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U.S. Debt Ceiling To Take Center Stage

While inflation, economic growth, central bank policy, and concerns of systemic risks to the banking sector will continue to influence precious metals prices, the market’s near-term attention will be focused on the U.S. debt ceiling. The U.S. Treasury has estimated that it will run out of funds to meet its debt obligations by early June. While this is an estimated period, it has been moved up from an estimated date later in the year.

Tax receipts have not risen per expectations which has been cited as the reason for an earlier X-date. With this estimate from the Treasury and virtually no progress between the Democrats and Republicans on how to address this issue, concerns of a default will rise in the coming weeks.
The actual likelihood of a default is very slim, but brinkmanship between the two political parties will most likely take the issue to the last minute. In this environment, market volatility should be expected to rise and portfolio diversifiers like gold and silver should perform well. The debt ceiling has been raised 14 times since 2008. The last time it turned into a major issue was in 2011, and U.S. government debt lost its AAA rating for the first time that year.
While it is hoped that a 2011 like episode is not repeated, until there is a clear resolution the risk of a repeat will remain.
Looking back at 2011, the price of gold shot up strongly during July and August 2011. In July the debt debate was at its pinnacle. The government raised the debt ceiling on the actual debt ceiling deadline for that year, which was 2 August and S&P downgraded U.S. government debt to AA+ on 5 August. Prices at the start of July stood at $1,482.60 and had touched an intraday high of $1,664.50 on 2 August 2011. The downgrade that followed shortly helped to take gold prices to an intraday high of $1,917.90 on 23 August. While prices softened from these highs, they remained at elevated levels through the first half of September before they began to slide lower.

The increase in gold prices during July 2011 and the 2 August 2011 deadline can be attributed to the inability of the U.S. government to raise the debt ceiling, while the gains after 5 August 2011 can be attributed to the credit downgrade of U.S. debt. At the time gold prices were being pushed higher by the European sovereign debt crisis as well as the U.S. government’s inability to act responsibly.
If the standoff this time around turns out to be similar to that seen in 2011, gold prices could see further meaningful gains, which could take gold prices to fresh highs. This strength in gold prices could drag higher with it the rest of the precious metals complex. Silver would benefit in particular because the metal is often viewed as a proxy or companion to gold. The platinum group metals could find some support because they belong to the precious metals complex, but given the negative implications of a potential default on economic growth, these metals due to their heavy reliance on fabrication demand, are more vulnerable to declining than rising.

A Widening Gulf

There is a widening gulf between market expectations and Federal Reserve projections of monetary policy. The Federal Reserve projects that it will keep the target federal funds rate at the current 500-525 basis points (bps) through the end of this year. Meanwhile the market expects the Fed to start cutting rates as early as September 2023. At the time of writing this report on 5 May, the market is projecting a total of 75 bps in cuts to the federal funds rate by the end of 2023, with a 25-bps cut at each of the September, November, and December federal open market committee meetings. These market expectations of the federal funds rate are gathered from the CME Group’s Fedwatch tool, which shows the probability of rates as implied by the 30-day Fed Funds futures pricing data. This data keeps on changing as market perceptions constantly are responding to news and data and has an important influence on the values of various assets. It is worth noting that the market is projecting these three interest rate cuts following the release of the strong April U.S. employment report.

What The Fed Is Saying

The Fed projects holding the target federal funds rates steady at 500-525 bps for the remainder of 2023. While the Fed acknowledges that inflation has started to trend lower it believes that if monetary policy is loosened too soon inflation still has the power to come roaring back and that such a renewed increase in inflation would require even more intense efforts to be bought under control than those that have been put in place since last year.
The Fed has been holding steady on its projections, despite various concerns in the minds of market participants, which include the recent bank collapses and softening inflation data.

There are various reasons for this.

• The first is the Fed makes its decisions based on data rather than on speculation of what that data will be. Given the transitory phase that the economy is presently in, it is hard to say with certainty whether inflation or unemployment are trending one way or another. With regards to these two metrics and the Fed:

– As mentioned before, the Fed acknowledged the softening in inflation data but would like to see more sustained declines before it can claim victory on winning the battle against inflation.

– The labor market has been strong. While there are some recent signs of softening demand for labor, it is too early to say that the trend has changed. Given the current economic environment the labor market should cool from the hot conditions observed over the past several quarters. But it is hard to say at this time how much and how long it would take for the labor market to normalize. Until there are strong and sustained signs of this cooling the Fed is unlikely to change its projections.

• Another reason the Fed needs to hold the line on its projections is to maintain credibility with markets and to keep financial conditions tight, which is what it needs to accomplish its goal of containing inflation.

