Sive Morten
Special Consultant to the FPA
- Messages
- 18,120
Fundamentals
It seems that suggested process is started. Gold now is under pressure, which was absolutely imminence. It is even possible to say that this was predefined. Raising rates and tightening of liquidity are the two major headwinds components. In the environment of massive demand for USD, it is not surprising that all assets are going down, and this is not about its wrong valuation (although I would argue about stocks), but just technical process - margins and collaterals are exhausting, marked-to-market bonds show operating loss and all this stuff has to be covered and compensated somehow. To do this, investors, banks, funds are selling assets to get more dollars. Now we stand in a hot stage of this process, but it will not last for too long. Supposedly it should be over until the end of the year by few reasons. Mostly because the Fed has limited margin safety of raising rate - 2-3 steps more and it will reach the limit. Otherwise country will fall in poverty. Fed has to struggle with inflation but not in the way of destroying everything together with it. Second, as we've mentioned yesterday, Fed plans to start QE in 2024, which we consider today with more details. Hardly the US economy will go out of the wood so fast, and together with crisis processes it will become additional boost for gold market. So, everything is going with our long term plan by far.
Market overview
Gold slipped as the dollar rallied and bond yields gained amid speculation that central banks will keep interest rates elevated for longer to rein in inflation. A gauge of greenback strength rose for a fourth day, soaring on Monday to the highest level this year, while a sell-off in the bond market saw 10-year Treasury yields hitting the highest level since October 2007. Meanwhile, Federal Reserve Bank of Chicago head Austan Goolsbee said in a CNBC interview that it’s still possible for the US to avoid a recession.
Gold in China dropped the most in three years after Beijing permitted more imports, all but closing the gap with international prices that’s persisted for weeks.
The precious metal fell 3.8% on the Shanghai Gold Exchange, with losses accelerating toward the end of the trading day. It follows a months-long rally in local prices, which created a record premium to gold outside of the country.
Just couple weeks ago the premium was around 6% to London level. Shanghai prices were about $10 an ounce above international prices at the close, according to calculations by Bloomberg. This month, premiums had risen to a record of over $120 an ounce.
Factor in China’s protracted property crisis, loose monetary policy and tumbling bond yields, and it’s no mystery why demand for a haven like gold would soar.
Withdrawals from the Shanghai Gold Exchange in August jumped 40% from the previous month, while imports climbed 15%. Meanwhile, inflows into Chinese exchange-traded funds rose to their highest since July 2022. Gold is also finding support from China’s central bank, which has boosted purchases for 10 straight months as it diversifies its reserves.
A fresh round of quotas to import gold was recently issued by the authorities, easing tightness in the local market, according to traders familiar with the matter. The plunge is also “likely to reflect low levels of liquidity ahead of major holidays in China starting this weekend,” said Nicholas Frappell, global head of institutional markets at ABC Refinery in Sydney.
The unprecedented gap between local and international prices was driven by robust demand combining with constrained supply. The People’s Bank of China imposed imports curbs over the summer at a time when local bullion buying was boosted by the country’s economic malaise. The constraints on gold shipments — which reduce the need for local banks to buy dollars — is one of several measures Beijing had taken to defend the yuan. The currency has come under pressure from tighter monetary policy elsewhere in the world.
As analysts write - gold is about to face a massive test as prices approach vulnerable levels. The precious metal is finally starting to succumb to a surge in inflation-adjusted bond yields that tend to put pressure on non-interest bearing assets. Gains in the dollar are also pressuring bullion, which is priced in the currency. Prices are hanging on near the psychologically important $1,900 an ounce mark, but it could face a precipitous drop if buyers don’t emerge soon. Over the past 12 months, central bank purchases — driven by a need to find an alternative to the dollar — have underpinned the market even as investors sold up.
The latest data indicates that consumption has slowed in recent months. It’s hard to know whether that’s because of high prices or lower appetite from central banks. The stakes are big with bullion overvalued compared with bonds. The market’s focus will now shift to holdings data from bullion-backed exchange-traded funds, which provides a useful proxy for investor demand. ETFs have consistently shed gold since May, albeit at a slow rate that provides only a mild headwind to prices. If investors become spooked by the metal’s decline and outflows accelerate, the drop could rapidly become self-fulfilling and lead to a crash.
