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Resilient In The Face Of Headwinds

CPM Group had expected precious metals prices to soften over the summer, and prices did soften, but the weakness was a lot tamer than expected particularly in gold and silver. Precious metal prices showed resilience in the face of traditional headwinds like rising bond yields which were at multi-year highs, a strong U.S. dollar, and typical seasonal weakness in prices. Gold and silver held up best, with platinum and palladium struggling due to certain fundamental supply and demand weaknesses in those two metals at this time. At the end of August, gold, silver, platinum, and palladium prices were 6.6%, 7.4%, 15.2%, and 34.4%, lower than their high for 2023, respectively. It is worth noting that, in the case of gold, the 2023 high was a record.

CPM Group’s forecast was for prices to soften over the summer and strengthen during the last four months of the year. This expectation still is intact, but the increase in prices will now be from a higher base. The fact that gold and silver prices remained at relatively elevated levels despite various headwinds suggests that there is a lot of underlying bullishness in these markets.

Monetary policy tightening that began in 2022 is expected to have a more pronounced negative impact on economic growth over the next few quarters. Economic conditions could be considered somewhat ideal at this time, with inflation having declined and economic growth holding up. But this could begin to change going forward, which should be supportive of gold and silver prices.

There also is the ongoing support for these precious metals as portfolio diversifiers amid cross border political tensions and the U.S. presidential election in 2024. Investors typically are more cautious and there is increased volatility during election years because of the potential changes in policies. Such an environment is expected to be at least supportive of gold and silver prices but could also prove to be positive if there is increased uncertainty about who would win the election. The possibility of another Trump presidency already has many countries on the edge. With no judgment regarding Trump policies, they have shown themselves to be disruptive during his last presidency. The first response of most financial markets to disruptive policy changes is to turn risk off, which could be additionally supportive of gold and silver prices. While concerns related to a second Trump presidency is widespread globally, the reality is that both within the United States and around the world many people and governments, perhaps a majority in both instances, are expressing concern over the quality of the entire slate of potential presidential candidates in both parties.

As mentioned before, economic conditions appear quite attractive at this time, with softening of high inflation and economic growth holding up despite tighter monetary policy. While economic conditions are on the right track there still are various risks that have a high probability of materializing.

The biggest risk still comes from inflation, where headline inflation has softened rapidly this year, but core inflation has remained sticky. A healthy job market will continue to support core inflation. Furthermore, while higher interest rates have dampened housing market activity it has done little to slow price appreciation. In fact, higher rates have shrunk the pool of sellers which has lowered housing inventory and pushed housing prices higher in various markets. Furthermore, risks to various agricultural products around the world coupled with a restriction on crude oil supply by Saudi Arabia and Russia risk providing support or even driving headline inflation higher.

The presence of these factors has led central banks to keep their options open regarding further monetary policy tightening. Central banks at this time seem to have more of a cautious than hawkish stance. Monetary policy is unlikely to be loosened anytime soon. Lowering core inflation is important to central banks. Market expectations, based on the CME FedWatch tool, that the first interest rate cut will occur in May 2024 are likely to be too optimistic. The Fed would like to see that core inflation is headed in the right direction and that the slowing of core inflation can be sustained first. Given the various risks to inflation both headline and core, policy is likely to be kept restrictive for an extended period of time. The longer policy remains restrictive the greater the probability that something breaks economically.

Recession Expectations

The question is whether economic growth slows slightly or precipitously over the next few quarters resulting in no recession, a short shallow recession, or a deeper recession sometime next year. Market consensus has shifted from expecting a 2023 recession to questioning whether economic growth remains resilient, forcing monetary authorities to tighten policy further, resulting in a delayed but deeper recession. CPM foresees a recession. CPM has projected a recession emerging around 2024 – 2025 for some time, and not in 2023. We are adhering to that projection even as the consensus shifts from one side of our expectations to the other.

