Another night another limit down halt on Wall Street as we saw over 7% drops again before a little relief rally to be down around 6%. For context, from its high of over 29.000 the Dow dropped to 19,000 at one point last night. And yet gold and silver again fell in USD terms, down 2.7% and 4.9% respectively (UP 1.3% and down 1% in AUD terms but more on that below). Below we share an excellent account of what’s going on with precious metals from Jeff Clark of Peak Prosperity.
Today could be an historic one for Australia. In addition to all the government fiscal stimulus measures announced the RBA is holding an emergency meeting this afternoon where we will almost certainly see a mid term rate cut down to their ‘line in the sand’ of 0.25%. They are on record saying they won’t go lower which just leaves QE or the BoE’s response of free loans to banks in the ‘hope’ they will give cheap loans to businesses. The odds are on that RBA see Australia open its printing presses for the first time since QE was a thing. The stimulus machine is going full tilt. This is important context before reading the piece below. As we mentioned yesterday this crisis could be unique for many reasons. We’ve not had the global confluence of both supply and demand being hit simultaneously. We have early signs too that never before will so much freshly printed or free money be thrown at a crisis to stave off what could be the biggest crash and ensuing depression in history. At some point that means stagflation (low/negative growth and high inflation) or straight out inflation if things turn around more quickly but we still have more currency buying the same amount of (or less given supply chains) things. Everyone thinks of inflation as the price of goods going up. In reality, in this context, it is more money buying the same (or fewer in this case) things. Inflation is historically where precious metals thrive as you can’t just ‘print’ more gold and silver. Jeff points out below just how little silver there is available for its traditional monetary role. Even if solar panels and electronics and jewellery etc plummet, that demand is stupendously dwarfed by the amount of investors’ cash that will soon look for money as cash is debased at an historically unprecedented pace. By example, at the start of this financial year the AUD was 70c to the USD. It is now just 57.7c. That is a 17.6% drop. So in AUD terms gold is still UP 20% this year. Silver is down 18%, both much better than the USD spot price performance of -2% and -33% respectively. The ASX is down 26% as is the S&P500. So again keep silver’s relative performance in mind before you read below, and please read below, it is an important piece.
“Most investors know that gold represents wealth. And that it can be one of the most effective hedges against economic and financial turmoil.
It sure doesn’t feel that way right now. Not only has their volatility spiked, neither metal has logged a gain since the Coronavirus was first widely reported on January 1. As I write on March 17, gold is down about 1%, while silver has crashed 30%.
Why are they performing so poorly? Are they really not crisis hedges?
There are answers to these questions. And when one looks at history we can even get a hint about when it will all turn around…
The Great 2020 Sell-off
First, there are several specific reasons that account for the decline in gold and silver right now.
Margin Calls/Liquidity Needs
The biggest factor is a direct result of the rout in stocks. The selloff has been so violent and unrelenting that there is an overwhelming and immediate need for liquidity. Cash is desperately needed by traders and investors to meet margin calls and offset losses elsewhere.
Combine the selloff in stocks with a crash in oil prices and you get a need for liquidity that is off the charts.
As many investors know, stocks were already bloated and vulnerable. More importantly, margin debt was at record highs, as Mike Maloney pointed out over a year ago.
That extreme amount of margin debt is now coming back to haunt investors. They’re forced to scramble big-time to meet margin requirements—and they are requirements. In some cases they aren’t even asked to deposit more margin; other positions are automatically liquidated to cover them.
When the global stock market is four times bigger than the global economy, it’s not hard to see that an uncontrollable selloff can force investors to raise cash.
Traders can piggyback off the decline by pushing prices down further. They can also put on trades designed to take advantage of the volatility and push the price down. While charges have been brought against some of these traders, this activity still goes on.
Not all short positions are nefarious. Those with corrupt intentions, however, will get burned if they try to continue the manipulation when sentiment in this sector reverses.
The important thing to keep in mind is that manipulations always fail. They will again.
The Gold/Silver Ratio Just Made History
The highest reading in the gold/silver ratio (gold price divided by the silver price) was 100.8 on February 25, 1991.
But as noted above, the silver price has fallen much more than gold in this era of unprecedented volatility. And look how that has pushed the gold/silver ratio (GSR) to a much higher new record of 123+
Never in 5,000 years of recorded history has silver been this undervalued relative to gold.