What The Market Is Expecting

It is not that the Fed has not taken into consideration the bank collapses in recent weeks in its projections of rates. It did pull back from raising rates any higher for the current year than it had projected at its December 2022 meeting. The market nonetheless believes that the Fed has already done more than it needs to contain inflation, that it has overtightened policy, and that the Fed would need to reverse policy to avoid catastrophic implications of overtightening. These expectations are reflected in the CME Group’s Fedwatch tool, which at the time of writing this report show a 75-bps reduction in the federal funds rate by the end of this year.
The market is fairly sure of itself and has used every recent increase in the federal funds rate as a reason to double down on its opinion that the Fed will have to pivot.
The fact that this market view is at sharp variance with the Fed’s stated policies and plans does not seem to have much of an effect on what could be considered a cavalier attitude on the part of the market consensus.

If The Fed Sticks To Its Plan

The markets could be in for a rude shock, one that should not be a surprise to them at all if they were listening to the Fed. Various assets across the board are priced for a pivot. If the Fed does not pivot it could create a big repricing in asset values lower.

If The Market Is Correct

The market’s expectation is for the pivot to start in the middle of this year and to continue through the second half.
There could be various scenarios that play out with regards to the amount by which the Fed cuts rates if at all and when during the second half of the year it cuts rates, if at all.
If cuts occur as the markets anticipate, precious metals prices are likely to see more strength, although a lot of these expectations for cuts are already priced into markets. If they occur with a delay and if the total value of cuts is lower than the market is expecting at present, it could result in precious metals prices, especially that of gold, falling before they continue any higher over the medium to long term.

Why The Fed Cuts Rates In 2023 Matters… If It Does At All

In addition to the timing and magnitude of possible rate cuts the reasons for future rate reductions also will be important. If the Fed is cutting rates due to falling inflation, it is less supportive of gold and silver and more supportive of stocks and bonds. However, if the Fed cut rates due to falling growth, then the rate cuts are more supportive of gold and silver.

Gold Market

During the first half of April gold prices continued to move higher, building on the strength in prices that was observed in the second half of March. Prices touched an intraday high of $2,063 on 13 April before moving into a consolidation phase between $1,980 and $2,030 for the remainder of the month. Prices broke out to the upside of this range in the early days of May, and touched an intraday high of $2,085.40 on 4 May after the Federal Reserve Open Market Committee raised interest rates 0.25% and indicated a likely pause in its 14-month, 10-interest rate increase program.

Gold prices should be expected to remain at elevated levels in the near term. Prices are most likely to move between $1,985 and $2,090. Prices got within a stone’s throw of this resistance level, the high end of this range, on 4 May. While prices could struggle to break above this level, there are several factors at this time which are likely to push gold prices above this level in the near term. These include the following.

– The U.S. debt ceiling debate
– Concerns over more mid-size bank failures
– A recession in the second half of this year
– Expectations that the Fed will cut rates

While the probability that the U.S. will actually default on its debt obligations is low, the likelihood of drama and brinkmanship in the government is very high. The use of the debt ceiling issue for cheap partisan politics on both sides does not help the reputation of the U.S. government worldwide, even if a default is avoided. This should help to keep gold prices supported and may even further propel gold prices higher in the near future until some resolution is reached on the matter. If past experiences are any guide, an agreement is unlikely to be reached until the final hour.

In the middle of the 1990s Treasury Secretary Robert Rubin suggested in a press conference that the Administration could sell some gold to raise money to fund the government during an intransigent Republican Congressional impasse. The Republican senators from gold mining states passed a debt ceiling resolution within a day or two.

Concerns over more bank failures, as were seen in March, keep yoyoing. Opinions are split over whether those failures were idiosyncratic in nature or if they were the tip of the iceberg. While more opinions are tilted to the former, sporadic concerns over the banking system, which can single handedly sink the economy into a recession, should help to keep gold prices supported. Markets will keep a keen eye on the strength of the labor market, bank lending statistics, and the commercial real estate market. Signs of stress in any of these areas could boost concerns of bank failures and provide support to gold as a safe haven asset.

While some of the weaknesses that led to the three U.S. bank failures were unique to those banks, others were more general, including a slow response by mid-sized banks to adjusting their portfolios to a rising interest rate environment and weak risk management. There are more mid-sized banks with such issues, although, as Fed Chairman Jerome Powell said in his press conference 3 May many banks have taken note of the issues that were involved in those three bank failures and are adjusting their policies to protect themselves from the issues that contributed to the March failures.

The above two factors coupled with the Fed’s aggressive monetary policy tightening since last year has continued to give support to market expectations of a recession later this year. This then feeds into the market’s expectation that the Fed will cut rates later this year providing further support to gold prices. CPM’s view is that a recession emerging in the second half of this year has increased, and that the Fed will cut rates only when recession risks are more elevated than they are at present. That indeed could be during the second half of this year, but it also may be 2024 before the U.S. economy weakens sufficiently to trigger such a monetary policy response. Real economic growth has slowed in the United States over the past five quarters, helping to reduce price inflation rates; overall growth remains strong enough to warrant close monitoring of economic conditions but to hold on to the anti-inflationary stance for now.

