Within this environment there are two outcomes worth watching.
For starters, the Federal Reserve Board1 may have already tightened interest rates too much when it raised rates from zero to nearly 5% within 12 months. If policy rate changes take 18 months to affect the economy, the slowing effects of the first few rate hikes still have not been fully felt. Even so, there has been a very sharp drop in lending conditions as banks now require higher credit standards and offer loans at higher spreads over policy rates. Both conditions can presage a recession.2 If the Fed pauses and cuts interest rates, gold, and precious metals may deserve a look.
But if the drop in credit creation helps slow the economy without a recession, our focus shifts toward China, where the economy is reopening,3 and Europe, where growth is higher than expected.4 This scenario draws attention to the commodities market where there is an exceptional concurrence of low commodity inventory, insufficient spare supply, a multi-year period of low investment in future capacity, and potentially better demand than expected.Meanwhile, if a recession occurs keep in mind that even a mild one could be good for gold. There are five reasons why investors are looking at gold right now.
- The past three times the Federal Reserve paused rate hikes it has kicked off a gold bull market.5 After the last rate hike in 2000, gold rose 55% before topping at $426 on 3/31/2004. After the last rate hike in 2006, gold rose 230% before topping at $1900 on 9/05/2011. After the last rate hike in 2018, gold rose 70% before topping at $2063 on 8/06/2020.6 The cause and effect for this is that lower bond yields can weaken the US dollar, and gold does well when the dollar weakens. In addition, lower yields make bonds less competitive to gold, which doesn’t have a yield.
- Last year's low point on the S&P 5007 was October 12; since then, it has risen 12% through 4/12/2023, including dividends. However, gold has beaten the S&P 500 returns by 5%, returning 18% during the same time.8 It is unusual for gold to outperform the S&P 500 in an upturn. Gold appears to have momentum.
- Central banks and treasuries are buying more gold than ever before. In 2022, central banks bought 1,136 tons of gold, the most in the history of the data series going back to 1950.9 Foreign governments are showing an appetite to diversify their foreign exchange reserves away from the US dollar with gold purchases.
- The US dollar will not be the world reserve currency forever. Going back to the year 1450, the average length of a currency's dominance is roughly 100 years, and the US dollar has been dominant since 1921.10 Transitions in reserve currencies typically have occurred when the country that possessed the reserve currency became plagued by excessive debt caused by overly ambitious foreign and domestic spending, as well as bad outcomes caused by foreign entanglements.
- Gold is the asset that creates reasonable leverage on the Federal Reserve balance sheet. Gold is held at a book cost of $42.22 an ounce on the Fed’s balance sheet, resulting in 204:1 liability/capital leverage. If gold is adjusted to $2,000 an ounce, the leverage falls to 15:1 closer, much closer to the leverage at typical large commercial banks.11
The Chinese economy continues to rebound after Covid policies were relaxed at the end of 2022, and the Lunar New Year holidays ended in January. As a result, commodity inventories have started to draw down into April as activity levels increase. This increase in demand has contributed to better returns12 on industrial metals, as well as silver, platinum, and palladium.
Investors should pay attention to the China reopening and the strength of the European economy. Metals inventories are still near 25-year lows on the London Metals Exchange,13 leaving them ill-prepared for an uptick in demand.14 If demand increases the supply increase may be a long time coming regardless of the price rise because there has not been much investment in future production. The industrial metals market—copper, aluminum, nickel, zinc and lead—are particularly unprepared for increased demand from the clean energy transition.
