Sive Morten
Special Consultant to the FPA
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Fundamentals
Yesterday we've done important work, I suppose, because it is vital now to understand what to expect from central banks and in what positions do they stand. Analysis that we've made, leads us to conclusion that hardly we get any move from ECB in September. It is really heavy statistics in EU and hardly it will become better in two months. Concerning the US, we suggest that inflation could start a new spiral up, if we take a look at some "secondary" indicators that making evident ongoing destructive processes in economy.
Today, we mostly will make a cross market analysis for the gold by looking at crude oil, but in some specific manner. By look at crude oil market conjuncture we will show that inflation spiral is unavoidable, which indirectly means improvement position for the gold market as well.
Market overview
Analysts slightly lowered their gold forecasts for this year on the grounds zero-yield bullion would need a catalyst for another run to all-time highs, such as an interest rate cut from the Federal Reserve, a Reuters poll showed on Thursday. The poll of 36 analysts and traders conducted through July returned median forecasts for gold at $1,950 an ounce in the third quarter of this year, $1,995 in the fourth, $1,944.5 for the full year and $1,988 in 2024.
Three months ago, a Reuters poll predicted prices would average $1,950 in 2023.
As fears of a global banking crisis receded and the U.S. debt ceiling impasse was resolved, gold , considered a hedge against political and finiancial turmoil, retreated by nearly 5% since its surge in early May to a few cents shy of the all-time high hit in 2020.
Hawkish comment from the Fed and other central banks also drove the retreat since a high interest rate environment prompts investors to opt for assets such as bonds and the U.S. dollar rather than zero-yield gold. On Wednesday, the Fed raised rates by a quarter of a percentage point, marking the 11th hike in its last 12 meetings, and the accompanying policy statement raised the possibility of another increase.
Standard Chartered analyst Suki Cooper said gold is "more likely to test the downside until rate cuts materialise unless a new catalyst emerges".
But $2,000 was still a "viable target" for gold on the basis of factors including a likely end to the rate hike and sustained geopolitical tensions, StoneX analyst Rhona O'Connell said.
For silver , the poll forecast average prices of $23.52 an ounce in 2023 and $25.00 in 2024. Silver shed over 5% in the second quarter.
Analysts of gold mining shares point on retracement in the beginning of the August, but suggest that it should be short lived:
JPMorgan Chase & Co. sees an opportunity in gold ahead of a likely US recession, predicting prices will push past $2,000 an ounce by year-end and hit fresh records in 2024 as interest rates start to fall. Falling real yields in the US will be a “significant driver” for the precious metal when the Federal Reserve starts to deploy rate cuts, which should play out in the second quarter of next year, Greg Shearer, executive director of global commodities research, said in an online briefing on Wednesday.
Gold has rallied around 15% over the past 12 months, supported by signs the US rate-hiking cycle was nearing an end, buying by central banks, as well as bouts of haven demand. In early May, it approached its record high of $2,075.47 an ounce, set in 2020.
The bank has an average price target of $2,175 an ounce for bullion in the final quarter of 2024, with risks skewed to the upside on a forecast for a mild US recession that’s likely to hit sometime before the Fed starts easing.
Money managers’ net-long positions in gold futures have increased this year, but the trade still isn’t too crowded, he said. Other sources for physical demand have also come into effect, with central bank purchases becoming an increasingly strong driver of prices. “There’s an eagerness here to really buy in and diversify allocation away from currencies,” Shearer said, adding that geopolitical risks have made gold even more appealing to governments.
According to the report by State Street, on average, Millennials have 17% of their portfolios allocated to gold. Boomers and X-ers lag with a 10% allocation on average.
About 88% of the investors surveyed who hold gold called it a long-term investment. More than 70% reported that gold boosted the overall performance of their portfolios. More than half of the respondents who currently invest in gold said they plan to increase their allocation in the next six to 12 months.
While ETFs provide exposure to the price of gold and can serve a similar role in a portfolio, owning shares of a gold ETF is not the same as owning gold. There are good reasons to invest in ETFs, but they aren’t a substitute for owning physical metal. In an overall investment strategy, SchiffGold recommends buying gold bullion first.
