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.

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.

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.

For nothing more than an arbitrary statistic, as of Fridays close gold prices in US dollars are already up 2.3% on the year. That follows an approximately 4.5% gain in the month of December. The market technicians will remark of the strengthening seasonality picture this time of year also. Gold in January has averaged 3.4% gains over the past 10 years and for the last 5 years has gained every January between 3-8%. Examining fundamentals, several major market moving headlines over the past month can be turned into a bullish story for gold.

 

The gold market has momentum. The market moving forces of a weak USD dollar and the positive global growth story resulting from the anticipation of the US and China inking a Phase 1 trade deal has ensued a risk on trade. Additionally, events at the end of last week adding to heightened tensions between the United States and Iran have renewed gold’s geo-political safe-haven bid. It also can’t be forgotten that a strong base for the precious metals was provided by the theme of central bank easing in 2019 where we witnessed a 10 year high in terms of the percentage of central banks cutting interest rates.

 

Looking at the central bank picture, minutes out of the latest FOMC meeting released last week also revealed a heightened level of caution. Officials at the US Fed seemed focused on risks to the US and global economy. Current discussion is whether heading into another election cycle there is the possibility for a rate cut from the Fed. Nonetheless, a consensus seems to be building that the Fed would opt to let inflation run a little higher before being quick to raise interest rates.

 

In a gold market like this, where every headline seems to appear bullish, it might be wise to exercise some caution. A pull back following a geopolitical (war-type) spike should not be a surprise as investors can sometimes be a little overzealous or too cautious entering the safe-haven hedge. There seem as many historical examples of where a geopolitical induced rally has been short-lived verses being sustained. Ultimately it seems the dollar should be the area of focus right now with the Bloomberg US dollar index down 2% in December for its biggest monthly decline of the past 2 years. This potentially could be a headwind to gold.

 

Still, as the vulnerability of the risk assets showed back in July/Aug when the S&P500 fell 5% in a couple days, gold and the USD can trade higher together, which I think is possible when the next negative trade development comes. In addition to this, with equity markets trading at record highs following a banner year, the higher gold prices with the higher equity markets is exhibiting this degree of caution in the markets.

 

With a quick note to the physical market, the retail reaction to the events Thursday evening was a heightened level of buying/selling from customers as they continue to be ever more price conscious and reactive to large market movements. This isn’t necessarily an anomalous phenomenon as increased volatility traditionally sees higher volume in financial markets. On the one hand we’re back at our record 52 week high in USD and within 2.4% of record highs in Canadian dollars, so clients are both happy to be selling near record highs, but also buyers looking for diversification are active as we continue near record prices.