Gold has had a relatively dull 2023. It’s up around 16% compared to this time last year, but only around 4% year-to-date. What looks surprising, if anything, is the fact that gold is still up for 2023 at all. It’s become conventional wisdom (mainly because it’s been true for a long time) that gold is primarily driven by real interest rates. That is, interest rates once you take account of inflation.
Gold is seen as holding its value over the very long run (by which we’re often talking hundreds or even thousands of years). But in the short run, it doesn’t pay you anything and in fact, it costs you to own it. However, the two have decoupled from one another over the past year or so. Real yields on US 10-year Treasuries have headed higher this year and are now at levels last seen in 2009.
Hardly it relates to gold’s current strength. Instead, it’s probably got more to do with China’s current economic turmoil. “soaring demand for gold is the latest sign of economic anxiety in China.” Domestic sales of gold bars and coins rose by 30% on the year in the first half of 2023. Given that the Chinese currency, the yuan, has weakened sharply during 2023, and that a weak property market means that housing is no longer the go-to asset for sheltering wealth, this “capital flight” argument makes sense . From a Chinese investor’s point of view, the nice thing about gold is that it’s “an effective way to get wealth ‘out of the country’ while still being in the country.”
Certainly it’s hard to see China’s economy enjoying a miraculous recovery any time soon. And given the longer-term desire to reduce reliance on the US dollar, there is a logic to the idea that China will want to build its gold reserves over the longer run. Real US interest rates are undoubtedly a headwind for gold. However, there’s also no guarantee that they will continue to rise.
Inflation is now going to be a more persistent thorn in the economy’s side, then a great deal depends on the vigour with which the Federal Reserve tries to squeeze it out of the system. The jury is out on that one for now, though I suspect that the Fed’s bark will be worse than its bite once it comes to a choice between inflation tolerance and nasty recession.
I think it’s worth having gold as a (small) part of your asset allocation as portfolio insurance either way — it does tend to rise in periods of panic. That said, it doesn’t strike me as particularly cheap right now either. What could give higher conviction? Seeing a turn in the US dollar or US real rates would help. But we probably won’t be in a more bullish environment for gold until it becomes clearer that inflation will be an ongoing issue.
TO SOME INTERESTING STUFF NOW
So, indeed, Central banks reduce the pace of gold buying. If central banks wouldn't buy so much gold, we probably would have lower levels now. Together with other headwinds that we've mentioned above it makes solid pressure on gold prices now.
Some analysts argue that instead of falling, the price will rise if the yield or the dollar rate falls again. $2,100 per ounce due to the slowdown in the US economy is the first target. As evidence, the behavior of gold in March of this year, when real yields and the dollar fell due to the banking crisis, which caused a new influx into gold exchange-traded funds.
The questions asked by colleagues in gold are absolutely legitimate. When is the rocket already? - the buyers ask nervously. The rocket will not be until the completion of the separation in the financial markets. That is, when China withdraws everything it can from the United States, and the United States, respectively, from China, then it will bang. But it also smells peculiar.
The gold/oil ratio will be 30 (now it is walking in the range of 20-23) and oil will be in the Chinese half of the world in yuan or in the BRICS currency, if something worthwhile comes out of this venture. And what will happen in another part of the world is as God willing. China, India and Russia have been morally ready to return to the gold standard, but with the dollar not overthrown, this is impossible. So the evident stage of this process hardly happens until 2025 - it will definitely not work earlier. But, some early signs might be visible in 2024 on a background of the US elections.
I would like to add to my colleague that gold will goup when the acute phase of the crisis passes, which will be a consequence of the current phase of disengagement.
Previously, this will not happen simply because the price of gold is now primarily the result of speculative forces, and not of real physical purchases of gold.
The problem is that both now and in the acute phase of the crisis, the position of a conditional investor in gold acts as a source for closing holes in the liquidity of one’s own portfolio. Have the bonds sank and do you need to top up your broker/collateral bank? Close your gold position. And the collapse has not yet begun. When it starts, we will see a downward dive in the price of gold, and maybe like in 2008-2009.
