Sive Morten
Special Consultant to the FPA
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Fundamentals
Gold market shows impressive performance in last few weeks, suggesting that sentiment is changing. Gold is raising together with other assets - stocks, bonds. With the subject of recession that we've discussed yesterday it is not surprising. But recession and coming Fed easing is not the only reason of gold's rally. As we will show you below, the US already has broken fundamental agreements of global reserve currency - preserving of its value. For few years already, the US can't achieve this goal and the Fed rate lags behind inflation. From this standpoint and few other reasons gold has positive perspectives in coming year or maybe be even on longer distance.
Market overview
London's gold price benchmark hit an all-time high of $2,069.40 per troy ounce at an afternoon auction on Wednesday, surpassing the previous record of $2,067.15 set in August 2020, the London Bullion Market Association (LBMA) said. In the spot market, gold prices hit their highest in more than three weeks in anticipation of U.S. interest rate cuts next year.
U.S. jobless claims rose last week, indicating the labor market continues to cool in the year's fourth quarter. Investors are betting on an 88% chance of the Fed cutting rates in March, according to the CME FedWatch tool. On the physical front, China's net gold imports via Hong Kong rose by about 37% in November from the previous month.
Gold prices held steady on Friday as they headed towards the end of their best year since 2020 at levels comfortably above $2,000 an ounce, buoyed by hopes the U.S. Federal Reserve could cut interest rates as early as March. Gold investors anticipate record high prices next year, when the fundamentals of a dovish pivot in U.S. interest rates, continued geopolitical risk, and central bank buying are expected to support the market after a volatile 2023. Spot gold is on track to post a 13% annual rise in 2023, its best year since 2020, trading around $2,060 per ounce.
China's manufacturing activity shrank for a third straight month in December and weakened more than expected, clouding the outlook for the country's economic recovery and raising the case for fresh stimulus measures in the new year. The official purchasing managers' index (PMI) fell to 49.0 in December from 49.4 the previous month, an official factory survey showed on Sunday, weaker than a median forecast of 49.5 in a Reuters poll.
China's central bank said on Thursday it would step up policy adjustments to support the economy and promote a rebound in prices, amid signs of rising deflationary pressures. The government, which in October unveiled plans to issue 1 trillion yuan ($140.89 billion) in sovereign bonds to fund investment projects, is likely to focus on more fiscal steps to support growth next year, analysts said.
China's consumer prices fell the fastest in three years in November while factory-gate deflation deepened, weighed by weak domestic demand. The new orders sub-index was at 48.7, contracting for the third month, according to the PMI survey released by the National Bureau of Statistics. Weak external demand also remained a major drag on factory activity, with new export orders index registering 45.8 in December, contracting for the ninth straight month. The sub-index of factory gate prices was at 47.7, contracting for a third straight month, adding to signs of deflation and pressure on business profits.
The precious metal almost made uncharted territory in May this year as a U.S. regional banking crisis took hold. By October, it had retreated close to $1,800 an ounce until safe-haven demand triggered by the Israel-Hamas conflict spurred another rally. Investors returned to the popular SPDR Gold Shares exchange-traded fund , which posted net inflows of over $1 billion in November.
A Reuters poll in October forecast prices will average $1,986.50 in 2024. They have averaged above $1,950 so far this year, above any previous yearly average price. J.P. Morgan sees "a breakout rally" for gold in mid-2024, with a targeted peak of $2,300 on expected rate cuts. UBS forecasts a record of $2,150 by end-2024 if cuts materialise.
The World Gold Council, in its 2024 outlook, projected that a drop of about 40 to 50 basis points in longer maturity yields, following 75-100 points of rate cuts, could translate into a 4% gain for gold. The World Gold Council attributed gold’s sudden spike to short-term technical trading. "The longer-term story, that of strong central bank gold buying, probably had nothing to do with Monday’s quick move,” John Reade, the WGC’s market strategist, said in a statement. “By far the most important financial market drivers of gold will be the US dollar and the amount of cuts priced into the US interest rate market.”
Central banks have certainly been the biggest buyers; according to Metal Focus data, they’ve added 800 metric tons of gold this year. China has led the purchases, accumulating 180 tons, followed by Singapore and India.
