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Various markets began to decline following the most recent Federal Open Market Committee (FOMC) meeting, in late September. The Summary of Economic Projections report, released after the meeting provided the clearest signal yet to the markets that the Fed was serious about keeping rates higher for longer. The Fed has been saying this verbally for a long time, but an upward revision to the federal funds rate projections coupled with an increase in economic growth projections seemed to have had a stronger impact. U.S. economic data releases since the last FOMC meeting also have been generally supportive of the Fed’s view.
Meanwhile, Europe seems to be struggling with growth, raising questions about whether the European Central Bank will be able to raise rates any further. The European situation juxtaposed with that in the U.S. has pushed the dollar to its highest level against the euro since the first week of December 2022. On a trade-weighted basis the dollar rose to its highest level since the end of November 2022. U.S. 10-year and 2-year government bonds were at their highest levels since the Great Recession and while the spread between these two bonds remains negative, that spread has more than halved compared to as recently as the end of July, reflecting an improved sentiment toward U.S. economic growth.
All of these factors collectively resulted in markets adjusting their expectations, which in the case of precious metals meant weakness. Gold, which had been the best performing exchange traded precious metal during the first three quarters of this year, took a particularly strong hit initially. A confluence of various technical supports being broken resulted in gold prices falling around $100 between the FOMC meeting on 20 September and the end of that month. That weakness continued into the first few trading days of October as well.
Other precious metals also softened, but the weakness in these precious metals was less pronounced initially, although they accelerated in the first trading days of October. The initial reaction in these other precious metals may have been less pronounced at least in part because of their relatively lackluster performance compared to gold prior to September but also in part because the healthy economic conditions, which caused the Fed to raise its economic growth forecast for the next couple of years as well as keep its rates higher for longer. The idea of stronger economic activities is more positive for precious metals like silver, platinum, and palladium, which have various industrial uses. The ongoing strength in the U.S. dollar and government bond yields eventually pressured these metals sufficiently to crack below some of their key support levels at the start of October.
While precious metals prices are struggling at the time of writing this report, fundamentally these markets, particularly gold and silver, remain strong. And, while market sentiments have shifted toward a more sanguine economic outlook, underlying economic and political trends could turn more hostile in the next few months, and financial market sentiments could swing back toward greater interest in risk protection in precious metals. There still are various reasons to continue adding the metals to one’s investment portfolio as a diversifier. The current weakness in prices provides a good buying opportunity.
Political risk continues to be one of the strongest reasons to hold gold. The dysfunctional nature of current U.S. politics is a major problem for not only the U.S. but also from the perspective of what the U.S. means globally.
Domestically, the threats of government shutdowns, which have the potential to hurt economic sentiment, and threats of defaults on government debt which would tarnish the reputation of U.S. government debt as a safe haven are some of the factors which can be supportive of gold in the short and long term.
Both of these threats arose this year and both were averted with short-term measures, kicking the can down the road on both issues. There is a massive amount of debt being built up within the U.S. to support deficit spending policies of the U.S. government. These issues can be resolved if the government comes together to resolve them, as has been the case in the distant past.
The ongoing threats of default on U.S. government debt is a negative for the reputation of U.S. treasuries as a safe haven asset, while Treasuries still are among the safest assets in the world, the buildup of debt and the dysfunctional nature of U.S. politics will be beneficial to gold which also is a safe haven asset and is not controlled by any government.
Internationally, a dysfunctional U.S. government means that there will be an ongoing threat of situations similar to the one in Ukraine, which could lead to both political as well as economic issues for both the U.S. as well as the world, adding support to gold investment demand.
One of the most compelling reasons to invest in and own gold is the massive amount of debt built up around the world. The enormous debt load heightens the risks of financial crises; owning gold offers insurance and capital preservation protection against such events.
International Monetary Fund data shows that at the end of 2022, global total debt, which includes private and public debt, stood at $235 trillion, $200 billion above its 2021 level. A better way of measuring debt is via the debt to gross domestic product ratio. This ratio, for global total debt stood at 238 at the end of 2022, down from its peak of 258 in 2020, but still higher than the per-covid level of 229 observed in 2019.