Having physical metal in your possession is particularly important in the event of an economic meltdown. Think about it: what would you rather have in your possession during a crisis – a piece of paper, or a physical asset recognized as real money all over the world? In the event of an economic collapse, barter could become an important means of conducting business. That’s exactly what happened in Greece during its economic meltdown. You can use gold coins and easily barter in an emergency. People all over the world recognize gold as money. It’s much less certain that you would be able to liquidate an ETF during a time of crisis.
Consider a case of a dollar collapse or hyperinflation. The rapidly rising price of consumer goods, from groceries to gasoline, would make day-to-day living very difficult. Even if you managed to liquidate your gold-backed ETF, the currency you pull out would rapidly lose value. Physical gold, in your hand, would be immune to the government’s printing press. In all likelihood, your gold would buy you the same basket of goods and services a month, or even a year later. The cash you pulled from your gold-backed ETF would likely purchase far less as time goes on.
Physical gold offers stability and certainty in your investment. You can put a gold coin in your pocket. With a gold-backed ETF, all you have is a piece of paper representing a legal promise. That’s well and good in normal market conditions – but in a real emergency, promises are easily broken. Gold-backed ETFs have a place in an overall investment scheme. But for security in the event of a crisis, they simply cannot replace physical gold.
WHAT CRUDE OIL MARKET TELLS US
U.S. retail gasoline prices reached their highest levels since November. Average gasoline prices have risen by 13.4 cents from a week ago today, according to AAA data published on Thursday. The current price for the average gallon of retail gasoline in the United States climbed to $3.714 per gallon on Thursday—up from $3.687 per gallon the day before. A week ago, gasoline was $3.580 per gallon.
The EIA estimated that gasoline inventories fell again in the previous week by another 800,000 barrels, and are 7% below the five-year average for this time of year, with gasoline production dipping to 9.5 million barrels per day. It is the lowest seasonal inventory level since 2015.
Exxon Mobil had to shut down a gasoline unit at one of the largest refineries in the United States for expected repairs at the beginning of this week, sending gasoline futures up more than 5% on the news. The refinery has a capacity of 522,000 barrels per day, and may be closed for up to four weeks before repairs are completed.
According to GasBuddy data released earlier in the week, U.S. retail gasoline demand rose 0.6% in the week ending Saturday—a week that typically represents peak summer driving season in the country. The largest demand hike for the week was seen in PADD 2, according to GasBuddy.
Gasoline situation is just a interlude. Even described situation is enough to understand that soon it transfers to the price levels and inflation will go up. So is it time to open SPR again? But, it is nothing to open. The scale of the problem is huge.
The International Energy Agency in June predicted that global oil demand is on track to rise by 2.4 million barrels per day in 2023, outpacing the previous year’s 2.3 million barrel per day increase, and on pace to hit another record high. Over the weekend, secretary general of the International Energy Forum Joseph McMonigle had forecast that both India and China will make up 2 million barrels a day of demand pick-up in the second half of 2023, a number which will only rise if and when China is forced to inject another major stimulus to boost its flagging economy.
Goldman Sachs whose chief commodity strategist Daan Struyven told CNBC's “Squawk Box Asia” that the bank expects record demand in oil markets to send deficits soaring and drive crude prices higher in the near term.
Echoing Goldman's view are Standard Chartered analysts Emily Ashford and Paul Horsnell, who recently said that "supply deficits over the next two months are likely to be so visible and large as to allow the market to move above” $85/bbl in the third quarter" (considering Brent is at $84 as we type, this prediction will certainly come true). According to Ashford's calculation, shortfalls of 1m b/d in June and July will balloon to 2.8m b/d in August and 2.4m b/d in September. "The point when significantly tighter fundamentals should show clearly is now imminent."
Then UBS analyst Giovanni Staunovo also joined the bandwagon, writing that the deficit in global oil markets is set to be ~2m b/d in July and August compared with 0.7m b/d in June, adding that if Saudis extend voluntary cuts, September’s deficit could be more than 1.5m b/d. Same as the abovementioned analysts, UBS expects demand growth to be driven by Asia, mainly China and India, while Brazil and Middle East also remain solid.