And only then, when a tailwind appears, the price will begin to rise. Now only cautious investors are forming a long-term position in gold. The broad market, as we saw, invested in the FAANG and accelerated the AI hype. That is, the broad market does not see any need for gold in its portfolio at all; everything is fine with it. Its AI will increase productivity by an order of magnitude. It has a soft landing or no landing.
And when the broad market turns towards reserve assets, then gold will begin to rise. Well, this does not take into account the fact that in any case, as a consequence of the crisis, there will be a revaluation of the relationship between the dollar and gold as such. In short, what is obvious to those who buy gold now is not obvious to the vast majority of players, that's all. Well, or obviously, but for now everyone is playing with the bubbles blowing.
For the Central Bank, the flight into gold is a move away from unsatisfactory real interest rates in government bonds of other countries. While the treasuries bring a real minus, everyone is accumulating reserves in gold. That is, for them it is not a bet against risk. But the Central Bank is like a drop in the ocean of private investors’ money, and that’s exactly what they run into gold when they want to escape from risks. Moreover, the risks of the same treasuries, including the risks of debt in a broad sense, and the risks of shares.
The combination of recession, stock market decline, financial crisis, low (if not zero and negative) rates below inflation (are we expecting a second wave?) is the best combination for flows into reserve assets like gold. And this, by and large, is a combination comparable to 1973, when the dollar was delinked from gold.
Only this time, the rule (arrangement) of positive real rates was in effect for 50 years. All these clever words about the petrodollar and the consumer dollar are actually about this. The essence of the agreement is not that the Saudis or the Chinese receive investments and invest them in public debt. The point is that the US receive a specific resource that works for them, and in return they give dollars, the value/cost of which can be saved at a rate higher than inflation.
And that is why the Fed, under the pressure of the financial crisis, will keep the rate high/compensating for inflation (implying a second or maybe even a third wave of inflation) as long as it can. And this will hurt all economies and financial systems in the world (which, in principle, can also be one of the goals). But as soon as they lower rates below the inflation rate and begin to fill the problems with money, then the second agreement will cease to operate and everyone will run to the same gold to protect themselves from inflation. Let me remind you that 50 years ago gold jumped almost 20 times in a few years.
FEW POLITICAL ISSUES
Now the real big game is started in the US as country is entering Election race year. And this is not about Government shutdown. Game is really interesting and it starts with economical news - US Treasury announced bonds buyback in 2024. This news is presented just as a tool of "stabilizing of liquidity", but in fact, this is QE. We do not know the size and tempo of possible buybacks, but we could suggest that the US economy is counted to hold current interest rates pressure no longer than 1-2 years. Yesterday we've considered some speeches from J. Dimon, L. Fink, who were talking about 5-7% rates, which is also achievable within 1-2 years. So, taking it together, it seems that the US economy could exist in current environment of high rates for ~12 months.
But here is the tricky moment - Democrats, to keep chances in President run, can't announce the recession, it just should not happen in a time of their government. That's why, all statistics that we're getting right now doesn't show the recession. Although as we know the so-called recession has started in the end of 2021. The Fed is catastrophically loosing faith of investors. Just on Thursday, J. Powell were speaking again, this time to economics teachers at the Washington City Hall.
The translation from the Fed language it means - "please, keep trusting me". But for the market is more and more difficult to do this. CPI index has grown quite significantly month-on-month (August to July) from 0.2% to 0.4%. If we consider the indicators year-on-year, then from August to September it increased from 3.4% to 3.5%. Note that these indicators were already known to Powell last week (at least in a preliminary version). This was one of the reasons why he was nervous: everyone hoped that everything had already gone well, and he knew for sure that inflation could jump up!
Note, by the way, that the data on US GDP has not changed much, but the GDP deflator in the second quarter fell to 1.7% from 3.4% in the first. However, taking into account the wild deflation in the industrial sector (-9.5% in June) this is not surprising. In general, taking into account the constant distortion of GDP statistics (it is impossible to show a decline!), it is impossible to rely on this indicator. Because of its very simple feature: if you reduce the GDP deflator by x%, then GDP will grow by the same x%. Suddenly, BIS reports on real households savings are much lower than it has been thought. $2.6 Trln just has been lost.
