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A Decoupling That Makes Sense

Prices of gold and silver have risen sharply over the past two months. Those gains have come alongside a stronger U.S. dollar and higher interest rate yields, which has surprised some market participants. The reason why gold has risen in this environment becomes clearer when the reason for rising yields and dollar are taken into consideration.

U.S. yields have been rising in response to somewhat healthy economic conditions and stubborn inflation. The dollar is being helped by the relative strength in U.S. yields compared to other major currencies and on safe haven demand.

The stickiness of inflation and safe haven demand have played an important role in driving higher and supporting gold prices at elevated levels. CPM Group thinks what has been happening over the course of March and much of April is that investors around the world largely have continued to buy gold as a portfolio diversifier, capitalizing on high values of stocks and other assets at levels market participants view as being near cyclical peaks and vulnerable to declines. The economic and financial environment for assets seems to be too good to be sustainable. Investors are cycling out of more risky assets into gold, the dollar, and U.S. Treasuries.

It is becoming increasingly clear that inflation is not likely to return to various central banks’ inflation targets anytime soon. While this was to some extent expected by CPM Group, the data is now confirming this risk. The stickiness in inflation data has forced markets to make large adjustments to their interest rate expectations both in terms of timing of the first cut as well as the number of cuts. Where at one-point markets were expecting five or six rate cuts during 2024, they are now expecting one. If inflation data continues on its current path, even the one rate cut this year might become doubtful.

CPM Group has repeatedly said that market expectations of interest rates were excessively optimistic. Rates are expected to be kept higher for longer. It is unclear at this time if tighter monetary policy is facing greater lags or rates at current levels are just not sufficient in pushing inflation lower. There have been concerns whether higher rates are bad for gold prices. They are not if inflation starts to show signs of rising, as this would put downward pressure on real rates, especially if nominal rates are held steady at present levels. The reality is that ‘really high’ interest rates, for example real rates over 3%, can woo investors away from gold. The world is nowhere near real 3% or higher interest rates, and the economic outlook does not support expecting further increases in real rates to those levels for a long time, possibly for many years.

Inflation and economic growth data for the first quarter of 2024 have both moved in the wrong direction. Inflation has been particularly stubborn and shown strength by some measures, while economic growth seems to have lost some momentum based off the first estimate of first quarter U.S. gross domestic product (GDP), weaker economic data in many European nations, and economic issues appearing in China.

This relative weakness in U.S. and global economic growth coupled with sticky inflation complicates the Fed’s future rate trajectory and heightens uncertainties in financial markets. The Fed is mandated to work toward maintaining stable prices and promoting maximum employment. While the employment arm of its mandate is doing well at this time, inflation has been trickier to stabilize. While the Fed would not try to engineer a recession, some economic weakness or a shallow recession may likely be unavoidable consequences of the effort to get some relief from the upward pressure on inflation. Much of the upward pressure in inflation has been supported by services inflation, which is not surprising given the strength in the labor market and a decades-long deterioration in inflation-adjusted earnings in many service industries. That said, if the recent uptick in various commodity prices persists not only will it push up headline inflation but could also eventually start pressuring higher core inflation.

If inflation does not resume its downward trajectory there is a slim chance, at present, of a rate hike sometime in the future. While the Fed seems likely to steer clear of even suggesting a rate hike anytime soon, this is a low probability risk that needs to be considered.

The gold market does not need to fear elevated or potentially higher rates at this time, in part because the stickiness of inflation will put downward pressure on real rates and any increase in rates, while temporarily negative, possibly could cause a recession, which would again be supportive of gold and silver prices.

One of the reasons gold prices have risen so strongly this year is that the metal stands to win under various economic scenarios. Stronger economic conditions make investors wealthier and more worried about an inevitable decline in stock and bond prices, while also fueling inflation fears. A weaker economic environment similarly would heighten investor concerns about declines in stocks and bonds, which would encourage them to seek shelter in gold.

