Summary: Amid the precious metals rally that was set off by the rapid spread of coronavirus and uncertainty around the ability to contain it, gold prices had ratcheted up to a seven-year high. While silver lagged the gains of gold, a number of trends underlying the metal, including a rising gold/silver ratio, increased sales of gold by large silver miners, and steadily rising inflation, should pave the way for a new leg up very soon.
While other commodities have fallen in the wake of the COVID-19 (colloquially known as coronavirus) outbreak in China, precious metals have extended their strong 2020 performance until the big sell-off last week.
Gold spot prices broke above $1600 per ounce (oz) for the first time since 2013 and strengthened even further to break above $1680/oz last Monday. Commerzbank reported that inflows of gold into exchange-traded funds had risen for 21 consecutive business days through February 20. Not only are investors looking to hedge against the uncertain outcome of the coronavirus, but central bank demand remains healthy as their purchases are equivalent to approximately 20% of new gold production, according to Kitco. Silver, for its part, continued higher as well, reached its highest closing level since last September, climbing to $18.31/oz last Monday.
Large speculators sharply hiked their bullish positioning in gold futures by 22% in the week before the sell-off, according to data from the Commodity Futures Trading Commission. However, precious metals were caught up the volatility storm, causing money managers to trim some of those positions. Despite that trimming, BMO and Commerzbank noted that Gold ETFs tracked by Bloomberg still registered sizable inflows of "a good 9 [metric] tons."
On a technical basis, more upside looks likely for precious metals. Kitco predicts that gold bulls' next upside price objective is to produce a close in April futures above solid resistance at $1,700/oz, with support at $1,620.00/oz. A break above the $1700 level would mark the highest price for gold since December 2012.
Though silver has not yet surged as much as gold has, it is likely that silver will make an especially strong move upward soon.
Silver miners have actually outperformed gold miners since last summer, they still trail gold miners over the long term, leaving more upside potential to still be tapped. Additionally, while the gold/silver ratio cratered down to 81 from a multi-decade high of 93 in the late summer on a period of relative outperformance for silver, the ratio has been on the rise again in the past few months, peaking out at just below 90 this month. This, combined with strong miner performance that typically leads the strength in spot prices, suggests that silver is still set to make another leg up to catch up with the strength in gold.
The performance of silver miners is becoming more and more dependent on gold than it had been in the past. The Global X Silver Miners ETF's (SIL) 17 highest weighted miners averaged just 40.4% of their Q3'19 revenues from silver, according to The Bull.com.au. The majority of their sales came from gold, which carries much stronger cash flows, bolstering traditional silver miners. The more gold the major silver miners produce, the more they trade like gold stocks amplifying that metal's trends.
Though MRP continues to believe coronavirus will have a material impact on first quarter growth in China and the rest of the globe, as noted in our January viewpoint, we believe that it doesn't have the disruptive potential to create a sustained downturn or resulting recession. Demand in most markets is only being delayed by supply chain backups, as opposed to destroyed by declining financial health of major economies and their institutions. However, the precious metals do have the potential to be one of the asset classes that continues its run even after the coronavirus begins to subside with the end of flu season in March.
While a surprise 50bps cut to the Fed Funds rate on March 3 will provide support to the market, it will likely drive even stronger inflows into gold and silver assets as well, since it effectively legitimizes the perceived economic threat arising from the virus.
As we have maintained since August, we believe the greenback is set for a sustained bout of weakness after a long rally through 2019. Before coronavirus shock sent traders scrambling for safe havens, including the dollar, that is exactly what was happening as the spread between U.S. real rates and real rates of other major currencies like the euro had been tightening for some time, driving dollar depreciation.
After pushing the Fed Funds rate up to its highest level since the 2008 financial crisis in late 2018, the U.S. Federal Reserve was forced to admit that they probably raised short-term rates too quickly, pulling the upper limit back by 100bps in 2019. More cuts now seem likely.
While the dollar had surged alongside higher rates, it fell alongside the new monetary easing cycle and rising U.S. inflation. Lior Gantz, founder of the Wealth Research Group, told Kitco that silver is the true inflation gauge in the marketplace since it carries no "geopolitical premium" like gold does. Higher inflation, Gantz added, is expected to push gold prices higher yet.
Precious metals had also benefited from the weaker dollar, as they usually do, in late 2019, but that historically inverse relationship has broken down in the flight to safety we've seen over the last month. Both have been simultaneously rising steeply, but when the dust of coronavirus settles, it's likely they'll be headed back toward divergent paths. Because our base case for a weaker dollar remains in place, even if the Fed decides on further U.S. rate cuts this year, we believe spot prices for precious metals, particularly silver, as well as silver/gold miners, will be moving higher through 2020 as the dollar returns to depreciation.
Investors can gain exposure to gold and silver spot prices via the SPDR Gold Shares (GLD) and iShares Silver Trust (SLV) ETFs. The top gold and silver miner ETFs are the VanEck Vectors Gold Miners ETF (GDX) and the aforementioned Global X Silver Miners ETF (SIL).
This content was delivered to McAlinden Research Partners clients on February 25. To receive all of MRP's insights in your inbox Monday - Friday, follow this link for a free 30-day trial.
McAlinden Research Partners (MRP) provides independent investment strategy research to investors worldwide. The firm's mission is to identify alpha-generating investment themes early in their unfolding and bring them to its clients' attention. MRP's research process reflects founder Joe McAlinden's 50 years of experience on Wall Street. The methodologies he developed as chief investment officer of Morgan Stanley Investment Management, where he oversaw more than $400 billion in assets, provide the foundation for the strategy research MRP now brings to hedge funds, pension funds, sovereign wealth funds and other asset managers around the globe.[NLINSERT]
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