Last but not least, BofA's head of commodity research, Francisco Blanch repeated what his Wall Street colleagues said, predicting that oil prices could break out of their current range as market grapples with a "supply deficit of about 1m b/d in the second half of this year" while peaking US interest rates and OPEC+ supply cuts, including new discipline from Russia, could push prices even higher:
And now - attention. Biden administration announces purchase of 6 million more barrels of oil for Strategic Petroleum Reserve. While Russia has confirmed a reduction in oil exports by 500,000 barrels per day (additionally to S.A.) It means that US doesn't expect oil price decreasing any time soon.
So, oil production is under pressure, and demand, as we can see, has already exceeded the plausible values:
The main thing is that you can't fix the situation quickly. It will take a decade and trillions of dollars to return production to the old trajectory, which means an increase in inflation due to rising energy costs is inevitable. The situation is similar not only in oil and gas. The entire production of raw materials is under-invested. There are two reasons - eternal price swings, that is, instability, which makes it difficult to attract bank financing and the ESG agenda, which the financial (!!) sector picked up with pleasure. In general, it is very difficult to attract debt financing for the long-term "terribly polluted" production of raw materials for 10 years now.
You may asking why are you bother us with this crude oil stuff, how it relates to gold?
Directly. Above JP Morgan said that it expects drop of real interest rates. It could be achieved twofold - either decrease of Fed rate or rising of inflation. Fed said that no rate cut stands on the table until 2025, while oil deficit is expected in nearest time. It confirms our view - inflation will raise. Energy price is a vital component of any inflation index. Rising of Baltic Dry Index that we've mentioned yesterday - main sea freight index, which measures the cost of shipping goods worldwide, jumped by 13.5% to 1,110 points in the last week of July, the most in five weeks. Together with rising of crude oil is a deadly combination for any CPI index, because diesel and heating oil price will spread over all goods' prices.
And why we can't just increase the oil extraction and refinery?
The problem with the strategic reserve is not only that it is declining, but also that they are most likely draining what is in short supply and historically imported - heavy oil from Russia and before sanctions from Venezuela. Also a heating oil, which was also imported from Russia.
Refineries are created for a certain mixture of oils and, thus, are designed to produce a certain proportion of petroleum products. To get diesel oil, heavy oil is needed. No heavy oil? Add the fuel oil to the light one. Heavy oil can be diluted with light by-products to skew the proportion of petroleum products in favor of, for example, gasoline or kerosene, if the refinery requires it. And so on.
As a matter of fact, the price of fuel in the United States has already begun to rise (as we've shown above) and the price increase will inevitably spread throughout the value chain. The most important thing is that it will not be possible to do something decisive. Venezuelans cannot increase production. It may seem that you need to turn on some kind of toggle switch for this, but this is not the case. For example, they have a huge problem with the tank farm, which is simply clogged with sediment due to long downtime. And there are many such problems. Recovery of production is a long process.
Iran is under sanctions, so as Russia. So we are waiting for a shortage of diesel on the world market or an increase in imports from say India (which will be Russian oil for higher price) to the USA. And, of course, price increases. Plus, so far non-falling consumer spending. This is the second wave of inflation. However, its nature, as you can see, is not quite monetary.
What will the Fed do if inflation returns to 5-6%, especially since the Taylor rule already requires a rate of 9%? They can't do anything about the structural problem. There are simply no tools. As a result, in order for the debt pile to remain alive, you will only have to raise the rate and break everything that remains undone.
Briefly on Taylor rule - The Fed has used it for decades to determine the rate. The nuance is that now, according to this rule, the rate should be 9%.
So, it's a bit difficult to make forecasts here, but you can look at the trajectory of the oil price. $13 to the price per month. Can we see $100-120 by the end of the year? Absolutely. The decline from the peak went at about a similar pace. So by the end of the year we will have to see the acceleration of inflation, and then the population will run out of extra money. In short, an unpleasant picture.
In a good way, something would break now and it would be good to turn on the rear. Because when by the end of the year all the problems will converge into one point, and even the rate may be higher, it will be very painful to fall. Because the height of the fall will be higher.
Now it should be clear how it relates to gold - everything is just beginning. And it seems that JP Morgan forecast of ~$2.150 seems conservative in a shed of crude oil situation.