Debt is not only a U.S. issue but a global issue. U.S. public debt gets most of the attention because it is priced in U.S. dollars which is the de facto reserve currency of the world and U.S. public debt accounts for a little over a third of global public debt. At the end of 2022, U.S. public debt stood at $31.42 trillion while global government debt stood at $91 trillion.
U.S. and European government debt is the safest in the world. At the end of 2022, this debt accounted for around half of global government debt. The other half of government debt is riskier. European and U.S. government debt account for only 19% of total global debt (when private debt is added). Another way of thinking about this is that there is a substantial amount of risky debt floating in the markets and the more it grows the greater the reason to own alternate safe haven assets like gold.
While it may not seem like it to many at this time, economically too there are several reasons to own gold. While the markets jumped the gun with regards to the timing of a recession, CPM Group belongs to the camp that does not expect a soft landing (cooling inflation sufficiently and sustainably without creating an economic recession). Market expectations have swung from expecting a recession this year to expecting a soft economic landing. CPM Group thinks that a recession is unavoidable and should be expected sometime late next year or possibly in 2025. While one of the primary risks to economic growth is political risk, there also are other risks ranging from sticky inflation, the potential for higher interest rates, and risk to weak financial institutions as a result of higher rates. Sticky inflation and high interest rates also are sapping consumer purchasing power.
Healthy consumer spending, which accounts for the majority of U.S. GDP, has helped to support U.S. economic growth. That said, some of the tailwinds to this consumer spending have begun to weaken, with savings from the pandemic era depleted and the personal savings rate trending lower, resumption of student loan payments, record levels of credit card debt (a lot of which was racked up to make ends meet during a period of strong inflation), and rising oil prices, and some signs of softness in the jobs market like relatively slower wage growth. While none of these factors predict an immediate deterioration in economic growth, these factors are headwinds to core consumer spending.
Also, inflation still is a threat. While it has come down meaningfully from levels seen last year, it still is higher than where the Fed would like to see it. Additionally, headline inflation is now becoming a problem, which will persist if oil prices remain high or continue to rise.
The increase in oil prices is driven primarily by supply side constraints put in place by Russia and Saudi Arabia. This suggests that prices could remain elevated if these countries collude to keep them higher. While a few weeks or months of higher energy prices are not necessarily a threat to core inflation or growth, if prices remain high for an extended period, they will start to have a more meaningful negative impact on core inflation as well as on economic growth. Elevated headline inflation for an extended period will percolate its way through to push core inflation higher as well. Furthermore, while the Fed focuses on core inflation, the general population is impacted by headline inflation, which if left at elevated levels for an extended period will start to hurt consumer demand, especially with some of the aforementioned tailwinds to consumer demand weakening. Additionally, it could result in a price/wage spiral which would be very challenging to the Fed to manage, with causing serious economic damage.
These are bad for sentiment. The United Auto Workers (UAW) union has been on strike since 15 September 2023 and announced an expansion of this strike last week. The longer this strike lasts the greater the damage it will cause. Some of the initial problems are tied to the loss in part supplies to dealers and risk of job losses to around 6,000 people where operations need to be shuttered due to dependence on factories where the UAW are striking. At the time of writing this report, there was sufficient auto supply in the pipeline to last a few weeks, but if the strike is protracted vehicle supplies could become a threat once again pushing up the costs of new and used cars, a factor that played an important role in driving inflation higher in 2022. The shortage of part supplies in 2021 and 2022 also were one of the reasons for auto insurance costs rising strongly in recent quarters and playing an important role on supporting inflation as well.
A U.S. government shutdown, which was likely to begin on 1 October, has been averted for now. Some short-term measures have been put in place with a possible shutdown now likely in the second half of November. Concerns of such a shutdown, irrespective of whether they materialize, are likely to weigh on businesses that supply products and services to the government.
Markets In Summary
Gold prices had fallen to a six-month low, at the time of writing this report. While there is still potential for prices to soften further over the next few weeks, prices should regain their footing during the last two months of this year and are expected to rise once again, as various fundamentals support stronger gold prices.