Additionally, the metal is expected to continue benefiting from political risk, the ongoing war between Russia and Ukraine, the problems in the Middle East, and the run up to and outcome of the U.S. presidential and congressional election in November 2024.

Higher Later

This leave the gold market in excellent shape to see more investor demand and higher prices going forward.

CPM has been projecting sharp increases in gold prices for 2024 and 2025 for several years. Those projections were predicated on tightening gold supply and rising investment demand fueled by much more hostile economic and political conditions.

The hostile political conditions are here and justify investors’ interest in gold. The economic environment and financial markets are not particularly caustic currently, although there are plenty of indications of weakening economic activity and growing financial market issues readily visible on the horizon.

This suggests that the remarkable increases in gold prices in March and April are only the beginning of a period of more intense investment demand and higher prices.

While CPM Group expects gold prices to rise over the course of 2024, typically any market that experiences the sort of sharp run up observed in gold since the beginning of March goes through a pullback or at least a period of consolidation. A pullback in demand from fabricators, central banks, and the more price sensitive investors could act as an initial headwind to prices between May and September. Precious metals markets also go through a period of seasonal weakness during the summer months, which could act as a further drag on prices in the near future.

Gold Market

Gold prices continued to surge during April, building on the momentum that took root during the second half of February. Prices broke several records along the way, with the final record price, in the current leg up, reached on 12 April, when prices touched an intraday high of $2,448.80. Prices have cooled off since then but remain at historically elevated levels. Gold prices for the most part have been consolidating between $2,300 and $2,350 since the third week of April.

While CPM Group continues to expect higher gold prices as the year progresses, over the next few months there is a higher risk that gold prices move in a sideways to lower fashion. Prices could slide toward $2,150 during such a down move, although a larger drop to around $2,040, a level seen as recently as late March, cannot be completely ruled out. While these declines might appear sharp to some gold market observers, even a drop to $2,040 would mean that gold prices are only back to levels they were at during the start of March 2024.

There are various fundamentals that support high gold prices, but the recent move up has been extremely strong and has occurred over a very short period of time. There already are some signs of pull back in demand from longer term price sensitive investors, fabricators, and central banks. The market also enters a seasonally weak period over the next few months. The strong move higher over the past couple of months has drawn a lot of short-term momentum investors. These investors would be quick to exit the gold market if they or their computer models feel that the current up move is complete. A close below $2,285 could trigger such a sell-off.

As mentioned earlier, CPM Group continues to foresee higher gold prices as the year progresses, and with this forecast in mind, any weakness in gold prices toward $2,150 or $2,040 should be used as a buying opportunity.

While weaker prices over the next few months is CPM Group’s base case scenario, there is also the possibility that gold prices continue to consolidate in the present range and head higher. That said, a lot of the positive fundamentals for gold already seem factored into prices for now, which coupled with seasonal weakness and reduced demand from fabricators, central banks, and price sensitive investors could make moving higher more challenging.

Official Transactions

Reported net purchases by central banks during the first quarter of 2024 stood at 1.4 million ounces. This was down sharply – 64% — from 3.86 million ounces in net purchases during the same period in 2023.

Furthermore, gross purchases made by central banks declined during March 2024 compared to the previous two months. A major contributor to this slowdown was the relatively lower purchases made by the People’s Bank Of China (PBOC) during the month. After making purchases of 320,000 ounces and 390,000 ounces during January and February, respectively, the PBOC’s purchases in March slipped to 160,000 ounces – less than half the rate in the first two months.

Over the course of 2023 the PBOC had added 7.23 million ounces of gold to its monetary reserves, from gold that was sloshing around the internal Chinese gold market after a 72% drop in purchases during the last three quarters of 2022. (The PBOC also had bought around two million ounces in the final two months of 2022, after gold prices fell from a high of $2,043.30 in the first quarter to $1,623.60 in early November 2022.) The PBOC’s acquisition rate in 2023 averaged 603,000 ounces per month. March’s 160,000 ounces were off 74% from that rate. This slow down in purchases probably reflected a combination of the absorption of the ‘excess’ gold inventories in China over the course of 2023 and the higher gold prices in March, as there was less gold readily available and prices were much higher than they had been.

