the central bank to consider any changes to policy. Powell may even forcefully argue that any ideas of a rate hike are premature as he looks to lay out the central banks plans and thinking to the investing public.

 

The U.S. Dollar Index has lost ground after the announcement. The dollar weakening could be a sign of more downside to come. Further dollar weakness could pave the way for sharply higher gold, silver and metals prices. With no rate increases likely being seen unti at least 2024, it is difficult to imagine a scenario in which the dollar strengthens dramatically from recent levels. A downtrend in the dollar could keep upwards pressure on the gold market while providing key support for the yellow metal.

 

The bears still maintain control of the market on the daily chart. The bulls will likely make a push towards resistance in the $1750 area this week, and a breakout above this area could set the stage for a further rally. The Fed has apparently set the table for higher gold prices in the months ahead. Dinner may now be on the way.

Is Inflation Really A Problem?

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The idea of rising inflationary pressures has taken a large chunk of market attention in recent months. At first glance, the threat of inflation seemingly makes sense. Rising bond yields, higher crude oil prices and other factors have fed the notion that a period of rapid inflation could be on the way.

 

The idea of entering an inflationary environment comes at a time when the Federal Reserve is looking at adding additional stimulus measures to battle the ongoing COVID-19 pandemic. The idea of further government spending to help Americans hurting from the pandemic has some analysts concerned that too much free money floating around is likely to add fuel to the inflationary fire and boost prices.

 

Not only have rising price pressures, such as that seen in crude oil, pressured inflationary worries to the upside, but the rapid rise in key treasury product yields has also served to give investors cause for concern. The benchmark 10-year note yield, for example, has quickly risen from sub-1% levels to its current level around 1.5%. This move higher did not happen overnight, however it did seem to take place quickly and would seemingly suggest that higher prices could be on the way.

 

Fed Chairman Jerome Powell threw some needed water on the fire today as he spoke at the Wall Street Journal Jobs Summit. Powell suggested that while prices have been on the rise, that rise is transitory and is likely a one-time event. The central bank’s long-term inflation objective remains at 2%, and currently inflation is running well below that level. The Fed has also reiterated several times that it plans on allowing inflation to run a bit hot before it even considers removing accommodation.

 

Powell’s commentary today could be viewed in one of two lights for gold. Some may view the idea of a lack of inflation as allowing the Fed to keep rates ultra-low for longer. Others may view it as being bearish for gold as it suggests that the Fed has still been unable to make any significant economic changes.

 

The gold bears seemed to have the upper hand today, as gold declined below the key $1700 level following his comments. The drop below this area could potentially set the stage for a larger decline as it may draw bulls out of the market, causing them to effectively throw in the towel. Today’s declines in gold come shortly after the “taper tantrum” of late February fueled selling in bullion that took prices down over $114 per ounce for the month.

 

The reality, however, is that the Fed can only do one of two things going forward: It can begin to taper (which could drive yields up substantially in a short period of time) or it can stay the course. Given the risks associated with a rapid, large rise in rates, the Fed will almost certainly do nothing for some time. This should allow the bullish gold narrative to remain intact despite some bumps and bruises.

Cluelessness

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A reporter on Bloomberg earlier in the week commented that fear was not yet present in the markets. Global stocks have seen enormous selling pressure, but it is not until the hedges and safe-haven assets also trade lower simultaneously that fear is then present. In other words, everything is red. Certainly there may be a degree of subjectivity to that call, but I like the premise.

In this selloff/correction/decline, we witnessed that for the first time on Wednesday the Dow Jones Industrial Average and the TSX officially entered bear market territory (which is a 20% decline from their most recent high). The S&P500 joined them Thursday. On Wednesday, the price of the US 10 Year Treasury was also lower. Whether that’s anomalous or warning it could get worse is to be seen. The most challenging angle to this entire market action though, which is exemplified by the quick and drastic price moves, is deciphering this as a transitory shock or a recession incurring serious economic damage to consumer confidence and employment.

In just a week, consensus shifted to the latter.

I had written a blog last Sunday morning to be sent out at the beginning of the week, but for the above reason the piece was rendered irrelevant by the time the markets opened. The topic was on distinguishing the signals the markets were telling us. Particularly whether the bond market was pricing in rates cuts or a more extreme scenario including recession. The second point was on then being careful with the parallels that were being drawn to 2008. Beyond analyzing the virus impact, there is now an oil supply-shock entering the equation.