On the downside gold prices have initial support around $1,820 and then $1,790. While the most likely scenario is for prices to consolidate around these levels and then rise, a decline to $1,680 or even $1,620 cannot be completely ruled out. Weakness to these levels is likely to occur if economic growth in the U.S. shows no signs of slowing during the fourth quarter of this year and inflation begins to rise in a sustained fashion, forcing the Fed to adopt a more hawkish monetary policy than it currently projects. This is not CPM’s most likely scenario. While recessionary conditions are not expected to develop until late next year, economic growth is expected to face headwinds as tighter monetary policy begins to have a more pronounced effect on economic growth. In addition to monetary policy risk to growth there also is a lot of political risk which could adversely affect economic growth and stimulate investor interest in gold.
The current weakness in gold prices is also likely to draw the attention of central banks which are looking to buy gold for their reserves. These entities were net buyers of gold in a higher price environment earlier this year, so the softness in prices is likely to be an even more attractive proposition to these banks.
During the first eight months of 2023 central banks were net buyers of 7.35 million ounces of gold. If central banks continue at their current pace of net purchases, they could be on track to add around 11 million ounces of gold to their holdings this year. If central banks pick up their pace of purchases amid the softer gold price environment, net purchases for the year could be even higher. The net purchases figure actually has been restrained by relatively large sales in the early part of this year by Turkey, Kazakhstan, and Uzbekistan, all three of which sold gold to raise foreign exchange they needed in the face of higher imports. This level of central bank gold demand should be supportive of gold prices, offsetting any potential weakness in investment demand from short-term investors.
The increase in gold prices projected for later this year is expected to face initial resistance around $1,900 and then $1,950.
The premium on Chinese gold prices relative to the London gold price have rising since July this year. The premium got to a record high $121.19 on 14 September. Premiums have come down since then ending the month at $45.30. While the premium is off sharply from the record high seen just two weeks before, at $45.30 the premium still is more than ten times higher than the average premium of $4.4 between 2003 and June 2023.
There are various reasons for the increase in premiums, which have both to do with supply as well as demand.
The most important reason for the jump in premiums has been an increase in demand for gold in China. Chinese gold demand slowed strongly during 2022 in response to the zero-covid policy. There has been a lot of pent-up demand in China from investors as well as fabricators. This coupled with the resumption of gold purchases, which are sourced locally, by the People’s Bank Of China (PBOC) since November 2022 helped to push up the premium.
There are other reasons also that were responsible for driving the premium higher, which include the weakness in the Chinese yuan against the U.S. dollar. The yuan lost a little over 5.5% of its value versus the U.S. dollar over the course of 2023 as the Chinese economy did not perform as strongly as expected and the U.S. economy did not weaken as much as was expected by market participants.
The weakness in the yuan led to a shift in China out of the currency toward gold, which resulted in the PBOC placing a temporary moratorium on gold imports into China by small and provincial banks. This step coupled with the increase in demand for gold in China tightened the local gold market pushing local gold prices higher. The removal of this moratorium on 27 September led the premium to decline sharply during the last three trading days of September, falling from $105.70 on 26 September, the day before the moratorium was removed to $45.30 on 29 September. But as mentioned earlier, the premium still is significantly higher than that seen historically. And this is because of the strength in demand.
And finally, there is the difference in the Shanghai Gold Exchange (SGE), which is the price used in calculating this premium, which is different from an exchange like the CME. The SGE is primarily for professional market participants like mining companies, refiners, fabricators, and institutional investors unlike the CME which includes not only these professional participants but also thousands of retail investors. Many of the participants on the SGE would like to see higher gold prices, and while jewelers and wholesalers may not want to work with a higher price, they may or may not have the discretion as to whether to buy at SGE related prices or prices not related to the SGE quotes.
Central banks remained net buyers of gold during August. By the end of the month net purchases made by central banks during the first eight months of 2023 stood at 7.4 million ounces. This was an increase from 4.8 million ounces in reported net purchases during the first seven months of this year.
The weakness in gold prices during the first half of August coupled with a weak recovery in prices during the second half of the month is likely to have resulted in an increase in demand from central banks. Weaker gold prices during September and October are likely to increase buying interest from central banks
During August the largest net purchases were made by the People’s Bank Of China (930,000 ounces), the central banks of Russia (541,000 ounces), Poland (480,000 ounces), Australia (289,000 ounces) and Uzbekistan (280,000 ounces). There also were a handful of other central banks that made relatively smaller purchases. Total gross purchases during August stood at 2.6 million ounces, with gross purchases during the first eight months standing at 12.9 million ounces.