Over the next few months the outcomes to the above-mentioned risks will become clearer. Until there is more clarity, gold prices are likely to remain elevated and volatile.

As mentioned before, the risk of a U.S. default is low, but given the magnitude of its impact markets are expected to keep safe haven assets and portfolio diversifiers like gold well bid. Once the debt ceiling is raised, the premium in gold prices from this factor will come off quickly.

Time will also tell how much the banking system has pulled back on lending following the March collapse of three regional U.S. banks and failure of Credit Suisse. If evidence gathers that the failures were idiosyncratic some more of the premium factored into gold will fall away. The reduction in this premium is likely to be more gradual as it occurs.

And finally, one area where the market is most likely in for a rude shock is its pricing of interest rate cuts by the Fed later this year. That is unlikely to happen sans a major economic/financial shock. As has been said in several previous editions of this report, CPM Group believes this mispricing across assets will result in a decline in asset values across the board later this year.

So, while gold prices are expected to remain at elevated levels with an upward bias in the near term, there is a high probability of weaker gold prices in the middle to late summer period as some of the price premium due to the aforementioned factors fades. This fading also would coincide with a seasonally weak period for gold prices. Prices could slip toward $1,800 in mid-summer.

Official Transactions

Central banks were net buyers of 3.75 million ounces of gold during the first quarter of this year. The weakest monthly demand was seen in March, which makes sense given the higher price of gold that month compared to February and the generally price sensitive nature of central bank gold demand.

That said, central bank demand has been strong during the first quarter despite the strength in gold prices. Resilience in demand despite stronger prices suggests that central banks see higher gold prices in the future and are looking to add metal to their holdings to continue to diversify their reserve assets.

The People’s Bank of China (PBOC) was the single largest buyer of gold during the first quarter of 2023, having added 1.86 million ounces of gold to its holdings, which accounted for 33% of gross purchases and 50% of net purchases during the first quarter. The PBOC restarted adding gold to its holdings in November 2022 and has bought gold every month since then. Its largest monthly purchase this year was in February when gold prices had declined. The relatively higher gold prices in January and March had resulted in the PBOC buying less gold during those months.

India also stepped in as a buyer during February when gold prices had softened, adding 120,000 ounces of metal to its coffers.

Central banks reducing their gold during the first quarter stood at 1.87 million ounces. There were nine central banks that were net sellers and four of them accounted for 92% of the sales. These four were the central banks of Kazakhstan, Uzbekistan, Cambodia, and Turkey.

Seeing the interest in gold among central banks during the first quarter of the year, any weakness in gold prices should be accompanied by a healthy increase in demand. Meanwhile, further strength in gold prices is likely to only result in a pullback in net purchases versus any sharp reduction in holdings.

Silver Market

Silver prices continued to build on the upward momentum that was set into motion in the middle of March, through the first half of April. During the second half of the month silver prices moved in a sideways fashion at elevated levels.

While there could be some pullbacks along the way, silver prices look poised to continue rising in the near term until they head into a period of seasonal weakness during the summer months. There are various factors that could help push silver prices higher in the near term, including the United States debt ceiling debate and political impasse, expectations of a reduction in U.S. interest rates later this year, renewed concerns around bank failure contagion, and softness in the U.S. dollar. While many of these factors are more concerns and expectations of the market than they are fact, these factors could help to boost silver prices in the near term until there is greater clarity on the debt ceiling debate, banking sector risks, and direction of U.S. interest rates.

Silver prices have resistance around $26.50, which if broken could see silver prices rise toward $27.00, $27.50, or even $28.00. On the downside silver prices have initial support around $24.80, which if broken could see silver prices slip to $24.30.

Silver’s Turn To Shine

The gold:silver price ratio declined in April to 80.1 from 88.9 in February, suggesting that silver prices rose at a faster pace than gold over the course of the past couple of months. That is true, but silver prices still are lagging behind those of gold, which reached a new record high level at the start of May. Silver prices too had risen to their highest level in a year at the start of May 2023, but they are nowhere near the record high levels reached in 2011 and are still below the highs reached in recent years as well.

It has been repeatedly observed that the gains in silver prices typically lag those of gold. There are various factors at work that are potentially responsible for this, which include the following.

• More investors and more types of investors buy gold than silver. While the silver market is very liquid, it is relatively less liquid than the gold market both in terms of depth and breadth, with fewer institutional investors, retail investors, bullion banks, and trading companies interested in the silver compared to gold. This relative lack of liquidity also contributes to sharper moves in silver relative to gold.