Why is silver underperforming so much?
There are several answers to this…
First, as many readers probably know, silver is a tiny market. As just one example, if 10% of institutional investors devoted just 2% of their assets to silver, it would exceed 425% of the known silver bullion on the planet. This is why it is more volatile: it doesn’t take much cash coming in, or going out, to impact its price.
The second factor is that mainstream investors look at silver’s high industrial use (about 55%, and another third in jewelry) and believe demand will fall. It probably will if we enter a recession. Copper and other base metals have declined, too.
But what these investors aren’t looking at yet is that silver is also a monetary metal. They will when currency worries ignite.
When will the silver price rebound and the ratio fall? Gold is likely to outperform in in the midst of deflationary scares like we have now—but when inflation begins to kick in, or any monetary issue surrounding the excessive actions taken by governments around the world, silver will respond.
History shows this. Silver’s biggest modern-day rises occurred in the 1970s when inflation was soaring, and in 2009-2011 when we had the fear of inflation. The bottom line today is that the extreme debasement of fiat currencies around the globe are not consequence free—and will drive investors into silver (and gold) when they begin to play out.
Which begs the question…
What Will Turn This Market Around?
No one will know when gold and silver bottom until after the fact. And it’s possible the selling may not be over.
But we see several key hints that tell us, sooner or later, precious metals will turn around…
Hint #1: Central Bank Tools Near Exhaustion
Governments are throwing everything they have at markets and economies.
Rates have been slashed around the world, and various forms of QE have been instituted.
These are their two main tools—and both make gold and silver more attractive.
If conditions surrounding the spread of coronavirus worsen, it’s almost certain that other measures will be instituted, just like they did during the Financial Crisis of 2008-09. And most of these efforts are inflationary in nature.
In the big picture, these interventions will drive investors toward silver and gold, not away from them.
Hint #2: Confidence in the Fed’s Ability Is Eroding
It’s starting to dawn on the mainstream: how effectively will the Fed be able to navigate the turmoil?
Consider this quote last week from Bloomberg, about as mainstream as you can get.
“Some new financial order, to replace Bretton Woods and the system that Volcker built to replace it, is now needed. A decade of monetary expansion has delayed the issue. It is hard to see how it can be delayed much further. It would be wise to brace for disruption to match what was experienced at the end of the 1970s and the beginning of the 1980s.”
That sounds like Mike Maloney!
The more this line of thinking gains traction, the more investors will turn to silver and gold. We think that’s exactly what’s coming. Watch for this shift in trend, as that’s when I think a reversal begins to take hold.
Hint #3: Spiking Investment Demand
Gold and silver both have industrial uses, as well as widespread jewellery use.
But when it comes to determining the price, the biggest influence is investment demand. And that is through the roof.
Look what’s taken place in just the past two weeks:
- Through March 13, holdings in gold-backed ETFs already total more than half of 2019’s total.
- Virtually every bullion dealer reports record-level demand.
- The U.S. Mint is out of silver Eagles. Their press release stated, “Our rate of sale in just the first part of March exceeds 300% of what was sold last month.”
- The U.K.’s Royal Mint said last week that weekly precious metals sales quadrupled from the same period a year ago.
- Gold trading volumes tracked by the London Bullion Market Association reached almost $100 billion on Monday March 9, the highest ever daily volume.
This record-setting level of demand is likely to push prices higher once the forced selling is over.
Hint #4: History
Last, we’ve seen this movie before.
Gold and silver crashed back in 2008 with the stock markets, largely for the same reasons as today. Gold fell 30% from its high to low that year, while silver dropped a whopping 73%.
But both metals bottomed in October, and by 2011, gold had risen 166%, and silver soared 440%. And both of these rallies started before the stock market bottomed.
In other words, the selling was temporary. Once liquidity needs had been satisfied, investors rushed back into gold and silver and sent them on one of their greatest rallies in history.
Although no two circumstances are exactly alike (and yes the coronavirus is scary), the setup we see now in precious metals is not new to history. And history says that at some point they will reward investors this time, too.
If you already own precious metals, hang in there. Time will work in your favor.
If you don’t, you have a rare opportunity to gain exposure at today’s low prices, when we have high confidence demand for gold & silver is fast increasing.
An opportunity that not only will add protection against the desperate (and inflationary) actions of the world’s central banks, but could well provide extremely lucrative.”