1 Federal Reserve Board – responsible for managing monetary policy and regulating the financial system.
2 https://markets.businessinsider.com/news/stocks/banking-credit-crunch-consumer-loans-lending-dallas-fed-survey-crisis-2023-4
3 https://www.bloomberg.com/news/articles/2023-04-10/china-bets-1-8-trillion-of-construction-will-boost-economy?sref=wdbouC7s. (China 1.8 trillion spending)
4 https://www.bloomberg.com/news/articles/2023-04-05/germany-may-just-avoid-a-winter-recession-with-early-year-growth?sref=wdbouC7s (Europe avoids recession)
5 Bull market - A bull market is the condition of a financial market in which prices are rising or are expected to rise.
6 Data from Bloomberg, abrdn Gold in $ per ounce
7 S&P 500 – a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United
States. One may not invest directly in an index.
8 Data from Bloomberg, abrdn
9 https://www.reuters.com/markets/commodities/central-banks-bought-most-gold-since-1967-last-year-wgc-says-2023-01-31/
10 http://www.economicreason.com/usdollarcollapse/world-reserve-currencies-what-happened-during-previous-periods-of-transition/
11 Federal Reserve Balance sheet April 6, 2023, abrdn
12 Bloomberg data Bloomberg industrial metals index returns 3/15/2023 to 4/14/2023 +4.6%
13 London Metals Exchange - is a futures and forwards exchange with the world's largest market in standardized forward contracts, futures contracts and options on base metals. The exchange also offers contracts on ferrous metals and precious metals.
14 Bloomberg data London Metals Exchange, abrdn 1/1/2000 to 4/12/2023
IMPORTANT INFORMATION
The statements and opinions expressed are those of the author and are as of the date of this report. All information is historical and not indicative of future results and subject to change. Reader should not assume that an investment in any securities and/or precious metals mentioned was or would be profitable in the future. This information is not a recommendation to buy or sell. Past performance does not guarantee future results.
Trading in commodities entails a substantial risk of loss and is not suitable for all investors.
Diversification does not eliminate the risk of experiencing investment losses.
Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
ALPS Distributors, Inc. is the marketing agent.
There are risks associated with investing including possible loss of principal.
ALPS is not affiliated with abrdn.
ETF002032 4/30/24
ID:2607943
April has been yet another turbulent month marked by disruptive geopolitics, an unsettled economic outlook, and higher volatility in asset prices.
Within this environment there are two outcomes worth watching.
For starters, the Federal Reserve Board1 may have already tightened interest rates too much when it raised rates from zero to nearly 5% within 12 months. If policy rate changes take 18 months to affect the economy, the slowing effects of the first few rate hikes still have not been fully felt. Even so, there has been a very sharp drop in lending conditions as banks now require higher credit standards and offer loans at higher spreads over policy rates. Both conditions can presage a recession.2 If the Fed pauses and cuts interest rates, gold, and precious metals may deserve a look.
But if the drop in credit creation helps slow the economy without a recession, our focus shifts toward China, where the economy is reopening,3 and Europe, where growth is higher than expected.4 This scenario draws attention to the commodities market where there is an exceptional concurrence of low commodity inventory, insufficient spare supply, a multi-year period of low investment in future capacity, and potentially better demand than expected.Meanwhile, if a recession occurs keep in mind that even a mild one could be good for gold. There are five reasons why investors are looking at gold right now.
- The past three times the Federal Reserve paused rate hikes it has kicked off a gold bull market.5 After the last rate hike in 2000, gold rose 55% before topping at $426 on 3/31/2004. After the last rate hike in 2006, gold rose 230% before topping at $1900 on 9/05/2011. After the last rate hike in 2018, gold rose 70% before topping at $2063 on 8/06/2020.6 The cause and effect for this is that lower bond yields can weaken the US dollar, and gold does well when the dollar weakens. In addition, lower yields make bonds less competitive to gold, which doesn’t have a yield.
- Last year's low point on the S&P 5007 was October 12; since then, it has risen 12% through 4/12/2023, including dividends. However, gold has beaten the S&P 500 returns by 5%, returning 18% during the same time.8 It is unusual for gold to outperform the S&P 500 in an upturn. Gold appears to have momentum.