At the same time, Exchange-traded funds have sold over 100 metric tons of physical gold this year, an offload of 8%. And then there’s the supply side, with mine production this year up 6% to a record 1,267 tons. Recycling has increased 8% to nearly 300 tons.
The conflict in the Middle East, uncertainty from elections in major economies, and central bank purchases led by China will also boost safe-haven bullion's appeal next year, analysts predicted. But, "gold could be forced to unwind some of this year's gains if an inflation resurgence forces the Fed to abandon plans for a policy pivot in 2024," said Han Tan, chief market analyst at Exinity.
Inflation cooling faster than the Fed trims rates may also slow the economy and dent retail buying. Heraeus Metals expects higher gold jewellery demand in top consumer China this year, with more support possible in 2024 from stimulus measures. By contrast, silver looks set to fall 1% in 2023, trading just under $24 an ounce. It will trend towards $26 an ounce next year, benefiting from improved industrial demand, according to TD Securities.
On track to fall 6% in 2023, platinum will hold a range between $800 and $1,100 an ounce in 2024, Heraeus estimates. The impact of the energy transition was demonstrated as autocatalyst-dependent palladium fell by more than a third this year, the market's worst performance since 2008. Palladium , which fell below $1,000 an ounce in November - for the first time in five years - before recovering, faces surpluses as electric vehicles become more popular. Bank of America expects palladium to average $750 per ounce in 2024 subject to any major supply cuts.
GOLD-to-S&P Ratio
So the signs indicate that gold is undervalued (the chart, however, for some reason is about contango/backwardation in gold futures). Although sometimes you don't understand. Either the gold price comparison base is undervalued (oil) or overvalued (the S&P bubble), or gold.
But in any case, looking at the past breakdowns of the financial system using the example of the 70s, one can hope that this time there will be a comparable revaluation of gold by 5 times or more in 3-4 years. Everything is being looked at for this - then the dollar has become untied from gold, this time the inflation rate should be covered.
50-year Bretton Wood system is falling
Inflation targeting is the pillar on which the global financial system has rested for 50 years. Before this, everything was clear and understandable. Here is a dollar, here is the amount of gold that is “tied” to this dollar. In theory, you can take it and exchange it.
Then, for obvious reasons, when it became clear that the money supply exceeded the amount of reserved gold by several times, in 1971 the dollar was untied from gold. This was the very first post-war scam of the world financial system by the United States. That’s why everyone ran to gold and its nominal price increased 20 times. And this was even before the powerful waves of inflation began.
As a matter of fact, after this the petrodollar system was built, and then the consumer-dollar system, based on agreements with the oil-producing countries of the Middle East and China. In fact - consumer-dollar agreement with China has let P. Volcker to defeat inflation, as big dollar supply finally has been backed by Chinese goods and inflation has started to fade but not because of the Fed and P. Volcker efforts as everybody think.
At the same time, a new financial system appeared, based on the dollar, which was not backed by any hard asset. However, it was secured by the promise that the dollar is a reserve currency in which it is possible to maintain/preserve value (i.e. M. East petro countries and China, that received dollars for their oil and goods could invest them in US Treasuries) purchasing power through the purchase of American government debt.
This promise was based on the same “inflation targeting”, when the Central Bank rate, and therefore the yield on government debt, should be higher than inflation. It seems to be believed that, for example, the Fed can also control inflation through monetary policy, which is far from the case.
Here it is important to understand that the beautiful words of the Central Bank about the monetary policy transmission mechanism and all that other stuff that accompanies inflation targeting only works theoretically, since in addition to monetary policy there is also fiscal policy, which can destroy all the efforts of the Central Bank to keep inflation under control via rate and liquidity regulation. What we now actually see from the Fed’s unsuccessful attempts to return inflation to 2%.
Why, in fact, we talk about another scam of the global financial system by the United States is possible, that is, that they will break the promise on which everything has been held for 50 years? Because this has already been happening for two years. Cumulatively, the rate does not catch up with inflation, that is, the loss of purchasing power of the dollar has already occurred. Very roughly to explain the point - the accumulated inflation over 3 years is 20%, and the cumulative rate does not reach 10%.
No, of course, if (a very big “if”, taking into account the fact that in the 80s there are no ways to ensure demand with cheap Chinese goods and bring down inflation and this is not a matter of monetary policy) the Fed managed to reduce inflation to 2% , and keep the rate at 5.5% for another couple of years, this could compensate for the depreciation.
