If you agreed with us last week and thought yield alternatives were coming back in style, then you should feel even more strongly this week as global sovereign bond yields continued their dramatic decline. With German 10-year yields hitting all-time lows and the spread with US Treasuries tightening further, earning a yield on gold looks increasingly attractive.
There are, of course, many factors to consider when thinking about whether to invest in precious metals. One consideration, for example, would be that low and shrinking levels of absolute global bond yields reduce the opportunity cost associated with foregoing those positive yields to invest in precious metals. Beyond this shrinking differential between the yield on US Treasuries and the gold yield (positive with Precious Yield, negative in most other holding forms – see our white paper entitled “The Alternatives Available for Precious Metals Investors” from March 24, 2018), this strong flight to safety coupled with the market’s reduced assessment of US relative economic attractiveness signals increasing recession odds. As you know, we have been advocating investor alert for some time now and this week’s news/market movements reinforced our view.
If that weren’t enough, Morgan Stanley put out a compelling research piece which argues that the US yield curve has been inverted continuously, after adjusting for the effects of QE/QT, since November 2018 (see Exhibits 2 & 3 below). That means government bond investors have been signaling economic weakness BEFORE the negative effects of the trade war became more concrete. On that basis, and combined with additional tariffs going into effect on Mexico, we think that the likelihood of a recession has gone up and been pulled even further forward. While our moderate and decreasing conviction base case now indicates one more market rally to the highs/new highs before the onset of a downturn, we see the remaining probabilities split between a scenario where market highs have already been achieved this cycle and a scenario where recession gets avoided altogether.
Stocks continued their steady decline this week with the S&P falling 2.6%. This marks the fourth consecutive week of declines and a cumulative 6.6% decline since the beginning of May. In the early part of the week, falling global bond yields coupled with heated US-China trade rhetoric weighed on market sentiment. On Tuesday, the editor in chief of the Global Times suggested China may restrict access to “rare earths” and on Thursday, China said it will put purchases of US soybeans on hold. Friday’s slide was driven by Trump’s announcement of a 5% tariff on all imported goods from Mexico beginning June 10th which will gradually increase until the flow of undocumented immigrants across the border stops. These additional tariffs and tit-for-tat Chinese tactics will likely weigh on future growth. On the economic data front, some decent domestic data (Q1 GDP, consumer confidence) was countered with more data supporting a global manufacturing slowdown. China manufacturing PMI missed estimates and fell into contractionary territory, joining the prior week’s read on Eurozone manufacturing and the barely expansionary US numbers. As you would expect in a down market, volatility increased throughout the week with the VIX ending at 18.71 – slightly above the long-term adjusted, average since January 1990.
US 10-year treasury yields fell from 2.32% last week to 2.14%. These are the lowest US 10-year treasury yields and tightest spreads to the yield on gold since August/September 2017. In addition, the US yield curve inverted further (on an unadjusted basis – i.e. not taking into account the Morgan Stanley analysis) and US Treasury – German Bund spreads made new lows post their cycle highs back in November 2018. While we are uncertain that German Bund yields can fall much further, weakening US economic data, both actual and future perceived, could continue to drive this spread tighter. Of note, yields in the intermediate part of the treasury curve are all below 2% while short dated paper yields 2.35% and above. As mentioned above, the US yield curve inversion steepened to 19bps from 7bps last week between 3-month T-bills and 10-year Treasuries (see FRED chart below). The gold yield offered by Precious Yield has remained stable in this environment – please see our current rates page for more info.
The dollar index was slightly stronger this week and exhibited similar trends with the underlying basket of currencies that we have seen over the last several weeks. This means continued strength against the Euro (+0.31%) and Pound (+0.63%) offset by weakness against the Yen (-0.94%). We believe the yen continues to benefit from its trade war safe-haven status. While the shrinking US Treasury – German Bund spread did not cause the dollar to weaken against the Euro this week, we believe that this week’s trading dynamic is not viable longer-term. Given our current views, we would expect this inconsistency to resolve in a weaker dollar as opposed to a re-widening of spreads. Outside of the dollar index, the Chinese yuan held steady for a second straight week – keeping in mind that the US dollar made significant gains against it since mid-April. You can see those gains in chart format from our previous Market Update. We continue to monitor this FX pair for clues about the status of trade negotiations.
As measured by the LBMA afternoon fix, gold prices finished the week up a full percentage point to $1,295.55 /oz. All of the gains were made on Friday after the Mexican tariff announcement. With market volatility ratcheting up in the face of yet another equity market sell-off, flight to safety investing took center stage with gains in both gold and US Treasuries. From a supply/demand perspective, the price of gold could be augmented further with the potential for South African disruptions. South Africa is key to the PGM market but is also a gold producer of size.
Last week, we reminded investors to consider a host of factors when deciding to invest in precious metals including but not limited to market volatility, global bond yields, and dollar strength/weakness. Over the last several months, we have highlighted the tug of war between the receding need for flight to safety assets offset by the shrinking future perceived yield differential between US Treasuries and the precious metal. We may be entering a period where the receding need for flight to safety assets dynamic is changing while the shrinking future perceived yield differential is not. This would be supportive of gold in our opinion.
We also highlighted the role of recent US dollar strength in keeping a lid on precious metal prices. As discussed earlier, our view is that the recent inconsistency between US dollar strength and US Treasury -German Bund yield spread tightening is more likely to resolve itself in a weaker dollar. This also would be supportive of gold in our opinion.
While an investment in gold has historically been associated with negative carry, Precious Yield offers investors the opportunity to earn a yield on gold. If you are a long-term holder, turning gold as an asset for diversification purposes into an alternative investment with Precious Yield allows for some cushion against gold price movements via the gold yield. To learn more, please browse our website or contact us for more information. See you next week!
Gold 1-Month Price Chart
Silver 1-Month Price Chart
Platinum 1-Month Price Chart
Palladium 1-Month Price Chart
About the Author
Rob Perry is an avid student of the markets and an aspiring tennis player. He is currently Chief Strategist for Precious Yield as well as Chief Investment Officer of Pecan, a single-family office based in San Diego, CA. Most recently, he was located in New York City working as Chief Strategist of and a Portfolio Manager for Kingsland Capital, a multi-billion dollar boutique asset management firm focused on below-investment grade corporate credit.
Precious Yield, a subsidiary of Kilo Capital, offers long term precious metal investors the unique ability to safely own gold, silver, and platinum and enhance their total returns by earning a yield on these metal balances. Precious Yield deposits are always 100% backed by physical metal. The physical metal balances are regularly verified by EY, one of the largest global accounting firms. Over time, the benefit of earning interest on gold, silver, or platinum balances can meaningfully improve the returns on precious metal investments.
Kilo Capital is a specialty finance and trading company that provides tailored financing solutions and risk mitigation tools for companies who work, trade, deal or invest in precious metals. Our team of experienced precious metals professionals structure the right combination of loans, metal leases, select inventory finance, and hedging services so that our clients achieve their business goals. We work extensively with jewelry manufacturers and wholesalers, coin dealers, metal refiners, other industrial users of precious metals and investors in gold, silver, and platinum.
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