Lost $2.6 trillion in national savings in the US after one of the largest revisions of macroeconomic statistics at the Bureau of Economic Analysis (BEA). Historical series have been revised since 1981 (!), and the most intensive accumulation of errors began to occur from 2013 to 2021, which accounted for almost 80% of the entire revision. New release and old release in the column "Equals: Personal saving.
This leads to some modification of previous conclusions and a distortion in the perception of statistics. In any case, you need to be very vigilant for cheaters at the card table, they can fool you. What else did they do there? Still to be assessed, but this is another reminder that statistics cannot be constant, and things can change quite dramatically. All this means an extremely likely crisis in the market for credit cards, student loans and car loans. It’s clear why Biden is running around with his idea of forgiving everyone’s student debt. Of course, they will forgive from under the printing press. And here, even without it, inflation does not want to fall.
It means that statistics now is not representatives and mostly a political tool in the hands of government party, i.e. Democrats. They will try to endure this process as long as they could. Now it seems that it should last until the end of 2024. But there are few additional problems are coming. First is the tensions with China are raising. Despite all talking about normalization and negotiations - China takes back all pandas from UK and US zoos. This is the bad sign and usually happens when China breaks political relations. As you know all pandas are belong to China and stand only in a rent. This is important political sign.
Even Biden in recent statement said that he had reduced the US national debt by $1.7 trillion, but in fact increased it by $3.4 trillion. But the devil, as they say, is in the details. In terms of percentage of GDP, it actually decreased relative to 2020 and the record print by 8% or $1.7 trillion.
Second, the US SPR level. This is definitely some political bargain stands. Crude oil inventories at the largest US storage facility, Cushing, the delivery and execution point for NYMEX crude oil futures, fell by 943,000 barrels in a week. This is the lowest level since July 2022. They are dropping 7 weeks in a row and are coming to some historical low levels already. if the Americans have decided not to try to replenish the SPR, it means they no longer believe that oil prices, and therefore inflation in general, can fall further.
Now we have seen this trend reflected in inflation indicators.
Meantime, the average amount of corporate bankruptcies in the US economy over the past four weeks has reached a level that corresponds to the values of the global financial crisis of 2008-2009 and the beginning of the COVID-19 pandemic in 2020.
Americans are finally starting to feel the damage from the Fed rate hike. Those who are forced to take out loans now get much less for their money:
The United States has a record for the number of strikes in the current century. The similar 1970s, when there was stagflation, were also marked by a huge movement of all kinds of strikes.
The reason for this is very simple: when you allow a sharp jump in commodity inflation in the main reserve currency, then under no circumstances should you allow a subsequent increase in wages. Since the product will give a 15-20% boost (it happened), but salaries will catch up with the overall inflation rate to 40-50%.
If in 3 years you lose half of your capital in the reserve currency at a rate of 2-3%, then the reserve currency simply loses its status and everyone is trying to find at least some alternatives. There they immediately begin to talk about the return of the gold standard or about contracts where prices, for example, are tied to the average price of wheat, oil, gas, and anything else with a large market. Essentially a quasi-barter.
When Powell realized that everything was heading towards a spiral of wage inflation, he began to furiously increase the rate, but it seemed that it was too late. Prices in stores and at gas stations have increased and are not falling, but wages have practically not increased at all. Hence such a disturbing factor of the working class and trade unions. And the funny thing is that in these conditions, the Americans want to carry out re-industrialization with the involvement of huge masses of the working class of very average qualifications. Reagan, while fighting wage inflation in the 1980s, hastily moved production to Asia. But, it is nowhere to move production now...
The SPR will be empty, inflation will rise, OPEC+ and China will begin to openly manipulate the states, the economy will be strangled by high rates combined with colossal annual budget deficits. Now it is a big bargain around Ukraine. Based on recent bill that was accepted by Congress - starting tomorrow, Ukraine will be without US funding. How long and what amount will ultimately be agreed upon is unknown.
Hungary also continues to block EU aid. Now, elections in Slovakia are resulted with victory of Fico party, who is oriented on national interest and in fact a political copy of V. Orban. Nothing is known about new tranches from Great Britain, Australia, Zealand or Japan and Korea. But they have never been noticeable donors.
SPR was filled in August-September, contracts signed in May for 6 million barrels. And then suddenly the volume began to decrease!