Yesterday we've done important work, I suppose, because it is vital now to understand what to expect from central banks and in what positions do they stand. Analysis that we've made, leads us to conclusion that hardly we get any move from ECB in September. It is really heavy statistics in EU and hardly it will become better in two months. Concerning the US, we suggest that inflation could start a new spiral up, if we take a look at some "secondary" indicators that making evident ongoing destructive processes in economy.
Today, we mostly will make a cross market analysis for the gold by looking at crude oil, but in some specific manner. By look at crude oil market conjuncture we will show that inflation spiral is unavoidable, which indirectly means improvement position for the gold market as well.
Market overview
Analysts slightly lowered their gold forecasts for this year on the grounds zero-yield bullion would need a catalyst for another run to all-time highs, such as an interest rate cut from the Federal Reserve, a Reuters poll showed on Thursday. The poll of 36 analysts and traders conducted through July returned median forecasts for gold at $1,950 an ounce in the third quarter of this year, $1,995 in the fourth, $1,944.5 for the full year and $1,988 in 2024.
Three months ago, a Reuters poll predicted prices would average $1,950 in 2023.
As fears of a global banking crisis receded and the U.S. debt ceiling impasse was resolved, gold , considered a hedge against political and finiancial turmoil, retreated by nearly 5% since its surge in early May to a few cents shy of the all-time high hit in 2020.
Hawkish comment from the Fed and other central banks also drove the retreat since a high interest rate environment prompts investors to opt for assets such as bonds and the U.S. dollar rather than zero-yield gold. On Wednesday, the Fed raised rates by a quarter of a percentage point, marking the 11th hike in its last 12 meetings, and the accompanying policy statement raised the possibility of another increase.
Standard Chartered analyst Suki Cooper said gold is "more likely to test the downside until rate cuts materialise unless a new catalyst emerges".
But $2,000 was still a "viable target" for gold on the basis of factors including a likely end to the rate hike and sustained geopolitical tensions, StoneX analyst Rhona O'Connell said.
For silver , the poll forecast average prices of $23.52 an ounce in 2023 and $25.00 in 2024. Silver shed over 5% in the second quarter.
Analysts of gold mining shares point on retracement in the beginning of the August, but suggest that it should be short lived:
JPMorgan Chase & Co. sees an opportunity in gold ahead of a likely US recession, predicting prices will push past $2,000 an ounce by year-end and hit fresh records in 2024 as interest rates start to fall. Falling real yields in the US will be a “significant driver” for the precious metal when the Federal Reserve starts to deploy rate cuts, which should play out in the second quarter of next year, Greg Shearer, executive director of global commodities research, said in an online briefing on Wednesday.
Gold has rallied around 15% over the past 12 months, supported by signs the US rate-hiking cycle was nearing an end, buying by central banks, as well as bouts of haven demand. In early May, it approached its record high of $2,075.47 an ounce, set in 2020.
The bank has an average price target of $2,175 an ounce for bullion in the final quarter of 2024, with risks skewed to the upside on a forecast for a mild US recession that’s likely to hit sometime before the Fed starts easing.
Money managers’ net-long positions in gold futures have increased this year, but the trade still isn’t too crowded, he said. Other sources for physical demand have also come into effect, with central bank purchases becoming an increasingly strong driver of prices. “There’s an eagerness here to really buy in and diversify allocation away from currencies,” Shearer said, adding that geopolitical risks have made gold even more appealing to governments.
According to the report by State Street, on average, Millennials have 17% of their portfolios allocated to gold. Boomers and X-ers lag with a 10% allocation on average.
About 88% of the investors surveyed who hold gold called it a long-term investment. More than 70% reported that gold boosted the overall performance of their portfolios. More than half of the respondents who currently invest in gold said they plan to increase their allocation in the next six to 12 months.
While ETFs provide exposure to the price of gold and can serve a similar role in a portfolio, owning shares of a gold ETF is not the same as owning gold. There are good reasons to invest in ETFs, but they aren’t a substitute for owning physical metal. In an overall investment strategy, SchiffGold recommends buying gold bullion first.
