Precious Metal Market Update – 26 January 2020

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Every once in awhile, you get a week where a single event or news item overrides pretty much everything else going on in the market and becomes the singular issue impacting those holding a gold investment or a silver investment.  This week, undoubtedly, that event was the continuing spread of the coronavirus. For those of you who haven’t been inundated with constant updates on the status of this illness, the current coronavirus strain originated at a local market in Wuhan, China starting in December.  More recently, certain details regarding this illness have led to increasingly greater levels of concern and beg the question as to whether this current epidemic is turning into a more serious pandemic. For those of you yearning for the distinction, an epidemic is a widespread occurrence of an infectious disease in a community at a particular time while a pandemic is an epidemic of worldwide proportions.  Instead of boring you with the timeline of the spread of the disease, I think we are better served by figuring out where things stand as of this moment.  Let’s review recent news which is leading to this increasingly greater level of concern.

First, the number of new confirmed cases is continuing to accelerate and severe travel restrictions which are now currently in place appear to have been implemented late.  For example, the city of Wuhan has been on lockdown since Thursday, with trains, buses and airplane flights suspended. Furthermore, Chinese authorities have imposed indefinite restrictions on public transport and travel, with motor vehicles banned in the downtown area of Wuhan starting Sunday.  Also, Chinese travel agencies have been instructed to stop all group tours. Clearly, these types of necessary restrictions will begin to suppress business/economic activity. In my opinion, this Los Angeles Times article does a great job of detailing these efforts but even since its publishing, there has been a fourth and fifth case confirmed in the United States.  And by the time this hits your inbox Monday morning, I wouldn’t be surprised if these numbers ballooned further. As you can see from the following infographic, confirmed cases are now starting to show up in other areas of the world outside of China.



From an investor’s perspective, I believe the key piece of information here is the acceleration in the number of confirmed cases.  This is important because markets tend to trade on a data set’s second derivative.  To be more blunt, I would continue to expect a flight to safety if new confirmed cases continue to accelerate.  This should be good for traditional risk-off trades like government bonds, precious metals and the Yen. Conversely, I would expect equities to recover and possibly resume their upward trajectory if the instance of reported new cases decelerates and the overall economic impact is assumed to be temporary.  For the moment, we are in the acceleration phase as shown in the following chart and I would expect investors to continue to pair risk over the coming days.  



Second, recent information about the nature of the disease leads me to believe that it will continue to accelerate further over the near-term.  The World Health Organization was first to state that despite the virus’s animal-to human-origins, human-to-human transmission was occurring. Initially, China’s National Health Commission contradicted this finding but has since reversed its stance.  And now, China’s Health Minister, Ma Xiaowei, believes that people can spread the virus before they have symptoms.   If true, and noting that in CNN’s words, “information about the virus is constantly evolving”, this leads me to believe that the disease exhibits a relatively high degree of contagiousness and will cause the number of confirmed cases to continue to accelerate until even more stringent protections are put in place.  While I have confidence that global health authorities will ultimately get their arms fully around this outbreak, I do think that it will continue to remain messy and bring more volatility to the market.

Before we discuss the individual markets, here’s a couple of quick other points to note about last week.  1) There wasn’t much in the way of important domestic economic data and the data that was released did not seem to impact analyst estimates for Q4 GDP.  2) Corporate earnings continued to exhibit similar characteristics to the initial batch from last week. Remember, companies typically beat estimates and now, the expected decline in Q4 earnings is 1.9%. 3) Commodities such as oil & copper that are closely linked to global growth took a beating as fears over the ramifications of the coronavirus outbreak ramped up. 

With that, I’d like to remind readers that anyone who is thinking about buying gold as an investment or silver as an investment and who is worried about initiating a new position at current prices should carefully develop their own view and consider their expected holding period.  A gold long term investment or a silver long term investment is very different from investing in precious metals on a short term basis. Depending on one’s objective, when investing in gold and silver, there are several drivers of precious metal price that investors need to be mindful of that will drive gold investment returns.  In support of developing that view, let’s review the major markets that precious metals take their cue from.


US Equities:  

The S&P spent most of the week fluctuating at levels a touch higher than last Friday’s close as continued news flow surrounding the coronavirus played ping pong with equity prices.  This Friday, however, the steady increase in the report of new cases and the spread of cases to other geographic locations caused the market to sell-off in a more noticeable manner. As a result, the S&P ended the week with a loss of just over 1.0% to close at 3,295.  As you know, I’ve argued over the last several weeks that if we get a dip in equities, I expect it to be shallow with the Fed currently in QE/not QE mode. The spread of the coronavirus looks likely to be the catalyst for this sort of move. For the moment, as mentioned in the overview, we are still in the acceleration phase of the outbreak.  As a result, I would expect the market to continue to be under pressure. Last week I highlighted the 50-day moving average, now 3,195, a 3.0% decline from current levels. This is the first level I would look to for potential support.  