- Central banks and treasuries are buying more gold than ever before. In 2022, central banks bought 1,136 tons of gold, the most in the history of the data series going back to 1950.9 Foreign governments are showing an appetite to diversify their foreign exchange reserves away from the US dollar with gold purchases.
- The US dollar will not be the world reserve currency forever. Going back to the year 1450, the average length of a currency's dominance is roughly 100 years, and the US dollar has been dominant since 1921.10 Transitions in reserve currencies typically have occurred when the country that possessed the reserve currency became plagued by excessive debt caused by overly ambitious foreign and domestic spending, as well as bad outcomes caused by foreign entanglements.
- Gold is the asset that creates reasonable leverage on the Federal Reserve balance sheet. Gold is held at a book cost of $42.22 an ounce on the Fed’s balance sheet, resulting in 204:1 liability/capital leverage. If gold is adjusted to $2,000 an ounce, the leverage falls to 15:1 closer, much closer to the leverage at typical large commercial banks.11
The Chinese economy continues to rebound after Covid policies were relaxed at the end of 2022, and the Lunar New Year holidays ended in January. As a result, commodity inventories have started to draw down into April as activity levels increase. This increase in demand has contributed to better returns12 on industrial metals, as well as silver, platinum, and palladium.
Investors should pay attention to the China reopening and the strength of the European economy. Metals inventories are still near 25-year lows on the London Metals Exchange,13 leaving them ill-prepared for an uptick in demand.14 If demand increases the supply increase may be a long time coming regardless of the price rise because there has not been much investment in future production. The industrial metals market—copper, aluminum, nickel, zinc and lead—are particularly unprepared for increased demand from the clean energy transition.
1 Federal Reserve Board – responsible for managing monetary policy and regulating the financial system.
2 https://markets.businessinsider.com/news/stocks/banking-credit-crunch-consumer-loans-lending-dallas-fed-survey-crisis-2023-4
3 https://www.bloomberg.com/news/articles/2023-04-10/china-bets-1-8-trillion-of-construction-will-boost-economy?sref=wdbouC7s. (China 1.8 trillion spending)
4 https://www.bloomberg.com/news/articles/2023-04-05/germany-may-just-avoid-a-winter-recession-with-early-year-growth?sref=wdbouC7s (Europe avoids recession)
5 Bull market - A bull market is the condition of a financial market in which prices are rising or are expected to rise.
6 Data from Bloomberg, abrdn Gold in $ per ounce
7 S&P 500 – a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United
States. One may not invest directly in an index.
8 Data from Bloomberg, abrdn
9 https://www.reuters.com/markets/commodities/central-banks-bought-most-gold-since-1967-last-year-wgc-says-2023-01-31/
10 http://www.economicreason.com/usdollarcollapse/world-reserve-currencies-what-happened-during-previous-periods-of-transition/
11 Federal Reserve Balance sheet April 6, 2023, abrdn
12 Bloomberg data Bloomberg industrial metals index returns 3/15/2023 to 4/14/2023 +4.6%
13 London Metals Exchange - is a futures and forwards exchange with the world's largest market in standardized forward contracts, futures contracts and options on base metals. The exchange also offers contracts on ferrous metals and precious metals.
14 Bloomberg data London Metals Exchange, abrdn 1/1/2000 to 4/12/2023
IMPORTANT INFORMATION
The statements and opinions expressed are those of the author and are as of the date of this report. All information is historical and not indicative of future results and subject to change. Reader should not assume that an investment in any securities and/or precious metals mentioned was or would be profitable in the future. This information is not a recommendation to buy or sell. Past performance does not guarantee future results.
Trading in commodities entails a substantial risk of loss and is not suitable for all investors.
Diversification does not eliminate the risk of experiencing investment losses.
Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
ALPS Distributors, Inc. is the marketing agent.
There are risks associated with investing including possible loss of principal.
ALPS is not affiliated with abrdn.
ETF002032 4/30/24
ID:2607943