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.
9/5/2018: Gold firms as dollar weakens
In this issue:
Emerging market crises
Debt, debt, debt
A volatile fall
Bullion and classic coins
Gold fell sharply in August as the dollar surged to 2018 highs, driven primarily by international flights to safety over currency crises in emerging markets. Weakness in the metal quickly turned into a technical selloff as speculators piled into the gold futures market with a record number of "short" positions, betting on lower prices and creating a self-fulfilling prophecy.
While the dollar has now given up almost all those August gains, many speculative short-positions remain in the gold futures market, biasing sentiment and keeping gold from rebounding by as much as the dollar has fallen. In addition, US stock indexes hit new highs in August, adding to the atmosphere of complacency that prevails in financial markets today despite many warning signs like escalating trade-war tensions, emerging market financial crises, and political turmoil at home and abroad.
In other words, the August selloff has created an unusually good buying opportunity for the currency of last resort. Autumn is traditionally the period of rising prices after the dog days of summer. When gold does turn around, which we expect to happen this fall, speculators will have to scramble to cover their short positions, creating a wave of technical buying that could drive gold sharply and rapidly higher.
Emerging market crises
It's important to keep in mind that a strong but temporary rise in the dollar during global currency crises is nothing new. It happened during the Greek and Italian debt crises a few years ago, and it's happening with emerging market currencies now. The difference is that the stronger dollar is actually causing these new problems, at least in part. Its rebound from a three-year low earlier this year is creating serious international financial imbalances, especially in emerging markets, where huge amounts dollar-denominated debt must be paid back at much higher rates of exchange.
For example, the Argentinian peso has plummeted almost 50% against the dollar in the past year. To defend against further declines, Argentina hiked a key interest rate to 45% in mid-August and raised interest rates yet again to 60% on August 30, after the currency cratered over 15% against the dollar in two days. The Turkish lira is down 45% against the dollar this year, having lost nearly 20% in one day in August. Brazil’s real has fallen about 25% against the dollar since March, with a 10% drop in August alone. Inflation in Venezuela reached 46,305% in the 12-month period ending June 30. All these nations are carrying huge debt loads that become more expensive as the US raises interest rates and the dollar strengthens.
Countries with the largest current account deficits (balance of trade, net earnings on foreign investments and net cash transfers) are the hardest hit. After Turkey and Argentina, South Africa and Columbia have the next largest deficits. Some relief will come from the fact that the dollar has now given up most of its August gains, but confidence in these economies and their currencies has been severely damaged.
On a brighter note, German economic performance (the engine of Europe) has strengthened in the last month, buoying the euro against the dollar, despite rumblings over trade wars and tariffs. And this has helped to push the dollar back to around 95 on the US dollar index. Considering this dollar correction, gold remains substantially undervalued, in our opinion, at well under $1,250, trading today at around $1,195 per ounce.
Debt, debt, debt
Over the last ten years, all forms of debt have grown furiously. Total global debt is now a whopping $169 trillion, up from $97 trillion on the eve of the Great Recession. Globally, a record amount of up to $10 trillion in corporate bonds must be refinanced over the next five years. Many corporations face the same debt issues as Turkey, Argentina, and Brazil.
All this debt will end badly for all major currencies relative to gold, but today no one seems to care. A debt-fueled US economy and the longest bull market ever in US stocks are feeding risk appetite to gold’s short-term detriment—but likely to its longer-term benefit.
A volatile fall
Markets are likely to be more volatile than normal as US mid-term elections loom closer. We’ve never seen a more polarized electorate than we have today, and these elections are turning into a real showdown.
Gold and silver moved strongly, both up and down, during the run up to the 2016 presidential election. This fall will probably repeat that volatility. With 2018 lows for both gold and silver most likely already in place, there’s really nowhere to go from here but up.
Since 1992, when one party has won control of the entire government, the next election cycle has rebalanced some of the power and gridlock has ensued. Should the government become split once again, nothing will be accomplished. The only certainty is our debt will continue to grow. The dollar will most likely resume its fall and gold and silver will catch a strong bid as a result. We see this as an opportunity to add gold and silver to our portfolios now, on the cheap.
The inverse relationship between the US dollar and gold was the primary driver of the recent selloff in gold. Driven by strong GDP in the US during the second quarter and the prospects of a fourth rate hike by the Fed in 2018, the dollar has been the strongest currency in the world this summer. Against substantially weaker economic growth in Europe, Japan, and China, and a Chinese devaluation of the yuan to counter US trade tariffs, the US economy and the dollar were clearly safer bets for cash seeking the highest returns. As one analyst put it, "the dollar is winning by default because other currencies are worse."
As you can see in the chart above, the dollar flirted with a breakout to the upside above major resistance at 95 through July. In August, it finally broke strongly to the upside, turbo-charged by an international flight to safety after the Turkish lira plunged into freefall, losing 40% of its value in a matter of days and triggering fears of contagion throughout the Eurozone. A similar tumble in the Argentina peso added to the dollar's gains.
The dollar quickly surged to a peak of 96.61, pushing gold to its 2018 low of $1,184 in mid-August. A rising dollar weighs on gold and other commodities priced in it for global trade by making them more expensive in other currencies.
Today, we are seeing the pendulum swing back from those mid-August extremes towards short-term equilibrium. The dollar settled back down back to 95 on the index chart last week and gold rebounded back over $1,200.
All things being equal, relative to the US dollar index, gold should be $50 to $75 higher today than it is. Fear over tensions with North Korea and Iran has subsided dramatically over the last six months, helping to ease the demand for gold. But intractable problems with both North Korea and Iran remain.