Having physical metal in your possession is particularly important in the event of an economic meltdown. Think about it: what would you rather have in your possession during a crisis – a piece of paper, or a physical asset recognized as real money all over the world? In the event of an economic collapse, barter could become an important means of conducting business. That’s exactly what happened in Greece during its economic meltdown. You can use gold coins and easily barter in an emergency. People all over the world recognize gold as money. It’s much less certain that you would be able to liquidate an ETF during a time of crisis.
Consider a case of a dollar collapse or hyperinflation. The rapidly rising price of consumer goods, from groceries to gasoline, would make day-to-day living very difficult. Even if you managed to liquidate your gold-backed ETF, the currency you pull out would rapidly lose value. Physical gold, in your hand, would be immune to the government’s printing press. In all likelihood, your gold would buy you the same basket of goods and services a month, or even a year later. The cash you pulled from your gold-backed ETF would likely purchase far less as time goes on.
Physical gold offers stability and certainty in your investment. You can put a gold coin in your pocket. With a gold-backed ETF, all you have is a piece of paper representing a legal promise. That’s well and good in normal market conditions – but in a real emergency, promises are easily broken. Gold-backed ETFs have a place in an overall investment scheme. But for security in the event of a crisis, they simply cannot replace physical gold.
WHAT CRUDE OIL MARKET TELLS US
U.S. retail gasoline prices reached their highest levels since November. Average gasoline prices have risen by 13.4 cents from a week ago today, according to AAA data published on Thursday. The current price for the average gallon of retail gasoline in the United States climbed to $3.714 per gallon on Thursday—up from $3.687 per gallon the day before. A week ago, gasoline was $3.580 per gallon.
The EIA estimated that gasoline inventories fell again in the previous week by another 800,000 barrels, and are 7% below the five-year average for this time of year, with gasoline production dipping to 9.5 million barrels per day. It is the lowest seasonal inventory level since 2015.
Exxon Mobil had to shut down a gasoline unit at one of the largest refineries in the United States for expected repairs at the beginning of this week, sending gasoline futures up more than 5% on the news. The refinery has a capacity of 522,000 barrels per day, and may be closed for up to four weeks before repairs are completed.
According to GasBuddy data released earlier in the week, U.S. retail gasoline demand rose 0.6% in the week ending Saturday—a week that typically represents peak summer driving season in the country. The largest demand hike for the week was seen in PADD 2, according to GasBuddy.
Gasoline situation is just a interlude. Even described situation is enough to understand that soon it transfers to the price levels and inflation will go up. So is it time to open SPR again? But, it is nothing to open. The scale of the problem is huge.
The International Energy Agency in June predicted that global oil demand is on track to rise by 2.4 million barrels per day in 2023, outpacing the previous year’s 2.3 million barrel per day increase, and on pace to hit another record high. Over the weekend, secretary general of the International Energy Forum Joseph McMonigle had forecast that both India and China will make up 2 million barrels a day of demand pick-up in the second half of 2023, a number which will only rise if and when China is forced to inject another major stimulus to boost its flagging economy.
Goldman Sachs whose chief commodity strategist Daan Struyven told CNBC's “Squawk Box Asia” that the bank expects record demand in oil markets to send deficits soaring and drive crude prices higher in the near term.
Echoing Goldman's view are Standard Chartered analysts Emily Ashford and Paul Horsnell, who recently said that "supply deficits over the next two months are likely to be so visible and large as to allow the market to move above” $85/bbl in the third quarter" (considering Brent is at $84 as we type, this prediction will certainly come true). According to Ashford's calculation, shortfalls of 1m b/d in June and July will balloon to 2.8m b/d in August and 2.4m b/d in September. "The point when significantly tighter fundamentals should show clearly is now imminent."
Then UBS analyst Giovanni Staunovo also joined the bandwagon, writing that the deficit in global oil markets is set to be ~2m b/d in July and August compared with 0.7m b/d in June, adding that if Saudis extend voluntary cuts, September’s deficit could be more than 1.5m b/d. Same as the abovementioned analysts, UBS expects demand growth to be driven by Asia, mainly China and India, while Brazil and Middle East also remain solid.