But judging by Powell’s latest speech with dovish rhetoric, they cannot afford this. The condition of the real sector is deteriorating, and the financial sector is deteriorating even faster. Problems will start to emerge and it's only a matter of time. Moreover, the notorious monetary policy runs into fiscal policy and a budget deficit of 8% of GDP. That is, the state is doing its best to prevent the onset of a recession, and at the same time fuels inflation.
In general, there is still some belief that the old mechanism is still working; only large, including state, institutions are cautiously merging their positions in treasuries. Here both China and the Arabs have been signed on sell-off. But when the rate goes down due to problems in the economy and financial sector, and inflation becomes higher than the rate, then everyone will finally understand that the old mechanism and agreement has ceased to work and it is necessary to look for a new instrument for saving value.
A fifth of global oil trade this year was settled in currencies different from the U.S. dollar as countries such as Russia and China move away from the petrodollar. This is according to JP Morgan’s head of global commodities strategy, Natasha Kaneva, who spoke to the Wall Street Journal and said sanctions have been a major motivator for Russia and Iran to start doing their oil business in non-dollar currencies.
Is it possible to avoid a recession in the coming year? Of course it can. But at the cost of inflation. Conversations in this direction have already begun.
The reason is quite legitimate. For Democrats... Essentially, this proposal sounds like this: “let’s forget about the global dollar system, let’s abandon our obligation to target inflation, that is, to preserve the purchasing power of the dollar, so as not to collapse the stock market and the national economy.” Moreover, the consequences will be for the entire global financial system, because the entire interconnection of national financial systems rests on this principle.
US Debt buyers are not even embarrassed by the fact that the yield on long-term bonds is lower than current inflation and 1.5% lower than the Fed rate, although just two months ago the yield on 10-year bonds was creeping up to the Fed rate. Buyers are waiting for a deflationary impulse, nothing less. One cannot expect a deflationary impulse from productivity growth, so the only hope is for a recession and a financial crisis.
And we're not alone with these expectations.
As usual, there are three candidates - gold, raw materials (which, in fact, will further accelerate inflation and reduce added value in other parts of the value chain) and, oddly enough, and cryptocurrencies, say BTC. While the latter is not the most obvious candidate, the “BTC as a store of value” narrative is heating up. I'm willing to bet that once ETFs are approved and the recession gets closer, this narrative will start to be heard more often and louder.
US-China escalation is raising
As Taiwan elections are coming on January 13th, escalation is raising. In China, the new Minister of Defense is the former commander of the PRC Navy, a naval and military bone "to the core" Dong Jun. In the event of the first statement by authorized persons of Chinese Taiwan about secession or declaration of independence, China immediately and inevitably starts a war. The Chinese Navy will take “the main responsibility for winning the war by winning a “high-class naval war” (in fact, we are talking about an all-out naval conflict) with the US fleets.
Second, it is known already that Xi explicitly said to Biden that China will re-unite Taiwan back. Now it seems that saga turns to culmination.
Meantime, The Financial Times writes that China, like Russia, is threatened with cutting off the aircraft market in the future. “Geopolitical risk is forcing aircraft leasing companies to reconsider their attitude towards China,” says the English article (England geostrategically does not accept China). Now global companies, which previously suffered from losses in Russia, are reassessing their appetite for risk amid increasing tensions in relations between China and the United States.
A separate question is whether there will be this sharp demarcation and, if so, when. Elections in Taiwan are already on January 13th. Let's look at the results. There are plenty of options there. From the fair victory of the “pro-Americans” to throw-ins and carousels in both directions and the fair victory of the “reunifiers”. Moreover, in all cases protest movements are possible. The peacefulness of the process will precisely be an indicator of whether an agreement was reached or not.
Conclusion:
If we combine this report with the yesterday's one, we get whole picture of what should happen. Now it is absolutely unavoidable starting of QE programme and rate cut not later than in May-Jun. With spinning up of inflation closer to the end of the year or in early 2025. Together with other factors in place - tough geopolitical situation, inner US political clan clashes on a background of tough financial situation, another showdown on government financing and budget in early February and many other issues, together with anticipated drop of real interest rates again in long-term perspective make gold very attractive. By far we do not see any signs that could put the shadow on long-term gold perspectives and keep our strategy of gold accumulation.