Looking at the gold chart, it's clear that gold’s break below the primary blue major uptrend line is a technical setback. We anticipated gold would hold at or near the support line at $1,245 to $1,250 but selling pressure in August was surprising, and now we know why.
During this recent downturn, an unusually large number of “short” positions developed in the gold market, in which speculators sold futures contracts betting on a price decline. In fact, sellers outnumbered buyers to create a net short position for the first time since December 2001, when gold was $275 per ounce. The next time the net short position was this great, in December 2015, gold bottomed at $1,050 just before the Fed raised interest rates for the first time in nine years. Within two months it rallied $150 to more than $1,200 per ounce.
Markets tend to reach extreme valuations, either high or low, when speculators create one-sided long or short positions. Why? When the market moves against the shorts, speculators rush to buy back their short positions, creating upside pressure in the same way they created downside pressure when they sold “short.” It’s like people on a boat all moving to one side until suddenly the boat begins to tip over. When they realize they’ve gone too far, they all rush back to the middle at the same time.
This is exactly how the last two major up swings occurred, first in late 2015 and then in late 2016. The 2015 and 2016 lows were both caused by large short positions established ahead of the Fed raising interest rates. On both occasions, following strong sell offs and bottoms, gold rebounded sharply to create the big V-shaped movements you see on the chart.
Understanding the fundamental drivers of gold’s recent selloff, we've been looking for a short-covering rally. We got a mild one on Friday August 24, when gold jumped 1.6% for its biggest one-day gain since March, hitting a three-week high of $1,213. We think a bigger one is yet to come.
With gold around $1,200, price stability is returning. If it can reach $1,225, an even stronger rally should ensue, propelling it quickly towards $1,250. Time will tell. For now, though, the shorts remain dominant, which means the spring is loaded for a big jump on the next short-covering rally. Under $1,250, gold offers an unusually good buying opportunity, in our opinion, especially as we enter the autumn buying season.
While gold has undergone a major correction over the last month, silver has been hammered. Once it broke short-term support at $15.50 in early August, the rout was on and silver plunged quickly to an August low of $14.54, and then just yesterday silver traded down another leg to around $14, a 2018 low.
The latest Commitment of Traders report indicates that silver, too, has gone into a negative short position on the futures exchange. This is the first net short position we have ever seen in silver!
Today, silver is once again back to an extremely low value relative to gold as measured by the gold-to-silver ratio, with the current ratio at over 84:1. This is just the fifth time silver has been priced this low relative to gold over the last 20 years.
With a more normal valuation range of 77:1 to 65:1, even during periods of weakness, silver should be trading in the $15.75 to $18.70 range, relative to gold today at $1,200. Using this relative valuation, silver is easily over sold by $1 per ounce or more today. When silver moves, it can make 50 cent moves in one day. Silver under $14.50 will most likely be the deal of the year in the coming weeks.
With the US dollar weakening to 95 on the index chart, we believe gold and now silver have already hit their bottoms for 2018. As we said earlier, time will tell. Physical buying ramps up substantially in the fall, and especially during the fourth quarter. If we get the short-covering rally we expect, gold could easily be back over $1,250 and silver $15 before long.
Bullion and classic coins
The recent sell-off has created a buying wave for gold and silver bullion, taking much of the slack out of the market. After being squeezed for the past 12 months, premiums are back to normal for many of the most popular gold and silver bullion items, like US Gold Eagles and Silver Eagles. In many cases, the discounts we've been able to find over the past 12 months have dried up.
Classic European gold coins
For the time being, we have unusually low pricing on some of our most popular European gold coins. British Gold Sovereigns BU and Swiss 20 franc Helvetias BU are trading today at lower than modern bullion prices. Supplies are very limited, however, and quick sell- outs of available coins at discounted prices are the norm these days.
We are extremely excited to offer a small cache of French 40 franc Napoleon First Consul gold coins in Very Fine to Extra Fine grade. These fascinating and important coins date from the brief period after Napoleon Bonaparte's election as First Consul of France, before he overthrew the Republic and declared himself Emperor.
Minted in 1802 (or AN XI in the Revolutionary Calendar), they feature Napoleon's profile on the obverse along with his last name and elected title, "Premier Consul." Within two years, dispensing with any pretense that France was still a Republic, he would change the coinage to say "Napoleon Empereur," using the first-name styling of a king.
Given their age, scarcity, and amazing history, these classic coins are remarkably affordable. We don’t have many, so get them while you can!
Pre-1933 US gold coins
Premiums and prices for most Pre-1933 US gold coins remain unusually low, but they are beginning to rise. Some of our favorites like $20 Saint-Gaudens in MS65 and $20 Liberty in MS64 condition remain excellent values in the current market. We particularly like the $20 Liberty in MS64 condition due to its much-lower survival rate of just 127,239 coins, and its previous market high of over $3,600. Today these scarce coins are trading at about half of their previous market high in 2009.
Better still, we have several pre-1900 $20 Liberty gold coins in MS64 that we never see in any real quantity in the national market. We have a handful of $20 Liberty gold coins in MS64 dated 1899-P (only 4,107 known survivors in MS64) and 1898-S (only 2,775 known survivors in MS64). We cherry-picked the very best coins from two small deals we found at the Philadelphia ANA coin show last month, and we still have a few remaining coins available. Please call your account manager at 1-800-613-9323 for pricing and availability.
That's it for now. As always, thanks for your time and business!
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