It seems that suggested process is started. Gold now is under pressure, which was absolutely imminence. It is even possible to say that this was predefined. Raising rates and tightening of liquidity are the two major headwinds components. In the environment of massive demand for USD, it is not surprising that all assets are going down, and this is not about its wrong valuation (although I would argue about stocks), but just technical process - margins and collaterals are exhausting, marked-to-market bonds show operating loss and all this stuff has to be covered and compensated somehow. To do this, investors, banks, funds are selling assets to get more dollars. Now we stand in a hot stage of this process, but it will not last for too long. Supposedly it should be over until the end of the year by few reasons. Mostly because the Fed has limited margin safety of raising rate - 2-3 steps more and it will reach the limit. Otherwise country will fall in poverty. Fed has to struggle with inflation but not in the way of destroying everything together with it. Second, as we've mentioned yesterday, Fed plans to start QE in 2024, which we consider today with more details. Hardly the US economy will go out of the wood so fast, and together with crisis processes it will become additional boost for gold market. So, everything is going with our long term plan by far.
Market overview
Gold slipped as the dollar rallied and bond yields gained amid speculation that central banks will keep interest rates elevated for longer to rein in inflation. A gauge of greenback strength rose for a fourth day, soaring on Monday to the highest level this year, while a sell-off in the bond market saw 10-year Treasury yields hitting the highest level since October 2007. Meanwhile, Federal Reserve Bank of Chicago head Austan Goolsbee said in a CNBC interview that it’s still possible for the US to avoid a recession.
Gold in China dropped the most in three years after Beijing permitted more imports, all but closing the gap with international prices that’s persisted for weeks.
The precious metal fell 3.8% on the Shanghai Gold Exchange, with losses accelerating toward the end of the trading day. It follows a months-long rally in local prices, which created a record premium to gold outside of the country.
Just couple weeks ago the premium was around 6% to London level. Shanghai prices were about $10 an ounce above international prices at the close, according to calculations by Bloomberg. This month, premiums had risen to a record of over $120 an ounce.
Factor in China’s protracted property crisis, loose monetary policy and tumbling bond yields, and it’s no mystery why demand for a haven like gold would soar.
Withdrawals from the Shanghai Gold Exchange in August jumped 40% from the previous month, while imports climbed 15%. Meanwhile, inflows into Chinese exchange-traded funds rose to their highest since July 2022. Gold is also finding support from China’s central bank, which has boosted purchases for 10 straight months as it diversifies its reserves.
A fresh round of quotas to import gold was recently issued by the authorities, easing tightness in the local market, according to traders familiar with the matter. The plunge is also “likely to reflect low levels of liquidity ahead of major holidays in China starting this weekend,” said Nicholas Frappell, global head of institutional markets at ABC Refinery in Sydney.
The unprecedented gap between local and international prices was driven by robust demand combining with constrained supply. The People’s Bank of China imposed imports curbs over the summer at a time when local bullion buying was boosted by the country’s economic malaise. The constraints on gold shipments — which reduce the need for local banks to buy dollars — is one of several measures Beijing had taken to defend the yuan. The currency has come under pressure from tighter monetary policy elsewhere in the world.
As analysts write - gold is about to face a massive test as prices approach vulnerable levels. The precious metal is finally starting to succumb to a surge in inflation-adjusted bond yields that tend to put pressure on non-interest bearing assets. Gains in the dollar are also pressuring bullion, which is priced in the currency. Prices are hanging on near the psychologically important $1,900 an ounce mark, but it could face a precipitous drop if buyers don’t emerge soon. Over the past 12 months, central bank purchases — driven by a need to find an alternative to the dollar — have underpinned the market even as investors sold up.
The latest data indicates that consumption has slowed in recent months. It’s hard to know whether that’s because of high prices or lower appetite from central banks. The stakes are big with bullion overvalued compared with bonds. The market’s focus will now shift to holdings data from bullion-backed exchange-traded funds, which provides a useful proxy for investor demand. ETFs have consistently shed gold since May, albeit at a slow rate that provides only a mild headwind to prices. If investors become spooked by the metal’s decline and outflows accelerate, the drop could rapidly become self-fulfilling and lead to a crash.