China was not alone in pulling back on its purchases during March. Others including the central banks of Kazakhstan, the Czech Republic, and Serbia also lowered their March purchases compared with those made during the first two months of the year. Other central banks like the Reserve Bank of India and the central bank of the Kyrgyz Republic suspended purchases in March after buying gold in both January and February.

The primary culprit of the reduction in purchases during March was likely the sharp increase in gold prices during the month. Central banks are generally sensitive to price increases, although this sensitivity has declined somewhat in recent years. The sharpness of prices gains over the past two months is likely to result in these entities pulling back making purchases or at least large purchases.

The only exception to the group was the Central Bank of Russia, which added 512,000 ounces of gold to its holdings during March, making it the single largest buyer of gold during the month. That said, this purchase was a decline from the 618,000 ounces in net purchases during February. Also, the purchases made by the Central Bank of Russia during February and March essentially were the reversal of the 1.2 million ounces in net sales during January. Russian central bank purchases and sales have fluctuated greatly month to month since the country invaded Ukraine, as the Russian government has had most of its more than $300 million in foreign exchange reserves frozen and has had to use gold reserves to raise cash to fund the government over the past two years.

The ongoing strength in gold prices during April is likely to have dampened demand even more from these entities during the month.

Silver Market

Silver prices rose alongside those of gold. Unlike gold, which made several new records over the past month, silver prices are nowhere near their record highs reached in 2011.

While CPM Group expects silver prices to rise to record levels over the next two years or so, this may be unlikely to occur this year. That said, building positions now on dips would be a good strategy for investors, mining companies, and others to benefit from the sharp upward move anticipated in silver prices in the medium to long term. Fabricators also should take such opportunities to hedge in advance of such price increases.

The fact that silver is not at record price levels while gold is may not be unusual. It is often said that silver prices lag gold prices in a typical gold and silver bull market. This is largely true, but prices do not always follow this pattern. Silver peaked in April 2011; gold peaked in September that year. The silver price lag has taken on mythic proportions that can obscure real-time market developments and trends for people who rely on mechanical formulae.

Various investors already have started showing increased interest in silver over the past two months. Silver exchange traded fund (ETF) investors, for example, purchased 20.1 million ounces of silver during March. While they were net sellers in April, the net sales at 4.3 million ounces were much smaller than the net purchases in March. U.S. Mint coin sales to dealers also have been strong and premia paid for these coins by dealers also have remained above levels seen prior to the pandemic, unlike in the case of gold.

Silver prices are expected to soften in the near future, driven in part by the expectation of weaker gold prices and in part due to seasonal weakness in precious metals fabrication and investor demand that often appears over the next four months.

Platinum Market

All the gains that platinum prices made during the first half of April were lost during the second half of the month. Platinum prices have essentially been moving in a sideways fashion since July last year. Prices have largely been moving between $880 and $1,000 since the middle of last year.

There have been some positive developments for the platinum group metal (PGM) markets in recent months, one in particular being the slowdown in adoption of battery electric vehicles (BEVs), which do not use PGM bearing catalysts. Platinum demand also is being supported by ongoing strength in most major commercial vehicle markets.

These positive factors should help keep platinum prices supported in the near term, along with lower South African mine output. However, potential weakness in gold and silver markets and prices, and seasonal weakness across precious metals markets are likely to weigh on platinum prices.

While the adoption of BEVs is showing signs of slowing this year, it does not mean it is the end for EVs. Price cuts, an increase in choices of electric vehicles, and a steady build out of charging infrastructure will eventually help demand in the long run, which is likely to make investors skeptical about getting too optimistic regarding the PGMs.