There is a lot of uncertainty at this time regarding what comes next. Tightening monetary policy so far has helped slow inflation growth with only a minor negative impact on economic growth. Honestly, other factors have exerted greater negative pressures on both housing and auto sales than higher interest rates. The better than expected economic performance overall can be explained in part due to reduced supply chain bottlenecks, which were an important contributor to inflation growth during 2021 and 2022.

Also, while U.S. interest rates now are at their highest levels since 2001 or so, they are lower than they were for most of the 33 years from 1968 into 2001. Interest rates have risen sharply, but remain lower than levels at which they exerted significant negative influence on the overall economy in the past.

Economic growth responds to changes in monetary policy with a lag. This could mean that all of the tightening that has occurred so far could begin to more forcefully negatively impact economic growth in coming quarters. Monetary authorities plan to slow or pause their rate hikes as they assess the impact of past policy tightening. Many other factors are at work on these economic trends, including the growing international trade hostilities, perhaps offsetting any negative economic pressures from the rise in interest rates.

Monetary authorities set out on their policy tightening cycle with the primary objective of bringing inflation, which had reached multi-decade highs, down to their target levels. The process of inflation softening has started. For inflation to continue softening, economic growth might need to slow.

As mentioned before, this slowing economic growth is expected to occur due to past monetary policy tightening. There are a few ways in which future trends in inflation and economic growth could play out. In an ideal scenario, economic growth slows just sufficiently to reduce inflation rates further but does not precipitate a recession.

In a less ideal, but more likely, scenario economic growth slows to a level that would be considered a shallow recession, which helps lower inflation. Such a recession would be expected to be short and shallow. Markets seem to be pricing in this scenario as well, based on their expectation of a Fed interest rate cut in May 2024. Markets have been repeatedly wrong about the level of interest rates and the timing of any rate reduction, however.

Finally, there is a third scenario that could play out, which is a continuation of the current trends in inflation and economic growth, where inflation is declining and economic growth is strengthening. If this situation continues, real wages will rise, increasing consumer purchasing power and possibly pausing the decline in inflation or even causing it to increase. In this scenario strong economic growth would delay any recession, but the Fed would need to tighten policy further to quell inflation, which could result in a delayed but deeper recession along the lines of what CPM has been projecting in recent years.

Also, besides monetary policy there are macroeconomic (fiscal policy), political (both domestic as well as international), and other factors (supply and demand side issues) that will influence economic growth and inflation. Monetary trends may take a back seat to all of these factors.

The lack of clarity regarding the direction for inflation and economic growth could keep markets volatile in the coming quarters, which should provide support to gold and silver as portfolio diversifiers. That said, the precious metals markets pass through a period of seasonal weakness during the summer months, which could act as a headwind to their prices in the near-term.

Gold Market

There is a lot of uncertainty in the markets, however, and if economic growth does not slow sufficiently to lower core inflation it could result in central banks tightening policy further. This could cause gold prices to soften toward the $1,900 level and a break to $1,880 cannot be ruled out. That said, even if gold prices were to soften to these levels, gold still is at historically elevated levels.

Furthermore, in addition to economic growth, inflation, and monetary policy there are other factors that are influencing gold and which are expected to be positive and supportive of gold prices and investment demand. One such factor is the recent downgrade of U.S. government debt. A downgrade of U.S. government debt is long-term positive for gold as an alternative safe haven asset in the medium to long term. CPM Group has written about this being true even before the most recent downgrade and mentioned it in reports following the resolution of the most recent debt ceiling debate. While the downgrade may not drive gold prices up sharply, it will provide support for gold as an alternative to U.S. government debt from both investors and central banks.

Official Transactions

Central banks have been net buyers of gold during the first half of 2023. These entities had added 4.44 million ounces of gold to their holdings during the first half of this year.