Gold market shows impressive performance in last few weeks, suggesting that sentiment is changing. Gold is raising together with other assets - stocks, bonds. With the subject of recession that we've discussed yesterday it is not surprising. But recession and coming Fed easing is not the only reason of gold's rally. As we will show you below, the US already has broken fundamental agreements of global reserve currency - preserving of its value. For few years already, the US can't achieve this goal and the Fed rate lags behind inflation. From this standpoint and few other reasons gold has positive perspectives in coming year or maybe be even on longer distance.
Market overview
London's gold price benchmark hit an all-time high of $2,069.40 per troy ounce at an afternoon auction on Wednesday, surpassing the previous record of $2,067.15 set in August 2020, the London Bullion Market Association (LBMA) said. In the spot market, gold prices hit their highest in more than three weeks in anticipation of U.S. interest rate cuts next year.
U.S. jobless claims rose last week, indicating the labor market continues to cool in the year's fourth quarter. Investors are betting on an 88% chance of the Fed cutting rates in March, according to the CME FedWatch tool. On the physical front, China's net gold imports via Hong Kong rose by about 37% in November from the previous month.
Gold prices held steady on Friday as they headed towards the end of their best year since 2020 at levels comfortably above $2,000 an ounce, buoyed by hopes the U.S. Federal Reserve could cut interest rates as early as March. Gold investors anticipate record high prices next year, when the fundamentals of a dovish pivot in U.S. interest rates, continued geopolitical risk, and central bank buying are expected to support the market after a volatile 2023. Spot gold is on track to post a 13% annual rise in 2023, its best year since 2020, trading around $2,060 per ounce.
China's manufacturing activity shrank for a third straight month in December and weakened more than expected, clouding the outlook for the country's economic recovery and raising the case for fresh stimulus measures in the new year. The official purchasing managers' index (PMI) fell to 49.0 in December from 49.4 the previous month, an official factory survey showed on Sunday, weaker than a median forecast of 49.5 in a Reuters poll.
China's central bank said on Thursday it would step up policy adjustments to support the economy and promote a rebound in prices, amid signs of rising deflationary pressures. The government, which in October unveiled plans to issue 1 trillion yuan ($140.89 billion) in sovereign bonds to fund investment projects, is likely to focus on more fiscal steps to support growth next year, analysts said.
China's consumer prices fell the fastest in three years in November while factory-gate deflation deepened, weighed by weak domestic demand. The new orders sub-index was at 48.7, contracting for the third month, according to the PMI survey released by the National Bureau of Statistics. Weak external demand also remained a major drag on factory activity, with new export orders index registering 45.8 in December, contracting for the ninth straight month. The sub-index of factory gate prices was at 47.7, contracting for a third straight month, adding to signs of deflation and pressure on business profits.
The precious metal almost made uncharted territory in May this year as a U.S. regional banking crisis took hold. By October, it had retreated close to $1,800 an ounce until safe-haven demand triggered by the Israel-Hamas conflict spurred another rally. Investors returned to the popular SPDR Gold Shares exchange-traded fund , which posted net inflows of over $1 billion in November.
A Reuters poll in October forecast prices will average $1,986.50 in 2024. They have averaged above $1,950 so far this year, above any previous yearly average price. J.P. Morgan sees "a breakout rally" for gold in mid-2024, with a targeted peak of $2,300 on expected rate cuts. UBS forecasts a record of $2,150 by end-2024 if cuts materialise.
The World Gold Council, in its 2024 outlook, projected that a drop of about 40 to 50 basis points in longer maturity yields, following 75-100 points of rate cuts, could translate into a 4% gain for gold. The World Gold Council attributed gold’s sudden spike to short-term technical trading. "The longer-term story, that of strong central bank gold buying, probably had nothing to do with Monday’s quick move,” John Reade, the WGC’s market strategist, said in a statement. “By far the most important financial market drivers of gold will be the US dollar and the amount of cuts priced into the US interest rate market.”
Central banks have certainly been the biggest buyers; according to Metal Focus data, they’ve added 800 metric tons of gold this year. China has led the purchases, accumulating 180 tons, followed by Singapore and India.
At the same time, Exchange-traded funds have sold over 100 metric tons of physical gold this year, an offload of 8%. And then there’s the supply side, with mine production this year up 6% to a record 1,267 tons. Recycling has increased 8% to nearly 300 tons.
