Gold’s unique late-cycle characteristics

Short-term valuation metrics favour lower gold prices, say JPMorgan in the recently published Metals Quarterly, maintaining the same price forecasts for 2019 and 2020 that they have held since August 2018. This has them bullish gold over the medium term given its unique late-cycle characteristics, which they argue makes gold an ideal hedge in either a positive or negative scenario. For instance, even so late in this business cycle, if global central banks succeed in lifting growth, extending the cycle and bumping inflation higher, they argue that Gold tends to perform exceptionally well during such late-cycle periods, as long as the US dollar trades at least neutral to lower. Alternatively, in a more negative scenario, like if the damage to the global supply chain from the trade war is irreversible, or business confidence and investment don’t recover, and hence growth continues to drift lower, and the Fed pause turns into Fed cuts, gold also tends to outperform. In other words, JPM think being long gold over the medium-term and into 2H19 offers unique hedges to both a bullish and bearish macro narrative. Moreover, the metal is uniquely positioned to hedge a range of other risks such as major policy failures like a collapse in US-China trade talks, a hard Brexit, or a crisis of confidence in the US dollar if the Mueller investigation triggers the start of an impeachment process

Long-term projection for gold and palladium going parabolic

CPM Group is a commodities research, consulting, financial advisory and commodities management firm, and one of the foremost leading authorities on the precious metals market. As for the current trends in gold, CPM highlight the increased buying of gold from Central Banks, which concurs with views of FFTT above. They note that additions to gold reserves in 2018 were the third-highest since 2008, when CBs began re adding to their reserves. They also do a great job at visualising and quantifying the major risks/influences to gold prices in their  ”Risks, Probabilities, and Impact Of Factors Affecting” dynamic table, which is updated fortnightly. For some context on CPM’s views here, in 2017, CPM saw the outlook for gold and silver prices over the next 2 -years as basically flat, and then in early 2018, they expected prices would rise into early 2018 and then drop back in the second half. Gold and silver did, but prices dropped more than they had projected. However, they said prices would rise again starting in late 2018 into early 2019, as they did. On PGM, CPM saw platinum prices would be flat, but palladium would rise sharply, with rhodium rising even more sharply, ultimately ‘going parabolic.’ This is what is playing out currently. CPM are also well known for their long-term metals studies, which can be purchased, as single publication. See here for the full table of contents for the most recent edition, published late last year.

Does de-dollarisation of FX reserves lead to re-goldification?

The metals research team at BAML have just published a report that provides a broad analysis of the de-dollarisation theme and how this feeds into the demand picture for gold. They draw on a lot of data that shows how Central Banks are de-dollarizing and increasing their purchases of gold that concurs with the analysis of FFTT. This de-dollarization trend may only be gradual at this current time, but it will only grow, say BAML, who say that it is being influenced by various dynamics. More recently, changing global trade patterns and the emergence of countries like China have been important drivers, while it is also appealing for nations because the management of economies that heavily rely on the US currency can be challenging. Indeed, BAML say that beyond just impacting the effectiveness of monetary policy, exposure to dollar-denominated assets and liabilities, it can have a meaningful wealth effects. This has been very visible in Turkey of late, where FX volatility has been weighing on corporate balance sheets, as their economists note. Finally, political considerations often also matter, where countries are also looking to become more independent from US economic policies. BAML pick just one recent example, where the Iran sanctions put access to the US financial system at risks for companies that violate business restrictions with the Islamic Republic. 

Gold, Debt and Monetary Competition

OM Research have written extensively on the theme of rising monetary competition, where they believe that the economic, political and geopolitical situations are aligning towards a much more substantial shift in government attitudes towards gold. They say that with equity markets looking poised for a long-awaited correction and emerging market debt worries coming back to the fore, a concerted downturn could result. The opportunity set of palliative actions available to leaders is now substantially reduced vs 2007 and a synchronised devaluation of fiat currencies against gold/precious metals could be the most painless choice. OM has also looked at gold from a cultural perspective, looking at history and the allure of gold in specific cultures. OM say while the cultural drivers are a little different, they are still strong enough internationally to bring about a shift toward gold when the next financial crisis hits.

A new Gold Standard Through the Back Door?

Luke Gromen from Forest for the Trees, is a unique analyst with a very big picture framework that seeks to interpret asset price movements through the prism of changes in the global monetary order. He’s written extensively about de-dollarization, the role of China within that and its impact on gold prices. In a series of pieces written over the past 6-months, Gromen says Central Banks are mirroring the late 1960s, when they ceased buying US Treasuries resumed purchasing gold. He has argued that a competing Eurasian currency bloc, where gold is preferred as a reserve asset to US Treasuries, has now emerged. Furthermore, outsized hedging costs are making US Treasuries prohibitive and leave gold as by far the cheapest safe haven assets. He also says that the “Chinese capital flight” that Western economists have been waiting for is already here in the shape of  physical gold. The new Eurasian currency bloc which favours gold as a reserve asset will eventually force the US to compete in gold terms, Gromen adds. In his more recent work, Gromen has discussed the correlation between gold and the CNY (and the drain on stock in London’s gold vaults), and also the official recognition – by the BIS – of his thesis and what that implies about demand for gold.

Overweight Japan equities as investors catch up with stronger fundamentals

Japan’s slow-growing economy has hampered investor enthusiasm for equities despite improving corporate fundamentals, MRB argues on March 14. Corporate finances have improved in recent years, reflected in better profitability and stronger balance sheets. Profit margins are at record highs for both large and small and medium sized companies. MRB expects Japanese exports to be soft in the near term, but that they will start to strengthen in the second half, with a positive impact on corporate sales. Investors will revise their image of corporate Japan and catch up with the improved fundamentals, meaning an overweight position in a global equity portfolio is justified.

Time to shift from US into international equities

“Don’t fight the flows” is better advice than “Don’t fight the Fed”, Vanda argues in a piece published on March 6. The ongoing strength of emerging market equity inflows has been one factor behind non-US equity outperformance, Vanda argues. The eight emerging markets for which Vanda tracks high frequency equity flow data – which, does not include mainland China – saw a resurgence in foreign interest in the second half of February. European equities are also poised to benefit, with macro headwinds about to become tailwinds, Vanda argues. Inflows will accelerate on better economic data, and based on the numbers of client queries received by Vanda on Europe, those inflows could be sharp.

Why EU Blacklists and Taxation matter in EU-US trade negotiations

OM Research produce research that really digs into a lot of the issues that are the source of the simmering trade relations behind Europe and the US and how they might play out. One such issue is the recent publishing of the AML blacklist, and also proposed tax policy on US tech firms, which in different ways, brings it in conflict with US interests. Late last week they published an updated report on the AML blacklist, where OM say the technocratic approach by the EC led it to overreach in producing its AML blacklist, which has subsequently been voted down by member states. The EU also sought to reduce tensions with the U.S. by declining to act unilaterally over tech taxes. OM provides all the background of these policies, and what the implications might be for Europe-US relations and the broader relationship. OM Research has developed several streams of research in this area, including not just the blacklist and taxation of tech companies, but also the rollout of 5G, where Europe is leading the rollout of 5G, and where the role that Huawei could potentially play in that. This becomes problematic, not just from a security perspective, but more importantly how this impacts relations with the US.

US credit market conditions are being driven by the dollar

The dollar has emerged as an independent global risk factor that is not primarily linked to developments in the US, Systemic Risk and Systemic Value says in a piece dated March 9. The dollar exchange rate has become an important early indicator for credit market conditions, with appreciation associated with a reduction in commercial and industrial loans by US banks. This risk factor is not reflected in any other proxy of risk sentiment, SRSV argues. The main reason for the dollar-credit correlation is that the syndicated loan market has increased tremendously since the 1990s, as has the role of institutional investors as buyers of these loans. The US credit market, the implication is, may be driven by an external variable over which none of the key players will be able to exercise direct influence. Click below to read the full piece.

Blackstone, Deutsche Bank and credit spread correlations

Paul Schulte’s Asia based, independent research group, Schulte Research, is highly regarded. They specialize in analysis of the nexus between banks, liquidity and corporate credit, with Schulte having worked for over 27 years in financial markets. In his latest note he focuses on 3 separate themes. First he looks at how private equity firm, Blackstone, sits at the epicentre of the corporate leverage excesses of the last decade, via its exposure to the CLO market. He recommends shorting the stock. Secondly, he looks at initial newsflow on a planned bailout of Deutsche Bank, and how this might play out. He recommends investors should close out their shorts on this name, as there’s very little left in this trade now. And thirdly, he looks at credit spreads, where he has run some correlation analysis. This shows that when credit spreads are below the long term mean and the good times are rolling, the correlations between equities and credit are extremely low. When things get rocky and spreads blow out above the long term mean, spreads move towards 1.