Special Report - Gold - Q1 2020
For considerable time, Gold has been an enigma to all that follow it closely.
As the world’s central banks are busy printing money as if there is no tomorrow and governments are rolling out massive deficit spending programs, common sense should tell you that gold should be moving up like a rocket ship. Instead gold moved down almost 15%.
Before we get into more specifics on gold let’s understand what the Fed is trying to do. This time the Fed is really up for hyperinflation.
Before all this virus issue started to haunt us, the Fed had a debt of $ 23 trillion and was running a budget deficit of a trillion dollars a year. It is mostly financed by short term debt and this is all after 10 years of economic expansion and rising stock markets.
The government has three major financial obligations. 1) Baby boomers, 2) military budget, and 3) foreign creditors. And they don’t have the money.
The tax revenues are about to tank as its revenues are tightly connected to the economy and stock market. To top it up asset managers are dumping treasuries holdings to meet redemption requests and margin calls. The oil exporting countries don’t have any more money to buy treasuries. China won’t be buying more either. Emerging markets have their own problems and are forced to dump their treasuries to support their falling currencies. And the stock market is falling.
So what does the Fed do? The only thing that they can do without going bankrupt is to hyperinflate the Fed balance sheet. This time it is monstrous as they have removed all stops and they have set no limits as to how much they can print.
Think about it. If you owe me a dollar, it’s in your best interest for the dollar to devalue before you give it back to me. It reduces the value that you transfer to me. The US government owes $23 trillion and counting. So it is in the best interest of the US government to see a falling dollar.
All other countries also want a weaker currency at this point of time. They also want a weaker currency to export their way out. So who will win out? As long as the US has the printing machine and the dollar is accepted as legal tender, think the dollar should.
The one argument many pundits are holding is that a synchronized devaluation can be achieved by simply revaluing gold to $3000 or $ 5000. Is that possible? Well in the current environment anything is possible.
But let’s look at gold in the light of what we already know and how we have been interpreting it.
In the midst of all this mayhem in the markets, gold rose to $ 1700 and above and fell back to 1450. It again touched 1700 and has fallen back. So why is not gold unable to hold on to its gains? There could be nothing more bullish than the Fed’s announcement of unlimited quantitative easing on 23 Mar. That day prices only bounced just above 1560.
Anyone can think prices should have soared above 1700. Traders are still strongly bullish gold. While the pattern in gold is getting more complex, we believe all the recent up moves are a counter trend rally. The larger trend is still down.
As per Comex data, large specs are net long more than 282,000 futures contracts which is near the high end of the historic range. Large specs are trend followers and they are usually wrong. Finally they will turn from net long to net short and that may be the turning point for a gold rally.
Currently the rise from 1451 on Mar 16 looks very much a counter trend rally. Bloomberg recently had a headline “Gold faces historic squeeze as virus threatening NY shortage”. The story discussed investors ‘panic’ with respect to the disruption of gold’s physical trading routes. Open interest in the April gold contract stood at approximately 195,600 equivalent to 19.6 mio ounces of gold. The total deliverables in Comex warehouses were at 8.7 mio ounces. Futures contracts in NY are surging to a huge premium over spot prices due to worry over the deliverability of the product due to a production shut down particularly in Switzerland over the virus, and a curtailment in shipping venues such as cargo, trains, planes etc.
Panic buying is never a trend. This is a mechanical issue and a short-term discrepancy. The spread had widened to $80 and was the highest between the most active futures to the spot since 1980 when it reached $67. Normally the maximum spread is $2. Right now, the futures are out of whack with spot prices and this abnormal spread should normalize soon in the coming days or weeks.
Traders are already rolling April contracts into June and the London bullion market association announced last week that logistics companies are addressing the transport constraints. So, think this mechanical anomaly should be cleared soon. I should add because of the fear and panic physical gold has gone through the roof.
To sum it up, I think gold should top out soon and start its down move. A move below $1450 will be the first sign that the longs are getting jittery.
Be small. Be safe. Stay home.
Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund.