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It’s a gold bull market.  It was one already, of course, but we’ve got a clean breakout now and a path to much higher prices.  Gold still isn't making the front page, which I’m very happy about.  I want to see a nice sustained rally, not something parabolic that goes down in flames.

As I feared it would, covid-19 is making its way around the globe.  While the infection rate outside China is still quite low, the growth rate in places like Italy, South Korea and Iran has been alarming.  It’s still very early days.  We haven’t seen infections really accelerate in North America.  We don’t know if that’s luck or they just haven’t shown up on the radar yet.

After years of ignoring anything negative, Wall St is finally starting to get spooked.  Relatively speaking, the pullback is pretty minor but, here too, we don’t know what the ultimate impact will be.  I think things get worse before they get better.  I’ll be shocked if Wall St manages to dodge at least a garden variety correction (>10% drop) and something worse is very, very possible now.

Bond yields are vaporizing and central banks far and wide are promising more liquidity.  It’s a perfect storm for gold - in a good way.  Keep an eye on Wall St but enjoy the ride in gold and silver stocks.  I think the good ones will be going a lot higher before this rally is done.  See you at MIF in Toronto!

  Eric Coffin

“Most people don't believe something can happen until it already has. That's not stupidity or weakness, that's just human nature.”

From: World War Z

Ok, not really.  Probably.  I’m not expecting a zombie apocalypse, but its been mentioned (tongue in cheek) as the most likely reason for Wall St to have a real correction. As in “It’s all about liquidity. Everything else—earnings, economic cycle, valuation, none of it matters. The only thing that would make Wall St drop with the Fed pumping liquidity is a Zombie Apocalypse.”

Yeah, Wall St is being cynical, but only just.  It really does feel like it would take a zombie apocalypse to generate a real correction lately.  Nothing has been able to dent the rally. But I think that might be about to change.

Look at the SPX chart below. I noted in the last issue that it was closing in on its 50-day moving average, but that it had done that, and pierced it, three times in the past year only to bounce right back.  Sure enough, it did that again and is trading near all time highs as this is written. Though it’s taken a couple of “stick saves” in the form of late day surges to keep things from looking worse lately.  It’s still a bullish chart but you can sense traders starting to get more uneasy.  I’m surprised its taken this long. Unfortunately, I think things could get worse, and quickly.

Lately, it seems everyone is trying to downplay the importance of COVID-19, the coronavirus illness.  Much has been made of the relative decline in new daily cases and deaths in China.  That IS good news, though it needs to be tempered with a very large amount of skepticism. 

China has moved the goalposts a couple of times, changing how it defines active cases.  The problem is bad enough, with over 75,000 cases admitted to, but most observers believe the real total is much higher. China has long been the world’s epicentre for “draconian measures” - you can do that when you’re a one-party authoritarian state.  Even given that, the scale of the restrictions in China is unheard of. 

It’s hard to grasp the idea of hundreds of millions being quarantined but that’s what's going on. Beijing realizes the market is worrying and is trying to spin as positive a narrative as it can. It spews out press releases about potential treatments and talks about factories restarting. 

The news on the ground is different. The virus struck when hundreds of millions were on New Year’s holidays. Overlapping travel restrictions means its hard for them to get back home and to work.  And many don’t want to.  With Covid-19 fears high, who wants to be stuck on an overcrowded train or bus?  Anecdotal evidence is that many are not returning to work until they think the worst is over.

No one knows how long that will take.  New cases in China are starting to level off thanks to the containment efforts—if you believe the official numbers. But the virtual shutdown of most of China is now a month old and it could easily be another month or two, or more, before things return even partially to normal. And that assumes the virus spread stops almost immediately. There was news the other day about China building another nineteen pop up hospitals in Wuhan.  Does that sound “under control” to you?

I wrote in the last issue that the most important numbers would be ex-China, if only because they are more reliable.  The news there has been mixed but getting worse fast. Most countries have reported very slow growth of cases, but we’re very early still. It’s hard to gauge the rate of spread when you’re dealing with such small numbers.