The conflict in the Middle East, uncertainty from elections in major economies, and central bank purchases led by China will also boost safe-haven bullion's appeal next year, analysts predicted. But, "gold could be forced to unwind some of this year's gains if an inflation resurgence forces the Fed to abandon plans for a policy pivot in 2024," said Han Tan, chief market analyst at Exinity.
Inflation cooling faster than the Fed trims rates may also slow the economy and dent retail buying. Heraeus Metals expects higher gold jewellery demand in top consumer China this year, with more support possible in 2024 from stimulus measures. By contrast, silver looks set to fall 1% in 2023, trading just under $24 an ounce. It will trend towards $26 an ounce next year, benefiting from improved industrial demand, according to TD Securities.
On track to fall 6% in 2023, platinum will hold a range between $800 and $1,100 an ounce in 2024, Heraeus estimates. The impact of the energy transition was demonstrated as autocatalyst-dependent palladium fell by more than a third this year, the market's worst performance since 2008. Palladium , which fell below $1,000 an ounce in November - for the first time in five years - before recovering, faces surpluses as electric vehicles become more popular. Bank of America expects palladium to average $750 per ounce in 2024 subject to any major supply cuts.
GOLD-to-S&P Ratio
So the signs indicate that gold is undervalued (the chart, however, for some reason is about contango/backwardation in gold futures). Although sometimes you don't understand. Either the gold price comparison base is undervalued (oil) or overvalued (the S&P bubble), or gold.
But in any case, looking at the past breakdowns of the financial system using the example of the 70s, one can hope that this time there will be a comparable revaluation of gold by 5 times or more in 3-4 years. Everything is being looked at for this - then the dollar has become untied from gold, this time the inflation rate should be covered.
50-year Bretton Wood system is falling
Inflation targeting is the pillar on which the global financial system has rested for 50 years. Before this, everything was clear and understandable. Here is a dollar, here is the amount of gold that is “tied” to this dollar. In theory, you can take it and exchange it.
Then, for obvious reasons, when it became clear that the money supply exceeded the amount of reserved gold by several times, in 1971 the dollar was untied from gold. This was the very first post-war scam of the world financial system by the United States. That’s why everyone ran to gold and its nominal price increased 20 times. And this was even before the powerful waves of inflation began.
As a matter of fact, after this the petrodollar system was built, and then the consumer-dollar system, based on agreements with the oil-producing countries of the Middle East and China. In fact - consumer-dollar agreement with China has let P. Volcker to defeat inflation, as big dollar supply finally has been backed by Chinese goods and inflation has started to fade but not because of the Fed and P. Volcker efforts as everybody think.
At the same time, a new financial system appeared, based on the dollar, which was not backed by any hard asset. However, it was secured by the promise that the dollar is a reserve currency in which it is possible to maintain/preserve value (i.e. M. East petro countries and China, that received dollars for their oil and goods could invest them in US Treasuries) purchasing power through the purchase of American government debt.
This promise was based on the same “inflation targeting”, when the Central Bank rate, and therefore the yield on government debt, should be higher than inflation. It seems to be believed that, for example, the Fed can also control inflation through monetary policy, which is far from the case.
Here it is important to understand that the beautiful words of the Central Bank about the monetary policy transmission mechanism and all that other stuff that accompanies inflation targeting only works theoretically, since in addition to monetary policy there is also fiscal policy, which can destroy all the efforts of the Central Bank to keep inflation under control via rate and liquidity regulation. What we now actually see from the Fed’s unsuccessful attempts to return inflation to 2%.
Why, in fact, we talk about another scam of the global financial system by the United States is possible, that is, that they will break the promise on which everything has been held for 50 years? Because this has already been happening for two years. Cumulatively, the rate does not catch up with inflation, that is, the loss of purchasing power of the dollar has already occurred. Very roughly to explain the point - the accumulated inflation over 3 years is 20%, and the cumulative rate does not reach 10%.
No, of course, if (a very big “if”, taking into account the fact that in the 80s there are no ways to ensure demand with cheap Chinese goods and bring down inflation and this is not a matter of monetary policy) the Fed managed to reduce inflation to 2% , and keep the rate at 5.5% for another couple of years, this could compensate for the depreciation.