Numerous unknowns remain. Front and centre are the potential spread of this virus and the associated impact to economic activity. Trying to determine this almost seems like a rogue’s game at this point. Many of the more opportunistic analysts suggested that this health scare was no less manageable than previous pandemics (from an economic perspective) and the markets would see past it. But, the probabilistic scenarios still seem wide ranging, as illustrated by stock markets struggling to maintain a bid. Factoring in the destabilising effect of the energy shock to the credit markets and the effect on the real economy is whats driving the increasing concerns with recession.

To add to my obsolete (and unpublished) content, one key distinction worth making to 2008 and the Global Financial Crisis is the abandonment of multilateralism. Beyond whatever one’s preferred politics, it seems President Trump’s global led shift to a more unilateral approach seems less effective, or alternatively an audience less receptive. In 2008, it was a coordinated effort between monetary and fiscal stimulus to support the global economy. This last couple weeks has seen a communique from G7 nations that saw central banks follow in an uncoordinated fashion that is yet to see any effect.

The concern is that this deglobalization affect will create more dislocations and more market fragility. Without Western Powers acting in sync, there is the opportunity for more frictions and much more volatility. To illustrate this, Goldman Sachs Wednesday morning suggested the S&P500 could fall another 15%, but then rebound into year end by 30%. Buckle up.

Perspective Adds More Clarity

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Perspective adds more clarity to market action instead of looking at events in isolation. A very telling example this past week was US equity markets had their worst week since financial crisis and the quickest decline of more than 10% from their most recent high, in technical terms referred to as a correction, in the US market history.

Through to Friday, 5 trillion dollars in value was erased from global stocks. The MSCI Global Equity Index is down over 10%. One troubling indicator is that the similar fear trade concurrently taking place in sectors of the credit markets, sending treasury bond yields to records lows, indicate that we haven’t yet seen the worst of the selling action in stocks. This has prompted the debate of whether the US Federal Reserve and other central bankers will step up and cut interest rates as investors question whether a response from monetary policy officials can calm selling fears. Alternatively, some have raised the question that with central bankers limited firepower, whether markets would look instead for a response from public health officials that the virus is contained before showing signs of a bottom.

Where financial shocks based on liquidity issues or debt fears may be more simply reasoned and understood, the uncertainties around the extent of a virus are less clear, hence the wide-ranging opinions and outlooks.

It’s noteworthy that the US Federal Reserve, despite speaking engagements this past week, has remained tight lighted on their policy path. Even recently appointed European Central Bank President Christine Lagarde did an interview with the Financial Times this week on businesses needs to address climate change. However, policy direction has not been addressed and no guidance has been given to reassure markets.

As the financial markets are pricing in odds of four interest rate cuts from the US Fed by January of 2021, one analyst on Bloomberg Radio Friday morning warned that if the Fed fails to cut interest rates they are essentially tightening in this environment. He drew parallels (like the equity markets have) to the 2008 Financial Crisis where the US Fed was slow to react and consequently prompted further selling and lower prices in the stock market.

The merits of them not reacting is rooted in an academic approach on the efficacy of the Fed cutting rates in an economic slowdown that emanated from a supply shock. As supply chains backup and orders go on hold with factories being stalled, lower interest rates won’t transmit stimulus in that scenario. Still, the uncertainty is over the potential longevity of this economic slowdown. Easing of financial conditions for small businesses may provide a layer of relief for the time being, as many try to digest and determine the extent of the economic damage. Two points stand out.

First, since the financial crisis many have referred to a third or shadow mandate of the US Federal Reserve. The first and second mandates by congress task the Fed with targeting stable inflation and full employment. The third has been the Fed’s support for financial markets acting as a source of liquidity and creating a wealth affect through the economic recovery that benefitted those invested in the stock markets.

The second point speaks to the degree at which the most recent tightening policy, beginning with their taper program in trimming their balance sheet, followed by raising their policy interest rates. In some instances, they were anticipating the economic data and acting as proactive versus being reactive. If that were the case, instead of waiting for evidence of an economic slowdown in the US and global economy that might not be evident in the current data until mid-year, we might expect the fed to act sooner.