With a modest increase in fears over the coronavirus during the early part of the week, the VIX fluctuated at slightly higher levels until Friday, when the VIX saw a more pronounced spike to finish the week at 14.56.  Of note, the VIX reached an intraday high of just under 16. As I mentioned in last week’s report, mini-reversals in the VIX (upon achieving a level of 12 or lower) have become more muted post the Fed’s T-bill purchase program.  The spike up in the VIX at the end of the week is reflective of one of these muted reversals in my opinion. Case in point, even at Friday’s intraday highs, the VIX was still below the mean using log normal data (since January 1990).  Keep in mind, this is a purely technical analysis. If the coronavirus, a fundamental issue, continues to spread and worries build regarding global economic activity as a result of its impact on travel and therefore business activity, then we could certainly see higher levels of volatility and a more than modest pullback in S&P 500 index levels.   


Government Bonds: 

The US Treasury curve saw a pretty significant flattening this week as intermediate and longer dated government bonds rallied strongly in response to the continued worsening of the coronavirus situation.  Specifically, 10-Year Treasury yields saw a decrease of 14bps to finish at 1.70% vs. 1.84% last week. This week’s move now threatens the late October lows of just under 1.70% and should we convincingly break through this mark, I would look toward 1.50% as the next level of support.  In this instance, my prior upside yield targets will need to be reconsidered. As I’ve discussed for the last several weeks, those upside yield targets were going to be difficult to achieve anyway so long as the Fed continues to anchor the short-end of the curve with the T-bill purchase program (which is their intent at least through the second quarter of 2020).

As for US Treasury – German Bund spreads, they continue to trade in the range of +200bps to +210bps.  To remind our readers, this spread broke new ground with the turning of the calendar, dropping to new cycle lows.  In my opinion, the tightening that we have seen since the beginning of the year in this spread is more likely attributable to the Fed rather than a deceleration of the US economy relative to Germany.  Said differently, my level of concern seeing this spread shrink further (with respect to recession potential) is less than it normally would be. 

3-month T-bills (the best barometer of future Fed action) also saw yields decrease albeit more modestly – thus the flattening effect.  In essence, this week’s decrease in yield from 1.56% to 1.54% essentially retraced the prior week’s increase and is once again approaching the bottom of the current Fed Funds target range of 1.50 % – 1.75%.  Remember, this signal is somewhat distorted by the Fed’s current T-bill purchase program and I continue to prefer Fed Fund futures as a more reliable indicator in this environment. That said, the slight move lower in short-dated Treasury yields was accompanied by an almost 14 point increase in the probability of easing by year end 2020 from 53.9% to 67.8% – see chart below.  


To remind our readers, from a rate cut perspective, the Fed has taken the position that it remains “on hold”.  And as you know, from a holistic perspective, I don’t consider them to be “on hold” given the T-bill purchase program.  Based on current Fed Funds futures pricing, investors are leaning toward a future rate cut once this period of being “on hold” from a rate cut perspective ends.

Finally, 2-Year Treasury Note yields also declined, falling from 1.58% to 1.49% by week’s end.  With Precious Yield continuing to offer 2-year physical gold term deposit rates of 2%, the US Treasury – Precious Yield spread* is -.51%.  Note that a negative spread favors Precious Yield while a positive spread favors US Treasuries.  Since Precious Yield offers investors in gold the opportunity to earn interest, the US Treasury – Precious Yield spread is tighter than the US Treasury – gold yield spread.  To remind our audience, the gold yield is negative in most other holding forms outside of Precious Yield. This includes paying for storage of physical metal whether investor-owned or via a physically -backed storage program and paying management fees for GLD or similar ETFs.  See our how to gold investment white paper for a more thorough discussion. Precious Yield (whether hedged* or unhedged) provides a much needed yield alternative in this environment of ultra-low / negative global bond yields.  I believe yield alternatives continue to be a major investor focus.