Gold has had a relatively dull 2023. It’s up around 16% compared to this time last year, but only around 4% year-to-date. What looks surprising, if anything, is the fact that gold is still up for 2023 at all. It’s become conventional wisdom (mainly because it’s been true for a long time) that gold is primarily driven by real interest rates. That is, interest rates once you take account of inflation.
Gold is seen as holding its value over the very long run (by which we’re often talking hundreds or even thousands of years). But in the short run, it doesn’t pay you anything and in fact, it costs you to own it. However, the two have decoupled from one another over the past year or so. Real yields on US 10-year Treasuries have headed higher this year and are now at levels last seen in 2009.
Hardly it relates to gold’s current strength. Instead, it’s probably got more to do with China’s current economic turmoil. “soaring demand for gold is the latest sign of economic anxiety in China.” Domestic sales of gold bars and coins rose by 30% on the year in the first half of 2023. Given that the Chinese currency, the yuan, has weakened sharply during 2023, and that a weak property market means that housing is no longer the go-to asset for sheltering wealth, this “capital flight” argument makes sense . From a Chinese investor’s point of view, the nice thing about gold is that it’s “an effective way to get wealth ‘out of the country’ while still being in the country.”
Certainly it’s hard to see China’s economy enjoying a miraculous recovery any time soon. And given the longer-term desire to reduce reliance on the US dollar, there is a logic to the idea that China will want to build its gold reserves over the longer run. Real US interest rates are undoubtedly a headwind for gold. However, there’s also no guarantee that they will continue to rise.
Inflation is now going to be a more persistent thorn in the economy’s side, then a great deal depends on the vigour with which the Federal Reserve tries to squeeze it out of the system. The jury is out on that one for now, though I suspect that the Fed’s bark will be worse than its bite once it comes to a choice between inflation tolerance and nasty recession.
I think it’s worth having gold as a (small) part of your asset allocation as portfolio insurance either way — it does tend to rise in periods of panic. That said, it doesn’t strike me as particularly cheap right now either. What could give higher conviction? Seeing a turn in the US dollar or US real rates would help. But we probably won’t be in a more bullish environment for gold until it becomes clearer that inflation will be an ongoing issue.
TO SOME INTERESTING STUFF NOW
So, indeed, Central banks reduce the pace of gold buying. If central banks wouldn't buy so much gold, we probably would have lower levels now. Together with other headwinds that we've mentioned above it makes solid pressure on gold prices now.
Some analysts argue that instead of falling, the price will rise if the yield or the dollar rate falls again. $2,100 per ounce due to the slowdown in the US economy is the first target. As evidence, the behavior of gold in March of this year, when real yields and the dollar fell due to the banking crisis, which caused a new influx into gold exchange-traded funds.
The questions asked by colleagues in gold are absolutely legitimate. When is the rocket already? - the buyers ask nervously. The rocket will not be until the completion of the separation in the financial markets. That is, when China withdraws everything it can from the United States, and the United States, respectively, from China, then it will bang. But it also smells peculiar.
The gold/oil ratio will be 30 (now it is walking in the range of 20-23) and oil will be in the Chinese half of the world in yuan or in the BRICS currency, if something worthwhile comes out of this venture. And what will happen in another part of the world is as God willing. China, India and Russia have been morally ready to return to the gold standard, but with the dollar not overthrown, this is impossible. So the evident stage of this process hardly happens until 2025 - it will definitely not work earlier. But, some early signs might be visible in 2024 on a background of the US elections.
I would like to add to my colleague that gold will goup when the acute phase of the crisis passes, which will be a consequence of the current phase of disengagement.
Previously, this will not happen simply because the price of gold is now primarily the result of speculative forces, and not of real physical purchases of gold.
The problem is that both now and in the acute phase of the crisis, the position of a conditional investor in gold acts as a source for closing holes in the liquidity of one’s own portfolio. Have the bonds sank and do you need to top up your broker/collateral bank? Close your gold position. And the collapse has not yet begun. When it starts, we will see a downward dive in the price of gold, and maybe like in 2008-2009.