To recirculate to an earlier point, this raises the question when the Fed does ease, whether it gives equity markets and investors the necessary confidence. Without question supply chains have been disrupted, demand has been shocked, and markets seem to be pricing in a dire scenario. A question for the Fed that is yet to be tested, is whether anybody will listen.

Near Term Distractions

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The most noteworthy observation on the financial markets a month and a half into 2020 seems to be the resiliency of US stock markets. No market moving story, and there has been a few of them, can seem to change their trend and direction. To begin the year, we witnessed a US drone strike on an Iranian General that prompted escalation fears between the United States and Iran. For only the third time in history we saw the congressional impeachment of a US president. And of course, still playing out are the unknowns associated with the coronavirus through China and the impact to their domestic economy along with global growth.

Continuing with the coronavirus, it’s been a challenge for the medium to long term investor to make sense of headlines that often fail to put in perspective the extent of the health scare. The point of this blog is not to attempt to join the chorus of global health experts in conjecturing on the breadth of this scare, but instead echo the skepticism for how this pandemic will play out, and whether markets are mispricing the end result.

What has been interesting is assessing the potential economic impact and thus why it was the focus of officials from the Federal Reserve Chair Jay Powell before Congress this week and even Canadian Finance Minister Bill Morneau speaking before an audience in Calgary. As Minister Morneau stated, the Canadian economy will be impacted from tourism numbers to global supply chain, and even resource demand. Canada’s situation in a global economy linked to an increasingly important China is no different from the United States or Europe. Whether this creates a v-shaped decline or is anything negative sustained is the unknown, which speaks to assessing the depths or longevity of this crisis.

With regards to Powell and deviating from the short-term discussion above, it was another comment he made before Congress this week that is perhaps more interesting. In his twice annual two-day testimony Fed Chair Powell came close to questioning whether the Fed had the adequate tools to combat the next recession and called on Congress to play a bigger role in the fiscal side of the equation.

This message echoes and motivates the narrative from many commentators that the ability for the Fed to continue to spur economic growth from ultra-low interest rate policies is coming to an end. An insightful comment was made by Greg Ip in the Wall Street Journal a few weeks back when he mentioned how the US economy has transitioned to be made up of less interest rate sensitive sectors. An aging population has diminished the significance of a rate cut to prompt home purchase or take on auto loans as services and education and healthcare now account for a larger share of GDP.

Phillip Hildebrand, the former head of the Swiss National Bank, and former US Federal Reserve Vice-Chair Stanley Fischer suggested that “unprecedented policy coordination” could be the answer to the next economic slowdown. This speaks to the notion of central banks financing fiscal deficits.

The last six weeks have been an interesting start for the markets in 2020. Geopolitical events to date have failed to unnerve investors from their evermore advancing trade in US equity markets. Events that have been so monumental that they’ve even masked potentially more consequential headlines.

Reasons to Own Gold

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Don Coxe famously quipped, “never invest on the basis of a story on Page one, invest on the basis of a story that’s on Page 16─that’s on its way to Page one.” His rationale is simple. The story that’s already made its way to the front page and is top of the headlines is well known and priced into the market. In investing, sometimes you must be ahead of the curve. With the attention that precious metals seem to be getting in the press lately, they are looking more and more like the story heading to page one.

Bridgewater Associates’ Co-Chief Investment Officer made headlines a couple of weeks back in an interview with the Financial Times, where he discussed the prospects for gold. I think they are simple, concise, and justified. They illustrate why the average investor would want exposure to precious metals in their portfolio.

The first is regarding the outlook for central bank easing. Over the last year 49 central banks cut interest rates 71 times. Furthermore, it was the highest proportion of central banks cutting rates in the last decade. Forecasts are for the theme of central bank easing to continue into 2020. Discussions have shifted to how hot the US Federal Reserve will allow inflation to run before they even consider raising rates again, and this is as policy debates have surrounded the evolving role of monetary policy and its limited efficacy in a near-zero interest rate environment. Ultimately, it’s the expectation of further rate cuts that’s supportive of precious metal prices, and like the financial crisis, gold biggest moves were on expectation of policy changes versus when they came to fruition.

