Gold $1,323 on Interest Rate Gallop - Will Rising Deficits Help Gold?

Ambush
Eureka, Nevada

Friday, April 27, 2018 AM

Latest Mining Quarterly! (Checkout story on McEwen Mining's Gold Bar Project)

McEwen Mining Reports Q1 2018 Production Results (Press release, 4/16/2018)

Next Week: Target gold price $1,310 per ounce. Target Silver price $16.4 per ounce.

Morning Miners!

Gold felt the full weight of rising interest rates earlier in the week. If you buy gold, your investment only gains value with appreciation. Unlike stocks and bonds it pays you no rent for holding it over a period of time. Many stocks pay dividends and bonds pay a fixed interest rate so you are rewarded for being patient.

There is a second part to this. If inflation rises faster than interest rates, gold may indeed prosper. Investors seek "real returns" which are roughly the difference between a fixed or nominal interest rate and inflation expectations. If this turns negative, market participants can lose money holding debt assets (i.e. paying the tenant to stay using the rent analogy). Some some turn to gold as an alternative.

A key benchmark to watch is the yield on a 10-year Treasury Note which saw a rapid rise this week above the key 3%-level outpacing inflation expectations (see chart below). This results in a real yield approaching +1%, a bearish headwind for gold. The U.S. dollar is also regaining strength, another drag for metals as I explain in my input to the Kitco Gold Survey (below)

Tom McClellan of McClellan Oscillator fame has an interesting take on why gold hasn't fallen further given these pressures. History suggests that gold benefits from rising U.S. deficits. Sharply rising deficits in 2011 were concurrent with gold reaching its all-time high; deficits are on the march again. His chart (he notes correlation isn't perfect but instructive nonetheless):

I heartily recommend you check out McLellan Financial Publications and charts for why gold may have a lifeboat even if interest rates continue to climb.

Inflation Watch

Inflation expectations made another new 2018 high this week above new trend line of higher lows (blue dotted line, click on chart for larger size). 

10-year Inflation Expectations

Note: In the above chart inflation expectations peaked at 2.14% February 2 but were surpassed Tuesday at 2.18% and retreated slightly Wednesday to 2.17% (note old trend line, faded blue).

Interest rates and inflation numbers going forward are greatly influenced by central bank policy worldwide. My latest Kitco commentary discusses what some of the moving parts are as well as useful indicators - watch the U.S. Dollar Index (DXY) and euro/yen cross rate:

The Gartman Gold Trade Revisited (Kitco News, 2/14/2018)

Several of the charts in this column are updated below.

Have a fun weekend!

 Newark Valley
White Pine, Nevada

Scorecard 

Here's our scorecard on where we stand for the last six months:

Intraday highs on the Comex futures exchange: 

Gold $1,370.5 per ounce January 25, 2018 (April 2018 contract)

Silver $18.160 per ounce September 8, 2017 (Continuous chart))

Copper $3.3335 per pound ($7,349 per tonne) December 28, 2017 (May 2018 contract)

Comex copper is presently trading at $3.0615 per pound ($6,650 per tonne), nearly returning to correction territory at 9.5% below December's high. Improving global growth has kept the red metal above the key $3 per pound. Trade war fears dipped the red metal below this mark but copper is now back above $3. Recent weakness must be watched!

Copper futures remain down year-to-date on the Shanghai Futures Exchange (SHFE).

China growth resulted in a GDP 6.9% for 2017 compared to 6.7% for 2016. The GDP projection for 2018 is 6.5%, down but still fairly robust. Encouragingly, the Q1 result is a better-than-expected 6.8% although industrial production fell to 6.0%. Watch this one too, pardner.

Recent U.S. import tariff threats on steel, aluminum and other Chinese exports cloud the outlook for metals. Sanctions on Russian aluminum producer Rusal have spiked aluminum prices to 7-year highs (whose output represents 6% of global supply) but have fallen since with softening of U.S. position.

Copper stored in LME and Nymex warehouses are now lower at 0.59 million tonnes.

LME inventories are falling: 

It is instructive to keep our eyes on the Nymex inventories which are behind the LME and but moving up (346,300 versus 248,501 tonnes):

My Input to Kitco News 

Here's how I saw the weekly price action as told to the Kitco News Weekly Gold Survey:

My vote is down. Target gold price $1,310 per ounce. Target silver price $16.4 per ounce.

Interest rates. Interest rates. Interest rates. 

Although the U.S. 10-year Treasury yield has backed down from its Wednesday peak above 3%, its journey there was brisk. This takes shine away from gold. Although inflation expectations are also rising, they remain outpaced by interest rates. As measured by Treasury Inflation Protected Bonds (TIPS), real rates have doubled for 2018 and are approaching +1%*. Positive real rates are bearish for the lustrous metal.

The rising U.S. dollar index, now at a 3.5-month high, is also a headwind for gold and other dollarized commodities.

