AGE Gold Commentary is our regular report analyzing trends in precious metals and rare coins. We monitor domestic and international markets and extrapolate from our 30 years in metals to place current events into a hard asset perspective. View archives.
4/5/2018: Gold positioned for breakout
Rising debt and deficits
China and dollar hegemony
Trade war rumblings
Physical gold still on sale!
After surging 14% in 2017, its best year since 2010, gold had a relatively quiet beginning in 2018, adding 1.4% during the first quarter. But donít let the slow start fool you. Gold is now positioned to punch through major resistance at $1,375 and breakout into a substantially higher trading range. Rising debt and deficits, stronger inflation, a weaker dollar, and growing trade tensions are driving demand for gold, and all have the potential to propel it towards $1,500 this year.
Rising debt and deficits
In March, the US national debt exceeded $21 trillion for the first time ever, up more $1 trillion since September. The government ran a $215 billion deficit in February and borrowed another $300 billion last week to cover expenses. And the ink just gets redder. Reduced revenue from tax cuts, combined with the $1.3 billion spending bill signed recently, will further increase US borrowing in coming months and years. The annual deficit is projected to pass $1 trillion as early as next year. More alarming, annual interest payments on US debt are set to quadruple to more than $1 trillion in ten years, or 3.6% of the entire economy, according to the nonpartisan Committee for a Responsible Federal Budget, if current fiscal policies remain in place.
As our debt-to-GDP ratio expands, creditors (like China, which owns nearly $1.2 trillion of our debt) naturally expect higher compensation for the risk, driving up borrowing costs. Higher borrowing costs, in turn, slow our economy, making it harder to grow our way out of debt. It's a vicious circle. And if creditors decide to unload our debt, the shift would exert enormous additional pressure on the already-weak dollar. Weakness in the dollar, of course, supports higher gold prices because gold is priced in dollars for international trade. And slower growth spells trouble for US stocks markets, pushing investors toward safe havens.
The Consumer Price Index rose to 1.8% in February, still shy of the Fed's 2% target, which means the central bank is not under pressure to accelerate rates hikes. But a new measure of inflation created by the New York Fed, the Underlying Inflation Gauge, shows prices rising at a much faster paceónearly 3% for the same month. Capturing sustained movements in prices from a broader set of prices and financial data, the UIG was devised to more accurately reflect inflation in real time. It confirms what we've been feeling in our wallets, that prices are rising faster that the CPI shows. That's good for gold, which is traditionally used as a hedge against inflation.
China and dollar hegemony
China has taken a major step towards challenging the US dollar as the world's reserve currency. Last month it launched the Shanghai International Energy Exchange, a third benchmark for trading crude oil, alongside Brent and West Texas Intermediate crude. The trades take place in yuan, China's currency, instead of dollars.
Oil is the world's most traded commodity, with an annual trade value of around $14 trillion, roughly equivalent to China's gross domestic product last year, and China is the world's largest oil importer. Shifting just part of global oil trade into the yuan is potentially huge. It will improve the liquidity of China's currency in international markets and reduce the dominance of the dollar at the same time. The yuan has already gained over 3% relative to the dollar this year.
Today, over 90% of all commodity transactions use dollars, which has been the global reserve currency since World War II. The success of the Shanghai exchange will become the model for China to transition into other commodity markets. As the yuan's use in international transactions increases, traders worldwide will have a viable alternative to dollars, and demand for dollars will decrease. This is the biggest threat the dollar will face in the coming months and years, and the implications are enormous. Most Americans donít fully appreciate the degree to which the dollar's reserve status stabilizes and insulates us from volatile currency fluctuations. As the dollar's dominance slips, gold's role as a currency of last resort will become even more important.
Trade war rumblings
To protect US industries, President Trump recently announced stiff penalties on steel and aluminum from China, along with up to $60 billion in tariffs on 1,300 Chinese products. China retaliated this week with proposed tariffs on $50 billion worth of American soybeans, cars, chemicals and other goods. If this dispute blossoms into a full-scale trade war between the world's two largest economies, the likely results are slower growth, higher inflation, and falling stock markets in the short-term. Gold, however, would see a significant rally on flights to safety.
The dollar fell 2.1% during the first quarter and is likely to weaken further in the current environment. Looking at the US Dollar Index chart above, you can see the steep decline over the last 12 months. While we do not expect to see such a steep decline in the coming 12 months, an erosion below the major short-term support at 88.50 is likely.
Since channeling between 88.50 and 90.55 this year, any bounces off the 88.50 bottom have been anemic at best. The dollar has yet to move decisively above its 200-day moving average, which has served as an upside technical resistance level. Absent a firm move over 90.50, the trend remains lower. Ultimately, we believe the dollar could erode to as low as 85 if the current 88.50 support level is broken.
Barring catastrophes, the dollar's near-term fate is tied to relative growth and monetary policy in the US, Eurozone, and Japan. The US emerged from the Great Recession earlier, which allowed the Fed to end monetary easing and raise interest rates, supporting the dollar. But growth in the Eurozone is catching up. While the US grew at 2.9% last year, the Eurozone grew at 2.7%. And Japan is emerging from its 30-year sleep of deflation, posting nine straight quarters of growth, the longest run in 28 years. As global growth synchronizes, so will monetary policies and the dollar will lose some of its yield advantage. The ECB and Bank of Japan have signaled tighter policies to come. Should that happen, the dollarís decline will continue, and gold's uptrend will accelerate.