The more worrisome trend is developing elsewhere is Asia, where the virus has presumably had the longest time to spread.  We’re seeing confirmed cases spike higher in the past few days in Japan and South Korea.  Korea just announced what amounts to quarantine for the two cities with the most cases. The number of cases and areas quarantined could rapidly grow now.

In the past 48 hours we’ve seen new clusters pop up in Italy and Iran. Epidemiologists seem most worried about the Iranian outbreak because they haven’t been able to figure out where it came from.  There hasn’t been an obvious vector like a recent traveller to China discovered yet.

This might still pass without being a major crisis outside of China but, honestly, the odds of the world getting off that easy are getting worse, not better. Many countries are still taking it less than seriously. They could pay dearly for that later.

Even if things are mainly contained to the hardest hit Asian nations, we’ve barely begun to feel the repercussions.  China's manufacturing sector is part of just about every major supply chain you can think of, worldwide.  Throw in Korea and you’ve covered mst of the rest.  It takes time for the impact to be felt but we’re going to see more and more announcements about plant shutdowns in the west due to a shortage of components.  

Loss of demand within China is only the opening act, though that looks bad enough in itself.  China’s main association of auto retailers reported that car sales in China in the first half of February declined 92%.  Let that number sink in. China is the world’s largest car market.

Yeah, its only for two weeks, but it won’t have to last long to crater China’s economy.  And getting these supply chains back to normal could take weeks or months, depending on how long China’s factories are running on skeleton crews.

Up to now, Wall St has been dismissive of the whole situation because it’s happening “over there”.  That just shows you how myopic Wall St can be. You can feel the level unease rapidly rising now though. 

Its news outside of China that will drive things in the short term. It’s looking like both Japan and Germany could be about to slip into recession. In the medium term I expect to see a lot more revenue and profit warnings as companies have trouble getting parts out of China, and perhaps Korea and Japan as well.  This is going to get worse before it gets better.

Outside of Wall St, we’re seeing some big impacts already. One of the most impressive moves this month has been the US Dollar rally.  Yeah, I know, my USD call from a couple of issues ago is looking like crap. I noted then that “fear buying” could derail a move lower in the USD and it certainly has so far.  Money chasing Momo on Wall St, higher growth rates in the US or safety in US Treasuries have all contributed to the surge in the Dollar.

That’s not good news for the US, though some bulls point to it as proof that Wall St will remain exceptional.  I’d agree its evidence that investors are viewing the US as a safe haven. The downside is that a surging currency will damaging profit margins for the large multinationals that dominate the S&P 500.

The chart below is the latest Markit purchase managers survey, which shows a complete reversal of earlier upward momentum in February.  Note that this is the “composite” survey that covers both manufacturing and service sectors. Somewhat ominously, the big hits in the survey were in the broader service sectors, which show the first contraction since 2009.

Markit survey readings tend to be more volatile than the better-known ISM version, though their accuracy is improving. I think the reading is important though, as its one of the first to cover the period since covid-19 really hit.  The weak Markit reading is largely responsible for the big drop in the USD index on the final day covered in its chart. 

As you probably already know, that money flowing into the USD didn’t buy greenbacks to stuff under mattresses.  A bunch of it bought equities, but even more of it went into the bond market. You can see that in the three year 10-year Treasury yield chart, below.

As this is written, 10-year yields are back below 1.5%.  The US yield curve is again inverted out to beyond the 10 year mark.  As has happened before, bond traders see to be envisioning a darker future for the economy, or maybe they’re just more cynical about the ultimate impact of QE in all its forms.

The current level of yields looks like an important one.  It’s just above where yields bottomed last September, as well as in 2012 and 2016.  Below about 1.4% on the 10-year we’re in truly uncharted territory.  I don’t know where the downside target would be.  Some think it’s zero, or that the debate abut negative yields is about to restart.   They could be right.  Multiple central banks are pledging more support through QE if the covid-19 situation deteriorates further. China, in the center of the crisis, keeps pledging more monetary and fiscal stimulus in an attempt to quell market panic before it starts.  It looks like the decades long bull market in bonds still isn’t over.