The second bullish point for metals is ballooning fiscal deficits. In the United States the federal deficit tracked over a trillion dollars for the first time since 2012. Similarly, in other Western nations there seems to be less concern over government frugality in favor of spending programs to spur economic activity. Long gone are the days in 2011 when a debt rating warning from Standard and Poor’s over the creditworthiness of the US government spooked markets. Earlier in the last decade was the concern of a debt overhang and a nations inability to be able to borrow because of fiscal imbalances. Thus, the case for precious metals is made with increased uncertainty from renewed focus to growing government debt.

Finally, the case for precious metals can be made as a diversification from the US dollar. There are a couple angles to this scenario as gold historically has had an inverse relationship to the world’s reserve currency, whether the US dollar at present time, or the British Pound before it. Last year, the US equity indices exhibited their attractiveness to foreign investors marking their best returns since 2013. Gold acts as a natural hedge to those increased US dollar holdings, and this case is increased with every weekly record close.

Another view though relates to the unilateral and deglobalized approach to geopolitics from the current US administration. Isolationist policies have the potential to devalue the dollar and its role in global commerce. This has not been a fast-evolving transition, but one that continues to stay forefront in terms of global trends.

This post would be incomplete without addressing some of the risks to precious metals in this year. Front and center would be renewed global growth and a halt to the accommodative policy from the US Fed and their more cautious approach. Rising real interest rates could stand in the face of the continued momentum of the precious metal from the past year also. To backtrack a few years, and reference the Don Coxe quote above, investors’ appetite for and attention to the yellow metal was minimal when growth was advancing, stock markets were gaining, and market and economic risks remained relatively muted.

The difference to today where global growth is expected to pick up, and risk markets are still moving higher is the associate elevated level of risk. Call it a path to an unchartered territory that stems from political unease into an election cycle in the short-term, to the direction of monetary policies ability to influence markets, thus strong cases can be made for investor diversification in precious metals. This is as the trend has the potential to continue with gold’s ability to rally in multiple market scenarios whether its risk-off with the US dollar, or risk-on with the US equity markets.

Monetary Obsolescence

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In 2019, 49 central banks cut interest rates 71 times. The Bank of Canada was not one of them. The US Federal Reserve accounted for three of those instances. Interestingly, the Canadian central bank stayed put. A stable enough domestic Canadian economy buoyed by a rebounding housing market was able to withstand the geopolitical turmoil from China-US trade negotiations, Hong Kong protests, and even Brexit. The obvious question now is what’s in store for the new year?

 

Where it still seems likely the Bank of Canada may trim interest rates in by the middle of 2020, they have not had to be as reactive to a global slowdown. A resilient Canadian consumer and a rebounding housing market driven by the demographic trends of major cities were supportive of the Canadian economy in the past year. That said, a noticeable slowdown into the end of 2019 with sagging retail sales and a lethargic labour market shifts the picture and will test their hand in 2020.

 

One question though, is whether a single or series of rate cuts will effectively make any long-term difference to the trajectory of Canadian growth?

 

One of the discussions being had in policy making circles, especially in the United States and Europe is over the limits of central bank policies. Greg Ip wrote an excellent column in this weeks WSJ on the topic.  As financial market participants, we’ve witnessed the adjustment of interest rates to attempt to slow inflation in economic booms by raising rates, and conversely spur economic activity in downturns by cutting interest rates. As we’ve seen policy rates drift towards zero and go negative in other parts of the world, the efficacy of these policies is being tested in low growth and low interest rate environments.

 

To expand further, many market commentators have discussed a needed shift from monetary to fiscal policy. Simply put, the onus will fall to elected officials to make the smart choices of investments in infrastructure, skills training, and other selective investments. As a headline example, its obvious why some may be skeptical of handing more power to politicians as the fiscal deficit in the United States surpasses a trillion dollars for the first time since 2012. Similarly, in Canada, from a time when a balance budget was a matter of national pride even under previous Liberal governments, the conversation has shifted to maintaining ratios relative to the size of the economy. In both scenarios, the underlying assumption for their stability is low interest rates and economic growth.

 

Whether the Canadian bank cuts rates or not in July may create some short-term noise, but it should not distract from the bigger picture. That is a global trend of slowing growth and whether interest rates near zero have the same ability to spur economic activity.