There are longer term issues that could further slow consumer acceptance of BEVs, but the trend remains upward. Furthermore, the decreased adoption of EVs is in line with CPM’s analytic conclusions over at least the past seven years, which is that the growth of BEV and hybrid markets and light duty vehicle market share would be much slower than many public projections had it.

The most important factor that is supportive of platinum prices is the potential for short-term disruptions to mine supply and the high potential for reduced mine supply in the long-term.

Platinum prices are expected to remain in the range they have been in since the middle of last year. Prices have good support around the $880 level, and for prices to break below this level would require some sort of a demand shock, which is not expected at least over the next few months. Meanwhile on the upside, platinum has strong resistance around $1,000, which coupled with some of the external headwinds like weakness in other precious metals will be hard to break above in any sustainable way, unless there is some sort of a supply disruption.

Fabrication Demand

European passenger vehicle demand rose around 5% during the first quarter of 2024. While sales were healthy during the first two months of the year, there was some weakness during March, which weighed on quarterly demand. On the bright side for PGMs, BEV adoption in Europe slowed during the first quarter of 2024 compared to both the same quarter in 2023 as well as the last quarter of 2023. BEV market share among new passenger vehicle sales during the first quarter of 2024 stood at 11%, down from 13.1% in the corresponding 2023 quarter and down from 15.7% at the end of 2023.

Palladium Market

Palladium was the only exchange traded precious metal that ended April lower than where it started the month. While all precious metals softened during the second half of April, palladium prices took a particularly bad hit because its fundamentals and consequently investor sentiment toward the metal are negative. The weakness at the end of April has continued into early May. It would not be surprising to see palladium prices retest $860 in the near term.

While market participants are not thrilled about the prospects of palladium at this time, the slowdown in battery electric vehicles (BEVs) adoption in various markets provides a lifeline for the metal at least in the short term. The Chinese vehicle scrappage program which took effect starting 1 May incentivizes Chinese consumers to scrap their old vehicles for electric vehicles. This will to some extent offset lower adoption of electric vehicles in other markets. The Chinese government is also offering a smaller incentive to consumers that are looking to scrap their old internal combustion engines (ICEs) for new smaller ICEs.

The massive amounts of above ground palladium inventories coupled with new palladium capacity coming onstream and the shrinkage of demand from the auto sector are all factors that are expected to weigh on palladium prices.

Seasonal weakness and overall softness in other precious metals are expected to drive palladium lower in the short term. While $860 is the first support level, any weakness in economic growth as the year progresses which would weigh on auto and industrial demand could drive palladium prices lower, possibly toward $800.

Fabrication Demand

China’s passenger vehicle demand held up fairly well during the first quarter of 2024, rising 11% over the corresponding period in 2023. Part of the reason for the healthy demand is the comparison to a relatively weak period of demand and part of the reason is an uptick in economic activity in China.

Passenger vehicle demand is estimated to have softened in April, as consumers delayed purchases to take advantage of the vehicle scrappage program being introduced by the government. Per the program, those who turn in their old ICE or electric vehicles for new electric vehicles will be eligible to receive a 10,000-yuan subsidy.

While this is likely to increase China’s passenger vehicle demand, it will hurt palladium prices in two ways. One, the increased demand for electric vehicles in China means less palladium being used by the Chinese auto industry. Second, the scrappage of old ICE vehicles will mean an increase in platinum group metal (PGM) scrap which are palladium-intense in China. The Chinese government is also offering a smaller incentive of 7,000 yuan to consumers that are looking to scrap their old ICEs for new smaller ICEs. While this is less negative than the electric vehicle scheme, the new ICE vehicles will be smaller, which means holding all other factors that influence PGM loadings in catalysts constant, the smaller engines will require lesser PGMs. Furthermore, this scheme will also increase the amount of PGM available for scrap.

Call Monex today (800) 453-2924 or visit them online at www.Monex.com and learn why they have been a trusted name in precious metals investing for over 50 years.