Around half of those net purchases occurred in June when prices softened from their record high levels in May. This is not entirely surprising given the price-sensitive nature of central banks when it comes to adding gold to their reserve holdings. While gold prices softened in June from their record high levels in May, prices still were high by historical standards during June 2023.

That central banks are willing to jump in as buyers at these high gold price levels highlights the eagerness among these entities to add gold to their holdings. Central banks have been adding gold to their holdings as a way to diversify their reserve assets, a trend that is expected to continue into the foreseeable future. Several developing economy central banks are eager to add gold to their international reserves. Any softness in gold prices should therefore result in central banks entering the market as buyers.

The largest buyers of gold during June 2023 included the People’s Bank Of China (680,000 ounces), Polish central bank (440,000 ounces), Russian central bank (493,000 ounces), and the central bank of Uzbekistan (270,000 ounces).

There were also several smaller net buyers during June and a few net sellers, the most notable among them being the central bank of Kazakhstan which reduced its holdings by 101,000 ounces during the month.

Silver Market

Silver prices could see a brief period of weakness following the rise in prices during the second half of August. Prices have strong support at the $22 level. Prices could test these levels in the coming weeks. Silver prices are expected to follow gold prices higher during the last quarter of the year, with initial resistance for prices at $26.20.

If global economic growth begins to lose momentum, as is expected, it would act as a headwind to silver prices because this typically hurts fabrication demand. That said, silver demand from the solar panel industry has shown itself to be less sensitive to economic cycles, because of various governments’ efforts to push for greener sources of energy. Additionally, investment demand, which would benefit from any sort of weakness in economic growth is more important to silver prices.

Platinum Market

After declining during the first half of August, platinum prices staged a recovery during the second half of the month. In the middle of August, prices bounced off $880, which has been an important support level for platinum prices. Prices touched an intraday high of $993.30 on 30 August, before pulling back. Platinum prices have largely been moving between $900 and $1,000 since the middle of June. Prices could break out of this range during the last several months of 2023. Prices could be pulled higher by strong gold and silver prices as well as seasonal strength in platinum prices.

While there are broad market factors that could drive platinum prices higher, the metal’s own supply and demand fundamentals are less likely to help drive prices up sharply. The increased use of platinum in gasoline autocatalysts, healthy demand for commercial vehicles in most major auto markets, the possibility of supply side disruptions in South Africa, and the competitive relative value of platinum with palladium are all factors that are helping to support platinum prices. These factors, however, are getting offset by an ongoing increase in battery electric vehicles (BEVs) market share and slowing growth in China, which is expected to weigh on demand for both commercial vehicles as well as jewelry in that country.

Platinum prices are likely to move sideways to higher in this environment, with initial resistance around $1,000, which if broken could take prices toward $1,060. On the downside, platinum prices have strong support at $880.

Palladium Market

Palladium prices have spent much of their time trapped in a tight range between $1,200 and $1,320 since the middle of June. Prices have come within striking distance of the lower bound of this range on several occasions having broken below this level on a couple of occasions as well. The palladium market is faced with several headwinds on a fundamental basis. There are several factors on both the demand as well as supply side that do not bode particularly well for the metal. As examples, the increased use of platinum in gasoline autocatalysts comes at the cost of reduced use of palladium in these catalysts and the growing market share of BEVs is particularly bad for palladium because of palladium’s large exposure to the passenger vehicle market, which is where BEVs are gaining market share. BEVs are bad for platinum group metals because they do not need an auto catalyst. Palladium is also seeing an increase on the scrap supply side, which is further weighing on prices

While the fundamentals of palladium are not too compelling at this time, positive sentiment in the other precious metals could help to provide some support to the metal’s price. Furthermore, a lot of the bad news in the palladium market already is factored into prices, which could slow the pace of any future declines.

If palladium prices break forcefully below the $1,200 level, it would not be surprising to see prices slide toward $1,085. On the upside, prices have strong resistance around the $1,320 leveland it would require some supply disruption for prices to break above this level.