Gross sales during the first eight months stood at 5.5 million ounces, with the central bank of Mexico being the only central bank to report a sale in August. The Mexican central bank reduced its holding by 2,000 ounces.
Silver prices had been moving between $22.50 and $25.00 since the middle of May 2023. The support of that range held up well until the end of September, with prices breaking forcefully below $22.50 at the start of October.
Prices could move sideways to lower in the near term, with initial support for prices at the $20.40 level, followed by support at the $19.95 level. While such weakness is possible in the near term, prices are expected to move back into their earlier trading range of $22.50 and $25.00 during the last couple of months in 2023.
As with gold, an extreme breakout to the downside should not be ruled out, in which silver prices could fall back toward $18, but this is the less probable scenario. Such a price scenario would entail much stronger economic growth than is expected, which could be supportive of silver fabrication demand but would hurt silver investment demand. Given the greater importance of silver investment demand in influencing prices, weakness in this area would have a net negative impact on the price of silver. That said, this is not CPM’s base case. The more probable scenario is one of a slowdown in economic growth and silver prices stabilizing if not recovering slightly.
After moving in a mostly sideways fashion between $880 and $950 during the third quarter of this year, platinum prices broke below the important support level of $880 at the start of October. Platinum prices are likely to spend the next few weeks consolidating, with a bias to the downside.
Prices have some support around the $840 level. Weakness in chart technicals and the ongoing United Auto Workers (UAW) strike in the U.S. are likely to put some downside pressure on platinum prices. Eskom, South Africa’s state-owned utility, also has reduced its concern of loadshedding from those that it maintained over the past few months, which is likely to place additional downside pressure on platinum prices.
On the other side of the market, there is typically an uptick in demand for platinum during the fourth quarter and into the first quarter of the calendar year, which could help platinum prices trend higher after the recent decline. One risk to this uptick in demand comes from an unresolved UAW strike. These strikes are limited to three automakers and only to the U.S., but nonetheless any loss in demand will act as a headwind to platinum prices. That said, a majority of platinum fabrication demand in the U.S. comes from commercial vehicles, with platinum’s reintroduction into gasoline autocatalysts still playing a relatively smaller role in total demand.
As with other precious metals, a sharper move lower cannot be ruled out. However, the sharper move lower for gold and silver are predicated on stronger economic growth, which in theory should be supportive of platinum prices. Nonetheless, if such a stronger economic scenario were to play out platinum prices would initially take clues from the gold market. In such a scenario, platinum prices could fall as low as $800 before recovering.
On the upside, over the course of the fourth quarter, platinum prices have initial resistance around $1,000, which if broken could see prices rise toward $1,060.
At the start of October palladium prices fell slightly below $1,150, their lowest level since 2018. Prices had been holding above $1,200 for the most part since the end of June 2023. A broad market selloff, which started in the last week of September, pushed palladium prices below this support level that had held up well for one quarter of this year. Like the other precious metals, palladium prices are at risk of further weakness in the short term but could see some recovery in prices as the year progresses.
The palladium market’s fundamentals have been weak for some time now. They have been particularly hurt by the ongoing increase in electric vehicle market share and the partial substitution of palladium with platinum in gasoline auto catalyst. The United Auto Workers (UAW) strike in the United States and the reduced risk of loadshedding in South Africa are expected to add further downward pressure on palladium prices.
Seasonal strength in demand for palladium during the fourth and first quarter of the calendar year could help to provide some support to palladium prices, but these forces may not be enough to lead to a significant rebound in palladium prices.
Palladium prices are expected to consolidate in the near term, with the potential to soften further. Initial support for prices is at $1,100 but a drop to $1,000 or $900 cannot be completely ruled out at this time. On the upside, palladium prices have initial resistance at $1,200.
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,
Gold, silver, platinum, palladium prices discussed. Forecasts for gold at $1,875, silver at $20. Platinum could fall to $900, palladium to $1,190 amid seasonal weakness and monetary policy tightening. Supply/demand risks remain.
CPM Group examines debt ceiling debate, recession risks, bank failures, Fed policy, and price projections for gold, silver, platinum, palladium. Key topics include political brinkmanship on US debt ceiling, market expectations for Fed rate cuts, and outlook for precious metals prices.