And only then, when a tailwind appears, the price will begin to rise. Now only cautious investors are forming a long-term position in gold. The broad market, as we saw, invested in the FAANG and accelerated the AI hype. That is, the broad market does not see any need for gold in its portfolio at all; everything is fine with it. Its AI will increase productivity by an order of magnitude. It has a soft landing or no landing.
And when the broad market turns towards reserve assets, then gold will begin to rise. Well, this does not take into account the fact that in any case, as a consequence of the crisis, there will be a revaluation of the relationship between the dollar and gold as such. In short, what is obvious to those who buy gold now is not obvious to the vast majority of players, that's all. Well, or obviously, but for now everyone is playing with the bubbles blowing.
For the Central Bank, the flight into gold is a move away from unsatisfactory real interest rates in government bonds of other countries. While the treasuries bring a real minus, everyone is accumulating reserves in gold. That is, for them it is not a bet against risk. But the Central Bank is like a drop in the ocean of private investors’ money, and that’s exactly what they run into gold when they want to escape from risks. Moreover, the risks of the same treasuries, including the risks of debt in a broad sense, and the risks of shares.
The combination of recession, stock market decline, financial crisis, low (if not zero and negative) rates below inflation (are we expecting a second wave?) is the best combination for flows into reserve assets like gold. And this, by and large, is a combination comparable to 1973, when the dollar was delinked from gold.
Only this time, the rule (arrangement) of positive real rates was in effect for 50 years. All these clever words about the petrodollar and the consumer dollar are actually about this. The essence of the agreement is not that the Saudis or the Chinese receive investments and invest them in public debt. The point is that the US receive a specific resource that works for them, and in return they give dollars, the value/cost of which can be saved at a rate higher than inflation.
And that is why the Fed, under the pressure of the financial crisis, will keep the rate high/compensating for inflation (implying a second or maybe even a third wave of inflation) as long as it can. And this will hurt all economies and financial systems in the world (which, in principle, can also be one of the goals). But as soon as they lower rates below the inflation rate and begin to fill the problems with money, then the second agreement will cease to operate and everyone will run to the same gold to protect themselves from inflation. Let me remind you that 50 years ago gold jumped almost 20 times in a few years.
FEW POLITICAL ISSUES
Now the real big game is started in the US as country is entering Election race year. And this is not about Government shutdown. Game is really interesting and it starts with economical news - US Treasury announced bonds buyback in 2024. This news is presented just as a tool of "stabilizing of liquidity", but in fact, this is QE. We do not know the size and tempo of possible buybacks, but we could suggest that the US economy is counted to hold current interest rates pressure no longer than 1-2 years. Yesterday we've considered some speeches from J. Dimon, L. Fink, who were talking about 5-7% rates, which is also achievable within 1-2 years. So, taking it together, it seems that the US economy could exist in current environment of high rates for ~12 months.
But here is the tricky moment - Democrats, to keep chances in President run, can't announce the recession, it just should not happen in a time of their government. That's why, all statistics that we're getting right now doesn't show the recession. Although as we know the so-called recession has started in the end of 2021. The Fed is catastrophically loosing faith of investors. Just on Thursday, J. Powell were speaking again, this time to economics teachers at the Washington City Hall.
The translation from the Fed language it means - "please, keep trusting me". But for the market is more and more difficult to do this. CPI index has grown quite significantly month-on-month (August to July) from 0.2% to 0.4%. If we consider the indicators year-on-year, then from August to September it increased from 3.4% to 3.5%. Note that these indicators were already known to Powell last week (at least in a preliminary version). This was one of the reasons why he was nervous: everyone hoped that everything had already gone well, and he knew for sure that inflation could jump up!
Note, by the way, that the data on US GDP has not changed much, but the GDP deflator in the second quarter fell to 1.7% from 3.4% in the first. However, taking into account the wild deflation in the industrial sector (-9.5% in June) this is not surprising. In general, taking into account the constant distortion of GDP statistics (it is impossible to show a decline!), it is impossible to rely on this indicator. Because of its very simple feature: if you reduce the GDP deflator by x%, then GDP will grow by the same x%. Suddenly, BIS reports on real households savings are much lower than it has been thought. $2.6 Trln just has been lost.