A far more important signal to gold investors has cropped up in the bond market again.  Negative real interest rates in the US.  You can see the situation summarized on the chart below.  In addition to falling yields, there’s been a small uptick in the US consumer price index.  The green trace on the chart is the real 10-year rate (nominal rate minus the CPI).  It hovered around zero when 10-year yield made their last low in September but moved decisively lower in the past month or so.

It’s hard to say if the CPI increase lasts.  If we see further demand drops for commodities and oil it will put some downward pressure on the producer price index, which may flow through to the CPI. On the other hand, if the supply chain problems get worse and force a lot of substitution by midstream and downstream manufacturers, we could see some price increases to cover those higher costs.

I don’t know how CPI will play out yet, but it seems to me this move back into negative real yields won’t be short-term.  Unless covid-19 becomes a flash in the pan (possible, but not the most likely outcome) the combination of huge money flows into bonds and continued central bank support could drive real yields further into negative territory.

This is the largest omnidirectional move in yields since 2011.  And, no, I’m not picking that date at random.  You can see that dive in real yields when the US Fed was creating new QEs.  It marked the all-time high price for gold in nominal US Dollar terms. Are we going to see another USD new high in gold soon?  I don’t know how fast it will be—I’d prefer a measured move, myself—but if the trends building for the past 3-4 months continue then, yes, odds are we see a new high gold price in USD.

Another reason for gold’s recent move is that, in terms of many other currencies, its already had a clean breakout above previous all-time highs.  The 20-year performance chart below is a bit of a mess but helps get the point across.  I didn't add more currencies because it was unreadable enough already.

The first thing to note is the overall percentage gain since 2000, in any currency you care to look at. Gold’s done well as an asset class. Far better than the mainstream gives it credit for.  In some currencies it’s done fabulously well. 

In addition to fear buying, there’s some traders who don’t think in USD terms trading an obvious breakout. About the only major currencies gold is not at all-time highs in, yet, are the USD, Swiss Franc and Chinese Yuan. Given the fiscal an monetary path China seems destined to follow, odds are an all-time high in Yuan is next.

The one-year gold chart on this page is a thing of beauty. We’re almost $100/oz above the August highs and $1550-1600 should be support rather than resistance now.  We’ll see some pullback for sure if the market decides covid-19 fears are overblown.  Things will have to settle down in South Korea, Italy and Iran for that to happen though.  Those are the outbreaks being watched now.

It seems inevitable we’ll see new USD highs at some point in the next 12-24 months.  Gold won’t (I hope) go straight up.  Markets rarely do, and it’s a bad sign when it happens. 

One of the most impressive things about the current rally is that the mainstream financial press has barely noticed it.  I know that’s frustrating gold bugs, but it’s a good thing.  We’ve had a good run so far.  I think it can continue, with occasional corrective action.  I don’t want to see gold on CNBC morning, noon and night or have my Uber driver recommending gold stocks to me.  Some day yeah, but let’s get a couple of years of nice bull market under our belts first, ok?

Speaking of manias, look at the chart above that tracks small investor call buying.  It’s been going through the roof lately.  Options give you the ability to make highly leveraged bets, but they are also high-risk bets if you don’t know what you’re doing, and most option neophytes don’t.  Trading volume has now reached levels last seen right before the GFC.  That’s probably no coincidence as this level of call buying is sort of the equivalent to, you guessed it, your Uber driver telling you you’ve got to be long the SPY or FAANG stocks. Not good.

We’re a week away from PDAC.  Many juniors see pullbacks after that, mainly due to lack of news flow.  If gold holds up and moves toward $1700 it could forestall the “PDAC curse” this year, at least for the active names. That does happen some years, when we’re in a real gold bull market. It sure looks like one right now.

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