One may reasonably ask why gold price hasn't fallen further? Aside from present political/geo-political buoyancy, history suggests that gold benefits from rising U.S. deficits. Sharply rising deficits in 2011 were concurrent with gold reaching its all-time high; deficits are on the march again.

I believe gold will test its March low next week ($1,309.3) before recovering higher within its 2018 range. My target is $1,310 per ounce with silver following gold lower to$16.4 per ounce.

Gold pulled ahead of falling copper prices this week but fell in value compared to the broader Bloomberg Commodity Index (BCOM). Against major currencies, gold bullishly gained on both the euro and the Japanese yen.[see Weekly Summary and charts below]

* as measured by the 10-year U.S. Treasury break-even rate, now 2.17% with 10-year real rate at 0.79%. The latter is a 42 basis point jump for the year.

Additional Note:

The fate of the Chinese yuan remains a key tell for gold and copper - a material drop in valuation could boost gold and depress copper prices. There has been talk from China that currency devaluation may be used as a tool in a U.S./China trade war, just talk for now.

The yuan stabilized below 7 USD/CNY for 2017 and has been trending steadily stronger in the new year. The yuan is weaker than last week at 6.3353 USD/CNY but above the March 26th low (i.e. even stronger level) of 6.2342. A low 1-month yuan volatility of 0.33% is in the ballpark of major currency levels - a healthy sign for the Chinese currency (1-month volatilities of euro, yen and gold*).

* the euro & yen 1-month volatilites are  0.69% & 0.91% respectively; Comex gold 1-month volatility is 0.88%.

Weekly Summary  for April 27, 2018 AM 

(click on table for larger size)

Yearly Summary for 2017

(click on table for larger size)

Comex gold gained nearly 14% for the year but was outpaced by Comex copper that enjoyed a 32% uptick in price. Comex silver lagged both for a  respectable 7.2% gain. Overall, gold gained 12% on the broader Bloomberg Commodity Index (BCOMTR:IND) which includes everything from crude oil to things that oink. In terms of major currencies, gold in terms of yen advanced almost 10% but slipped 0.4% relative to the strengthening euro.

Although gold slipped 5% in value relative to the S&P 500 it was not a bad year at all for the yellow metal!

Gold Price Outlook for 2018:

My revised gold range for 2017 was $1,250 to $1,400. We closed 2017 comfortably above $1,300 at $1,309.3 (February contract).

Let's assume 2018, like 2017, is a mix of buoyant market expectations and rising rates with occasional geopolitical, political and economic shocks. Gold will feel the headwinds of the former and enjoy price spikes in times of market stress. I believe this will secure a price floor in the $1,200 to $1,250 range with highs challenging but not exceeding $1,380 per ounce.

2018 will prove a less bullish period for gold than last year unless interest rates return to 2017 levels and copper prices fall - a less likely scenario given the recent rise of the 10-year Treasury together with U.S. growth and synchronous global growth expectations. Inflation will be another key factor to monitor, it has been on the rise (see chart above in discussion). Geo-political tensions in the Middle-East have also re-surfaced.

The difference between interest rates and inflation expectations drive gold price; if the former leads the latter, there could be stiff headwinds for the lustrous metal. A trade war that results in slower growth and higher inflation could be potentially very bullish for gold.

Here's a good beer bet for 2018: Gold will fall below $1,220 before rising above $1,380. We ended 2017 n the middle of that range with prices just above $1,300 - a fair starting point. 

Which side of this bet you take depends on whether you have a half-empty or half-full view on interest rate direction and economic prospects, both global and domestic.

Important charts to watch remain the gold-to-S&P500 or AUSP (see "Chart to Watch" below) and gold in terms of major currencies euro and Japanese yen (directly below). An explanation of the charts below is given in my latest Kitco column:

The Gartman Gold Trade Revisited (Kitco News, 2/14/2018)

Click on the image for a larger size:

Gold in euro & yen terms with good margin above 2013 lows

Note upside trend of higher lows for gold in U.S. dollars for 2018 (dotted blue line).

Gold euro/yen spread widens again in 2018

Note for currency buffs: Value parity in the above chart occurs when the EUR/JPY cross rate is 139.24; something to watch for - presently 131.99 yen per euro as the gold euro/yen spread stalls from its recent rise (above chart).

Chart to Watch

Here's a chart to watch for 2018. Click on the image for a larger size:

Gold-to-S&P 500 Ratio

An important gold ratio is gold-to-S&P500 or AUSP. The ratio bottomed in early-December of 2015 and reversed to a bullish trend, peaking February 11, 2016. It bottomed again December 20, 2016 (0.4973) trended higher but then bearishly bottomed again in July, 2017 and more recently December, 12, 2017 (0.4661). Currently this AM the AUSP is 0.4944, bearishly trending below the key 0.5-level.

Cheers,

Colonel Possum & Mariana

Photos by Mariana Titus if not otherwise noted.