After a remarkable run over the past few months, gold and silver now appear to have entered a period of consolidation. Many speculators and short-term focused investors have sold their positions fearing a correction, while mainstream market commentators fuel these fears, with analyses that proclaim “the end of the road” for gold and silver.
Of course, nothing could be further from the truth. All the very serious concerns and the fundamental reasons that caused the metals to rise so aggressively in recent months are not only still intact, but they have grown, and spread, and find even more solid footing every time new data comes out of the Eurozone and the US. Recession fears among investors hit an all-time high in mid-September, according to a Bank of America Merrill Lynch survey, as 25% of those asked expect a recession to strike in the next 12 months. Even more worrying where the results of the survey released by Wilmington Trust at the end of last month: “About 61% of investors surveyed with a household income of $225,000 or more say that they would give up growth opportunity for downside protection. And among those who have an annual household income of $500,000 or more, 76% say they would make this trade-off.”
These concerns are more than justified. On the economic front, bad news continues to pile up. The trade war, as well as the numerous systemic vulnerabilities in all major economies, appear to be boiling over. In September, U.S. manufacturing activity tumbled to a more than 10-year low, according to the Institute for Supply Management, while growth in the services sector also sharply declined to the lowest point in 3 years. In August, German industrial orders fell by 0.6%, much lower than the expected 0.3% drop, while the economy shrank by 0.1% in the second quarter. This weakness is widely expected to continue and another contraction would put the country officially in recession territory. China’s industrial output grew at its slowest pace since 2002, while in the second quarter the world’s second largest economy grew at its slowest pace since the early 1990s.
In addition to the mounting recession fears, we’ve also seen central bankers cave to market and political pressure and commit to a decisive return to easing polices, which sets the stage for a very bullish period ahead for gold and silver. The Fed, following its historic rate cut in July, the first since 2008, has firmly continued on the cheap credit path. The central bank continues to hint at further cuts, while the markets are essentially taking them for granted. On September 12, the outgoing ECB President Draghi unveiled an aggressive easing package, in a last-ditch attempt to stave off the Eurozone recession that has arguably already begun. The central bank cut interest rates further below zero, to minus 0.5% from minus 0.4%, and revived its massive asset purchasing program. Starting in November, it will be buying $22 billion worth of debt every month, “for as long as necessary”. The ECB also changed its guidance on interest rates. They are now projected to remain at present or lower levels, until the outlook for inflation “robustly” converges to the bank’s target, close to 2%. Given the fact that this target has not been met even after years of extreme measures to revive inflation, it is safe to assume that what that this guidance really means is that negative interest rates are the new normal. This severely increases the risks for the economy. As James Grant accurately put it, “negative interest rates are unsustainable and once investors decide to stop paying for the privilege of holding government debt, a banking crisis could result”.
It is, therefore, clear that trouble lies ahead in the economy and in the markets. When we rationally and calmly assess the facts, the interest rate environment, the widespread economic weakness and the intense volatility in equity markets all point to a precious metals rally. The long-term picture and the fundamentals are exceptionally positive for gold and silver, that have already shown strength and once again confirmed their value as safe havens. In this context, the short-term fluctuations we see can be interpreted as the last hopes of short-sighted investors, who still believe that rate cuts will suffice to reverse the vast economic weakness we see across the board or that a slightly positive tweet by President Trump can mean the end of the trade war. This approach is, of course, based on sheer belief and wishful thinking, as it denies the facts and the data we’ve been seeing for months.
Thus, allowing irrational fear or unfounded hopes to dictate investment strategy now would be a serious mistake. A correction is a normal and healthy part of a sound bull market. It creates the foundation by driving out and replacing weak hands with strong hands. There will be moment in the not-so-distant future when mainstream investors will finally understand that they can find the strongest downside protection, at an honest zero interest, with a tremendous upside potential by buying physical gold and silver. Unlike the rest of their options now, physical precious metals carry no default and no counterparty risk. That’s a massive advantage over leveraged debt securities that can be printed out of thin air. The same can be said for their honest zero interest rate, as in today’s negative interest rate environment, the storage and insurance fees for physical gold are more attractive than negative-yielding bonds or the negative interest that is increasingly charged for cash deposits in the bank. Thus, for the prudent investor, who is familiar with monetary history, with economic cycles and with the virtues of a low time preference, moments like this present a rare buying opportunity. And in this case specifically, current price levels might be one of the few remaining opportunities to enter the market at such an attractive price level.
Claudio Grass, Hünenberg See, Switzerland
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