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Gold's perfect storm is upon us

Commentaries & Views

There is an old saying on Wall Street that the market is driven by just two emotions: fear and greed. While general equity investment decisions are driven by fear to the downside and greed (the current market emotion) to the upside, the gold price has the ability to move strongly to the upside by either emotion. And when the safe-haven metal is being driven higher during an atmosphere of both greed and fear, an extended move can end in parabolic fashion.

With global growth stabilization being of high concern to investors due to the coronavirus (COVID-19) outbreak in China, the fear component has gold futures breaking out of its 6-month consolidation towards its next target at $1700 as new cases of people contracting the virus continues to swell, and the death toll grows.

Chinese tourism, which has been a mainstay throughout the world, has come to an abrupt end as its people have been blocked from leaving the country. Nearly half of China’s population (more than 780 million people) are currently living under various forms of travel restrictions and the virus has caused scores of businesses to temporarily shutter stores or reduce hours. The hype over the COVID-19 virus, with a death rate of less than 3%, has reached incredible levels and is impacting the world economy on a massive scale.

In a note for G20 finance ministers and central bankers on Wednesday, the International Monetary Fund (IMF) mapped out many risks facing the global economy, including the disease and a renewed spike in U.S.-China trade tensions, as well as climate-related disasters. Finance ministers and central bankers from the top 20 advanced industrialized economies will gather in Riyadh, Saudi Arabia, this week, still uncertain about the impact of COVID-19.

Meanwhile, central banks have collectively continued to pump endless amounts of liquidity into their respective balance sheets. The Federal Reserve released the minutes report in which the U.S. central bank reiterated their decision to hold the benchmark interest rate, but stated they will remain flexible to change course if conditions alter drastically. The Fed also mentioned volatility due to trade uncertainties has diminished compared to last year when the U.S.-China trade war brought uneasiness to the global markets.

However, global growth stabilization is of high concern to the central bank due to the COVID-19 outbreak in China. Furthermore, the Fed would like inflation to return to 2% and are still deliberating over potential strategies to achieve that goal. The central bank pivoted from a hawkish to dovish approach to monetary policy in 2019. In 2020, the Fed is likely to stay on the sidelines during the election year, which is positive for gold.

On Thursday, China’s caution regarding the negative economic consequences from the CONVID-19 outbreak increase resulted in the PBOC cutting its one-year loan prime rate to 4.05% from 4.15% and the five-year loan rate to 4.75% from 4.80%. Gold’s reaction to the Chinese stimulus measures resulted in an eleventh session higher out of the past twelve and closed at a 7-year high above $1620 per ounce.

Gold’s biggest ally has been falling interest rates, both in the U.S. and globally, which have also increased bullion’s appeal as a hedge against further global economic slowdown. Along with the fear-based buying in the safe-haven mental, continued lower rates suggest that investors are pessimistic about global growth prospects in the near-term, which in turn bolsters gold’s appeal as an alternative to riskier equities.

Although the expanding Repo Crisis has mostly disappeared from the headlines, the Fed remains trapped into endless injections of liquidity into the repo market to keep short-term interest rates from rising. The world’s largest central bank has indicated they will continue buying billions of T-bills through approximately the end of April this year. With both short and long-term real rates never being this negative over the past 20 years, gold will remain well bid.

Additionally, we have a monetary crisis brewing externally to the U.S. as the euro has collapsed coinciding with the push back to an inverted yield curve in the treasury market. With respect to negative interest rates given the crisis externally in Europe and Japan, the end-result has seen capital flowing into gold, the U.S. dollar, and U.S. equities simultaneously.

When investors are feeling emboldened, they buy equities. When they're fearful, they shift into safe havens such as gold and Treasury’s. But global safe-haven capital flows are going into all three asset classes in tandem due to the major repo liquidity crisis that reflects the collapse in confidence impacting Europe and Japan in particular.

Sovereign bond yields have fallen again since the beginning of 2019 to all-time lows in the euro zone, with the 30-year rate in Germany returning below 0 percent. This not only has resulted in nearly 25 percent of the European sovereign debt offering a negative return, but also 15 percent of the private company euro zone debt.

While investors continue to lose faith in global monetary policies by bidding up gold to record highs in most major currencies, central banks have steadily increased their acquisition of gold to the point where their purchases are equivalent to approximately 20 percent of new gold production.  

Therefore, we have the perfect storm brewing for gold. In the longer term, this uptrend that has been taking place since August 2018 when gold bottomed at $1167 may very well end with a parabolic conclusion, which is common in fear-based moves. Due to the factors mentioned, the recent breakout could further exacerbate the bullish momentum in the safe-haven metal which could head for a climax to this powerful up-leg in the US$1,800 range within the next few months.

While gold equities and silver have lagged bullion, conditions seem in place for some catch-up to trigger Phase II of the bull market in the miners. The GDX has awoken this week from its previous relative weakness and should begin to consistently lead the gold complex higher soon. After a 6-month consolidation, the global miner ETF is on the cusp of breaking out of a cup & handle formation on its daily chart. While this technical pattern is bullish on its own merit, an even more powerful 3-year cup & handle pattern has formed on its monthly chart as well.

Although gold mining shares performed well in 2019, they are extremely undervalued as investors remain cautious despite the most bullish fundamentals the metal has ever seen. For all of 2019, the GDX saw significant outflows as the number of outstanding shares in the largest gold stock ETF declined from 502 million to 441 million, a 12% reduction. This occurred in spite of the GDX being up over 39% in 2019.

Despite gold trading at 7-year highs, the safe-haven metal remains under-owned by private portfolios. Moreover, gold stocks are severely under-owned by investors, while languishing at depressed fundamental valuations even as their earning power is improving.

Once a breakout has occurred in the GDX above $31 on a weekly closing basis, momentum traders will flock to this tiny sector and bring much needed buying into the precious metals equity complex. Over the past few years, I have positioned Junior Miner Junky (JMJ) subscribers in the best in breed precious metal juniors well ahead of the recent surge higher in gold. The JMJ real money portfolio gained 35% in 2019, while being up 160% since its inception in 2016. If you would like to receive my research, newsletter, portfolio, and trade alerts, please click here for instant access.

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.