• Silver investors repeatedly have demonstrated a willingness to sell their silver when the positive sentiment toward the metal fades. As a group, investors have repeatedly been net sellers of silver for long periods of time, showing themselves to be much more opportunistic than many but not all gold investors. This is not the case with gold. Gold investors tend to buy less gold when the sentiment sours but they only rarely and for short periods of time turn into net gold sellers as a group. Since silver investors will sell silver, some of that silver will back up in market makers’ inventories. These market makers tend not to be particularly price sensitive since they are hedged. Market makers by definition sell when investors or others in the market want to buy and buy when investors want to sell. Because silver investors turn net sellers when sentiment sours, those stocks that were sold earlier by investors get backed up in market-maker inventories and they come out sooner, keeping the silver price down longer than gold, which does not face this challenge.
• Lastly, because silver has several industrial uses, economic distress hurts fabrication demand for silver more than for gold, which initially weighs on silver’s price. Silver investors are and have always been a more dominant force in influencing prices than fabricators. Generalist investors typically divert their attention toward silver only when gold starts to rise strongly, however. This delayed attention from generalists also tends to contribute to the lag in silver price performance relative to gold.

Platinum Market

Healthy commercial vehicle sales figures helped boost platinum prices during April. Prices rose to an intraday high of $1,148.90 on 21 April. This was the highest level that prices had reached since March 2022, when Russia’s invasion of Ukraine had driven platinum group metal (PGM) prices higher due to concerns about disruptions to palladium supply.

Platinum prices were unable to hold onto their April gains, however, with prices down to $1,061.80 by 3 May. Both platinum and palladium are expected to face headwinds due to macroeconomic factors such as slowing growth and relatively higher interest rates.

That said, platinum is in a somewhat better position than palladium. The recent reintroduction of platinum in gasoline auto catalysts is boosting platinum demand at the cost of palladium. Platinum is also sheltered to some degree from the electrification of automobiles, because a large part of platinum fabrication demand comes from larger commercial vehicles where electrification has not taken market share in the same way as it has in the passenger vehicle market.

There also are underlying concerns about disruptions to South African platinum mine supply due to electricity shortages. While these supply concerns are relevant to both platinum and palladium, South Africa plays a more important role in platinum mine supply.

It is not all good for platinum, however, with ongoing losses in the diesel passenger vehicle market hurting demand. Platinum prices have support around $1,040, however, they are vulnerable to the downside in the absence of supply side disruptions. It would not be surprising to see prices fall back toward $1,000 or $980 in the near term.

Fabrication Demand

Commercial vehicle sales have been healthy across most major auto markets during the first quarter of 2023. Commercial vehicle sales in the United States, Europe, and Japan rose by 14.3%, 10.6%, and 9.1% during the first quarter of this year compared to the same period in 2022.

Sales in China meanwhile were down 2.7% over the corresponding period in 2022. Nonetheless, there was a marked improvement in Chinese commercial vehicle sales during March. Commercial vehicle sales during the first two months of 2023 were down 15% year-on-year.

The healthy demand for commercial vehicles across major markets around the world suggests that businesses still were spending and investing in capital goods during the first quarter of the year. Economic growth has been decelerating and interest rates are likely to remain higher than they were a year ago. This could eventually begin to weigh on commercial vehicle demand as the year progresses.

It is also worth noting that while commercial vehicles still are primarily internal combustion vehicles, pure battery electric motors have started to make inroads into this market as well, especially in smaller delivery vans and buses, with heavy duty trucks the only category within commercial vehicle markets still experiencing limited electrification, primarily because batteries are not well suited for trucks due to a combination of their size/weight and distance travelled.

Palladium Market

Palladium prices rose alongside platinum prices during the second half of April. The strength was short-lived, however, and palladium prices were back down to where they started April during the first couple of trading days in May.

Slowing economic growth and high interest rates are not expected to bode well for palladium. The path of least resistance for palladium prices is lower at this time. While there are some supply side factors, such as potential loss in output from South Africa and actual loss in output in the United States due to the suspension of Sibanye’s Stillwater West mine, that could limit the downside, weakness on the fabrication demand side is expected to overpower any loss in supply.

The fabrication demand for palladium is expected to hurt from a slowdown in Chinese passenger vehicle demand this year, an increase in the amount of platinum being used in gasoline auto catalysts, an ongoing increase in electric vehicle market share around the world, and general macroeconomic headwinds due to higher rates, slowing growth, and slowing but still high inflation.

Palladium prices are expected to move in a sideways fashion between $1,300 and $1,570, with a bias to the downside, over the next few months. In addition to the aforementioned challenges to palladium prices, the market also enters a seasonally weak period as the market heads into summer.