US Dollar: 

For the third consecutive week, the US Dollar strengthened as measured by the US Dollar Index (Ticker:  DXY). Of note, the 0.22% gain for the week was fairly modest and driven entirely by a 0.58% increase vs. the Euro (57.6% index weight).  On Thursday, the ECB left both its key interest rates and stimulus programs unchanged while launching a review of its overall policy. Dollar performance against the other major index constituents, however, was quite the opposite.   The USD weakened 0.51% against the Pound (11.9% index weight) and 0.79% against the Yen (13.6% index weight). With flight-to-safety dominating this week’s trade in general, the performance vs. the Yen comes as no surprise. The Pound, on the other hand, benefitted from good economic data including a strong jobs number and better manufacturing sentiment which decreased the likelihood of a rate cut at the Bank Of England’s upcoming January 30th meeting. 

With Wuhan, China being the epicenter of the coronavirus, it should come as no surprise that the dollar strengthened vis-a-vis the yuan this week.  In general, over the last several months, if the dollar strengthened as measured by the US Dollar Index, then the dollar weakened vs. the yuan (and vice versa).  This past week obviously broke that trend and I would expect that correlation to remain broken while news of the spread of the coronavirus continues to dominate headlines.  All together, the dollar strengthened 1.12% against the yuan for the week and I would expect the yuan to remain under pressure near-term. Once the spread of the virus ebbs, I would expect the yuan to revert back to being range bound until such time as there is further progress rolling back more tariffs during phase two trade negotiations with the US. 



With equities selling off, volatility increasing, and Treasury yields falling, the price of gold in ounces had several tailwinds this week only partially offset by the strengthening dollar.  As a result, as measured by the LBMA afternoon fix (10:00AM EST), the price of gold per ounce increased a little over 0.4% to finish the week at $1,564/oz. As with other markets (equities, government bonds), I believe current Fed actions are putting somewhat of a floor underneath gold prices.  Until we see a meaningful break below the old cycle high of $1,546/oz., I think it will act as a floor, albeit potentially flimsy. Beyond that, the next (and more likely) downside at this point is the 50-day moving average, currently $1,504/oz. However, I don’t see a near-term case for that level to be tested given the uncertainty over the coronavirus.  Remember, fundamentals are also in gold’s favor with global central banks increasing reserves and reduced selling from retail holders of physical coins.

Moving on to the “Gold VIX”  (Ticker – GVZ ), the index showed an increase from 11.31 to 12.48 this week.  Based on this move, gold volatility is now sitting almost exactly 1 standard deviation below the average (since June 2008) using log normal data.  Looking at both the AM & PM LBMA fixes, the gold price per ounce trading band was $13/oz. or 0.8% between the high and low (vs. $12/oz. or 0.8% between the high and the low last week).  I use these price bands to better understand the movements in the “Gold VIX” (Ticker – GVZ ) levels from above.  To remind our readers, the Gold VIX measures the market’s expectation of 30-day volatility of gold prices by applying the VIX methodology to options on SPDR Gold Shares (Ticker – GLD ).  GLD is an exchange-traded fund that represents a fractional, undivided interest in the SPDR Gold Trust, which primarily holds gold bullion. As such, the performance of GLD is intended to reflect the spot price of gold, less fund expenses.     



As a quick follow-up to last week’s special report on PGMs, particularly palladium, I thought I’d mention the following.  First, palladium held on to the vast majority of its price gains this past week, trading solidly above $2,400/oz. To remind readers, as the price of palladium has soared, there has been talk of substituting platinum as a catalyst for palladium in gasoline engines.  But, as also discussed, you need platinum AND rhodium to replace palladium in a gasoline engine. That brings me to my second point. The move in rhodium, particularly this past week per Reuters, makes the move in palladium look alot less parabolic and gives more credence to the theory that maybe we’ve hit that tipping point.  The following chart does a great job of illustrating the magnitude of these price moves.  





While gold and silver investing have historically been associated with negative carry, a Precious Yield precious metal account offers investors the opportunity to earn a yield on gold and silver instead.  If you are a long-term holder, turning gold and silver as an asset for diversification purposes into an alternative investment and yield alternative with Precious Yield allows for some cushion against price movements via the gold and silver yield.  To learn more, please browse our website.  Alternatively, contact us directly for more information or to answer your precious metal investment questions.  For up to the minute thoughts, please follow me (@CIORobPerry) or Precious Yield (@PreciousYield) on twitter.

* Note that while I use the US Treasury – Precious Yield spread as a relative value metric, a better apples to apples comparison of similar instruments would be US Treasuries vs. a fully hedged gold position.  For more information on a fully hedged gold position as a yield alternative, please visit our website and read about The Cash and Carry Trade.


Gold price per ounce 1-Month Chart



Silver price by ounce 1-Month Price Chart


Platinum price per ounce 1-Month Price Chart


Palladium price per ounce 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. Twitter: @CIORobPerry


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