But judging by Powell’s latest speech with dovish rhetoric, they cannot afford this. The condition of the real sector is deteriorating, and the financial sector is deteriorating even faster. Problems will start to emerge and it's only a matter of time. Moreover, the notorious monetary policy runs into fiscal policy and a budget deficit of 8% of GDP. That is, the state is doing its best to prevent the onset of a recession, and at the same time fuels inflation.
In general, there is still some belief that the old mechanism is still working; only large, including state, institutions are cautiously merging their positions in treasuries. Here both China and the Arabs have been signed on sell-off. But when the rate goes down due to problems in the economy and financial sector, and inflation becomes higher than the rate, then everyone will finally understand that the old mechanism and agreement has ceased to work and it is necessary to look for a new instrument for saving value.
A fifth of global oil trade this year was settled in currencies different from the U.S. dollar as countries such as Russia and China move away from the petrodollar. This is according to JP Morgan’s head of global commodities strategy, Natasha Kaneva, who spoke to the Wall Street Journal and said sanctions have been a major motivator for Russia and Iran to start doing their oil business in non-dollar currencies.
Is it possible to avoid a recession in the coming year? Of course it can. But at the cost of inflation. Conversations in this direction have already begun.
The reason is quite legitimate. For Democrats... Essentially, this proposal sounds like this: “let’s forget about the global dollar system, let’s abandon our obligation to target inflation, that is, to preserve the purchasing power of the dollar, so as not to collapse the stock market and the national economy.” Moreover, the consequences will be for the entire global financial system, because the entire interconnection of national financial systems rests on this principle.
US Debt buyers are not even embarrassed by the fact that the yield on long-term bonds is lower than current inflation and 1.5% lower than the Fed rate, although just two months ago the yield on 10-year bonds was creeping up to the Fed rate. Buyers are waiting for a deflationary impulse, nothing less. One cannot expect a deflationary impulse from productivity growth, so the only hope is for a recession and a financial crisis.
And we're not alone with these expectations.
As usual, there are three candidates - gold, raw materials (which, in fact, will further accelerate inflation and reduce added value in other parts of the value chain) and, oddly enough, and cryptocurrencies, say BTC. While the latter is not the most obvious candidate, the “BTC as a store of value” narrative is heating up. I'm willing to bet that once ETFs are approved and the recession gets closer, this narrative will start to be heard more often and louder.
US-China escalation is raising
As Taiwan elections are coming on January 13th, escalation is raising. In China, the new Minister of Defense is the former commander of the PRC Navy, a naval and military bone "to the core" Dong Jun. In the event of the first statement by authorized persons of Chinese Taiwan about secession or declaration of independence, China immediately and inevitably starts a war. The Chinese Navy will take “the main responsibility for winning the war by winning a “high-class naval war” (in fact, we are talking about an all-out naval conflict) with the US fleets.
Second, it is known already that Xi explicitly said to Biden that China will re-unite Taiwan back. Now it seems that saga turns to culmination.
Meantime, The Financial Times writes that China, like Russia, is threatened with cutting off the aircraft market in the future. “Geopolitical risk is forcing aircraft leasing companies to reconsider their attitude towards China,” says the English article (England geostrategically does not accept China). Now global companies, which previously suffered from losses in Russia, are reassessing their appetite for risk amid increasing tensions in relations between China and the United States.
A separate question is whether there will be this sharp demarcation and, if so, when. Elections in Taiwan are already on January 13th. Let's look at the results. There are plenty of options there. From the fair victory of the “pro-Americans” to throw-ins and carousels in both directions and the fair victory of the “reunifiers”. Moreover, in all cases protest movements are possible. The peacefulness of the process will precisely be an indicator of whether an agreement was reached or not.
Conclusion:
If we combine this report with the yesterday's one, we get whole picture of what should happen. Now it is absolutely unavoidable starting of QE programme and rate cut not later than in May-Jun. With spinning up of inflation closer to the end of the year or in early 2025. Together with other factors in place - tough geopolitical situation, inner US political clan clashes on a background of tough financial situation, another showdown on government financing and budget in early February and many other issues, together with anticipated drop of real interest rates again in long-term perspective make gold very attractive. By far we do not see any signs that could put the shadow on long-term gold perspectives and keep our strategy of gold accumulation.