Lost $2.6 trillion in national savings in the US after one of the largest revisions of macroeconomic statistics at the Bureau of Economic Analysis (BEA). Historical series have been revised since 1981 (!), and the most intensive accumulation of errors began to occur from 2013 to 2021, which accounted for almost 80% of the entire revision. New release and old release in the column "Equals: Personal saving.
This leads to some modification of previous conclusions and a distortion in the perception of statistics. In any case, you need to be very vigilant for cheaters at the card table, they can fool you. What else did they do there? Still to be assessed, but this is another reminder that statistics cannot be constant, and things can change quite dramatically. All this means an extremely likely crisis in the market for credit cards, student loans and car loans. It’s clear why Biden is running around with his idea of forgiving everyone’s student debt. Of course, they will forgive from under the printing press. And here, even without it, inflation does not want to fall.
It means that statistics now is not representatives and mostly a political tool in the hands of government party, i.e. Democrats. They will try to endure this process as long as they could. Now it seems that it should last until the end of 2024. But there are few additional problems are coming. First is the tensions with China are raising. Despite all talking about normalization and negotiations - China takes back all pandas from UK and US zoos. This is the bad sign and usually happens when China breaks political relations. As you know all pandas are belong to China and stand only in a rent. This is important political sign.
Even Biden in recent statement said that he had reduced the US national debt by $1.7 trillion, but in fact increased it by $3.4 trillion. But the devil, as they say, is in the details. In terms of percentage of GDP, it actually decreased relative to 2020 and the record print by 8% or $1.7 trillion.
Second, the US SPR level. This is definitely some political bargain stands. Crude oil inventories at the largest US storage facility, Cushing, the delivery and execution point for NYMEX crude oil futures, fell by 943,000 barrels in a week. This is the lowest level since July 2022. They are dropping 7 weeks in a row and are coming to some historical low levels already. if the Americans have decided not to try to replenish the SPR, it means they no longer believe that oil prices, and therefore inflation in general, can fall further.
Now we have seen this trend reflected in inflation indicators.
Meantime, the average amount of corporate bankruptcies in the US economy over the past four weeks has reached a level that corresponds to the values of the global financial crisis of 2008-2009 and the beginning of the COVID-19 pandemic in 2020.
Americans are finally starting to feel the damage from the Fed rate hike. Those who are forced to take out loans now get much less for their money:
The United States has a record for the number of strikes in the current century. The similar 1970s, when there was stagflation, were also marked by a huge movement of all kinds of strikes.
The reason for this is very simple: when you allow a sharp jump in commodity inflation in the main reserve currency, then under no circumstances should you allow a subsequent increase in wages. Since the product will give a 15-20% boost (it happened), but salaries will catch up with the overall inflation rate to 40-50%.
If in 3 years you lose half of your capital in the reserve currency at a rate of 2-3%, then the reserve currency simply loses its status and everyone is trying to find at least some alternatives. There they immediately begin to talk about the return of the gold standard or about contracts where prices, for example, are tied to the average price of wheat, oil, gas, and anything else with a large market. Essentially a quasi-barter.
When Powell realized that everything was heading towards a spiral of wage inflation, he began to furiously increase the rate, but it seemed that it was too late. Prices in stores and at gas stations have increased and are not falling, but wages have practically not increased at all. Hence such a disturbing factor of the working class and trade unions. And the funny thing is that in these conditions, the Americans want to carry out re-industrialization with the involvement of huge masses of the working class of very average qualifications. Reagan, while fighting wage inflation in the 1980s, hastily moved production to Asia. But, it is nowhere to move production now...
The SPR will be empty, inflation will rise, OPEC+ and China will begin to openly manipulate the states, the economy will be strangled by high rates combined with colossal annual budget deficits. Now it is a big bargain around Ukraine. Based on recent bill that was accepted by Congress - starting tomorrow, Ukraine will be without US funding. How long and what amount will ultimately be agreed upon is unknown.
Hungary also continues to block EU aid. Now, elections in Slovakia are resulted with victory of Fico party, who is oriented on national interest and in fact a political copy of V. Orban. Nothing is known about new tranches from Great Britain, Australia, Zealand or Japan and Korea. But they have never been noticeable donors.
SPR was filled in August-September, contracts signed in May for 6 million barrels. And then suddenly the volume began to decrease!