Last but not least, BofA's head of commodity research, Francisco Blanch repeated what his Wall Street colleagues said, predicting that oil prices could break out of their current range as market grapples with a "supply deficit of about 1m b/d in the second half of this year" while peaking US interest rates and OPEC+ supply cuts, including new discipline from Russia, could push prices even higher:
And now - attention. Biden administration announces purchase of 6 million more barrels of oil for Strategic Petroleum Reserve. While Russia has confirmed a reduction in oil exports by 500,000 barrels per day (additionally to S.A.) It means that US doesn't expect oil price decreasing any time soon.
So, oil production is under pressure, and demand, as we can see, has already exceeded the plausible values:
The main thing is that you can't fix the situation quickly. It will take a decade and trillions of dollars to return production to the old trajectory, which means an increase in inflation due to rising energy costs is inevitable. The situation is similar not only in oil and gas. The entire production of raw materials is under-invested. There are two reasons - eternal price swings, that is, instability, which makes it difficult to attract bank financing and the ESG agenda, which the financial (!!) sector picked up with pleasure. In general, it is very difficult to attract debt financing for the long-term "terribly polluted" production of raw materials for 10 years now.
You may asking why are you bother us with this crude oil stuff, how it relates to gold?
Directly. Above JP Morgan said that it expects drop of real interest rates. It could be achieved twofold - either decrease of Fed rate or rising of inflation. Fed said that no rate cut stands on the table until 2025, while oil deficit is expected in nearest time. It confirms our view - inflation will raise. Energy price is a vital component of any inflation index. Rising of Baltic Dry Index that we've mentioned yesterday - main sea freight index, which measures the cost of shipping goods worldwide, jumped by 13.5% to 1,110 points in the last week of July, the most in five weeks. Together with rising of crude oil is a deadly combination for any CPI index, because diesel and heating oil price will spread over all goods' prices.
And why we can't just increase the oil extraction and refinery?
The problem with the strategic reserve is not only that it is declining, but also that they are most likely draining what is in short supply and historically imported - heavy oil from Russia and before sanctions from Venezuela. Also a heating oil, which was also imported from Russia.
Refineries are created for a certain mixture of oils and, thus, are designed to produce a certain proportion of petroleum products. To get diesel oil, heavy oil is needed. No heavy oil? Add the fuel oil to the light one. Heavy oil can be diluted with light by-products to skew the proportion of petroleum products in favor of, for example, gasoline or kerosene, if the refinery requires it. And so on.
As a matter of fact, the price of fuel in the United States has already begun to rise (as we've shown above) and the price increase will inevitably spread throughout the value chain. The most important thing is that it will not be possible to do something decisive. Venezuelans cannot increase production. It may seem that you need to turn on some kind of toggle switch for this, but this is not the case. For example, they have a huge problem with the tank farm, which is simply clogged with sediment due to long downtime. And there are many such problems. Recovery of production is a long process.
Iran is under sanctions, so as Russia. So we are waiting for a shortage of diesel on the world market or an increase in imports from say India (which will be Russian oil for higher price) to the USA. And, of course, price increases. Plus, so far non-falling consumer spending. This is the second wave of inflation. However, its nature, as you can see, is not quite monetary.
What will the Fed do if inflation returns to 5-6%, especially since the Taylor rule already requires a rate of 9%? They can't do anything about the structural problem. There are simply no tools. As a result, in order for the debt pile to remain alive, you will only have to raise the rate and break everything that remains undone.
Briefly on Taylor rule - The Fed has used it for decades to determine the rate. The nuance is that now, according to this rule, the rate should be 9%.
So, it's a bit difficult to make forecasts here, but you can look at the trajectory of the oil price. $13 to the price per month. Can we see $100-120 by the end of the year? Absolutely. The decline from the peak went at about a similar pace. So by the end of the year we will have to see the acceleration of inflation, and then the population will run out of extra money. In short, an unpleasant picture.
In a good way, something would break now and it would be good to turn on the rear. Because when by the end of the year all the problems will converge into one point, and even the rate may be higher, it will be very painful to fall. Because the height of the fall will be higher.
Now it should be clear how it relates to gold - everything is just beginning. And it seems that JP Morgan forecast of ~$2.150 seems conservative in a shed of crude oil situation.
Last edited:
Yes, it was a typo