Over the last 15-months, gold has continued to set a series of higher lows against a flat top. The major corrective phase it has undergone since peaking at over $1,900 in 2011 is coming to an end. A new, more bullish phase appears to be on the horizon. Looking at the latest gold chart, weíve not seen a more solid uptrend in gold in years.
Starting with the December 2016 low of $1,130, five of the last six bottoms have occurred around Fed meetings. In each case, the central bank had widely telegraphed that rate hikes were coming. Gold dropped before each of these five meetings only to rebound afterwards. As weíve said before during this tightening cycle, the actual effect of rate hikes on goldís price movement is diminishing. Gold swung $150 higher and lower in response to the first two hikes, $75 in response to the next two, and a scant $40 around the latest rate increase.
Exactly on cue last month, gold skidded from $1,350 to $1,310 leading into the latest Fed hike, setting a higher short-term low in the process. Traders were concerned that the Fed might signal four rate hikes for 2018, one more than December's forward guidance of three. The Fed's post-meeting assurance of only three hikes this year helped gold to rebound firmly. Then President Trump's announcement of trading tariffs on China spooked equities markets and spurred safe-haven demand, keeping support for higher gold intact.
In the short-term, we see support at $1,310 and again at $1,275. We see upside resistance at $1,360 and major resistance at $1,375. A move over $1,375, a four-year resistance level, would be a major breakout for gold. But given the drivers outline above, we think it is distinctly possible that gold makes at run above $1,400 and toward $1,500 this year. With a solidly rising bottom and a flat top, gold really has no where else to go but higher. Once gold breaks over $1,375, it could move higher very quickly as speculators to pile into the market.
Silver continues to be undervalued, with the current gold-to-silver ratio at 80.5:1. This is at the very high end of the range over the last 20 years, meaning silver is extremely cheap right now relative to gold. A gold-to-silver ratio of 60 to 75 has the metals roughly balanced, and a ratio under 60 means gold is clearly the better value.
Gold is leading silver in the current environment because of its stronger status as currency of last resort. Silver is more tied to industry, and therefore global trade and stock markets. Still, if gold can break out over $1,375, silver will play catch up. We would expect the gold-to-silver ratio to drop to 75:1 or even 70:1.
In the current environment, $17 continues to be the equilibrium point for silver. Silver under $17 is attractive and under $16.50 it is even more so. As you can see above, up to the recent dip below $16.50, previous dips have been V-shaped and short-lived. Silver, like platinum and palladium, has been trading with a real lack of enthusiasm over the last several weeks. In this environment we may see one more drop lower, testing major support at $15.75, before price movement higher begins in earnest.
We see support at $16.35 with major support at $15.75. Silver will find upside resistance at $16.75 and again at the upper blue trend line at just over $17.25, with major resistance at $18.25 and again at $18.50. A move over $18.50 would signal a major breakout; a fall below the 2017 low of $15.42 would signal a breakdown.
As we said in our last Commentary, silver is in a major pennant formation. Once a pennant formation reaches its point, the market usually breaks strongly either higher or lower and a new market direction is established. Because the trend for gold is higher, and because gold and silver normally trade in sympathy, we expect silver to break higher when it reaches its pennant apex, and perhaps explosively so. As many of you know, when silver plays catch up, it can do so very sharply. We see the apex of this pennant forming this summer, so there may be time to still buy silver cheaply relative to gold, based on current market values.
Physical gold still on sale!
With stocks faltering and trade-tensions rising, demand for physical gold and silver has increased in the past month. While many gold and silver coins remain on sale, premiums have rebounded while on-the-shelf supplies have dropped substantially. We still have some great values to offer but they are becoming fewer. If you are interested in adding to your physical holdings, especially in classic Pre-1933 US gold coins, please donít wait!
Modern gold bullion coins like 1 oz US Gold Eagles are selling as low as $29 over their intrinsic gold value. Even better, classic $20 Liberty Double Eagles and $20 Saint-Gaudens Double Eagles in Almost Uncirculated condition are trading at a few percentage points over their melt value. These coins normally have a bid that is higher than we are offering these for today, which effectively negates the buy/sell spread in a healthier market.
Premiums for higher-grade classic US $10 and $20 gold coins are also abnormally low. These pre-1933 gold coins offer the potential for greater leverage to their intrinsic gold value due to their overall scarcity.
$20 Saint-Gaudens in MS63 grade offers the best scarcity for its current market trading price of just 5% to 7% over the spot gold price. This coin has enjoyed a 5-year average premium (price above gold content) of 26% and a 10-year average premium of 37%. Today this coin is a steal but probably wonít be for much longer. This is a fantastic bargain that should not be passed up!
Once again, we believe 2018 is the year gold will make its next leg higher towards $1,500. Now is the perfect time add to your holdings. If you have any questions, our market experts are happy to assist you. Just give us a call at 1-800-613-9323.
As always, thanks for your time.
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AGE Gold Commentary
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