The Precious Metals Week in Review – November 25th, 2022

1. On Monday it was reported that Russians are increasingly traveling back to Spain, despite restrictions imposed by the European Union on flights from Russia after its invasion of Ukraine. Back in February, the European Union decided to close its airspace to Russia, attempting to further isolate President Vladimir Putin. The collective action applies to any plane owned, chartered, or otherwise controlled by a Russian person, European Commission President Ursula von der Leyen said announcing the measure. “So let me be clear,” she told reporters in Brussels. “Our airspace will be closed to every Russian plane, and that includes the private jets of oligarchs.” That said the number of short-term visas granted to Russian nationals by Spain so far this year has almost tripled to 108,862 from the same period a year ago, according to Spanish foreign ministry data. A ministry spokesperson declined to comment on the reasons for the increase. While the overall number of visas issued is still below levels before the Covid-19 pandemic, the bounce shows growing travel by Russians to western Europe, despite the EU limits on Russian aircraft. A ban on Russian travelers by eastern European countries, including Poland and the Czech Republic, could be prompting some to redirect to western Europe, said one European diplomat. Economists estimated that millions of Russians have left their country since the invasion of Ukraine, a trend which accelerated after President Vladimir Putin ordered a partial military mobilization in September.

2. As warning signs for the economy mount, investors are cheering for the bad news. That’s because they expect economic weakness will force the Federal Reserve to stop raising interest rates and eventually re-embrace loose monetary policy. One reliable indicator over the years of an upcoming recession is an inverted yield curve. An inversion occurs when short-term interest rates rise above long-term rates. Typically, a 3-month Treasury bill or 2-year note will yield less than a 10-year note or 30-year bond. Shorter-duration debt instruments entail less risk and therefore deliver less reward under normal circumstances. But over the past four months, short-term IOUs have begun to yield more than longer-term papers. This week, the yield on the 10-year Treasury fell to 3.7%, while the 2-year rose to 4.4%. That represents the biggest yield curve inversion in decades. The U.S. economy technically dipped into a recession in the second quarter when GDP came in negative for a second consecutive quarter. At that time, however, the jobs market remained strong, and the housing sector had only just begun to show signs of softening. The double-dip downturn that many economists see coming in 2023 could result in millions of job losses and a major retrenchment in home prices. The stock market will obviously be vulnerable as well. As for precious metals markets, they have often shown relative strength during previous recessions. They have also tended to get a boost when an inverted yield curve starts to normalize. That would be expected to occur when the Fed begins to cut its benchmark short-term rate. For now, though, central bankers are vowing to keep hiking. Financial markets are pricing in a 50-basis point hike at the Fed’s next meeting but not much more hiking after that. The sharp drop in the U.S. Dollar Index last week means currency traders are looking for the Fed to become more dovish. The dollar managed to rebound only slightly versus foreign currencies. Other central banks around the world are growing wary of holding Federal Reserve notes and other forms of fiat as reserves. Many central banks are aggressively stockpiling hard money reserves in the form of gold. Global Central Bank purchases surged to nearly 400 tons in the third quarter. That represents the largest single quarter of monetary demand for gold on record. It also marks the eighth consecutive quarter of net purchases by central banks. The year-to-date total is already higher than any other year total since 1967. These are estimates by the World Gold Council which notes that some countries underreport their actual holdings. Some may be secretly accumulating more than the Council estimates while others could be exaggerating their reserves. But the trend of rising monetary demand for gold is indisputable. With inflation now hitting double digits in Europe and the Federal Reserve still unable to get U.S. price levels anywhere near back down to target, it’s no wonder gold is in high demand.

3. The Federal Reserve isn’t the only one tightening credit. Commercial banks are too. And that spells trouble for the U.S. economy. The proportion of U.S. banks tightening terms on loans for medium and large businesses and for commercial real estate rose last quarter to levels usually seen during recessions, according to a Fed survey. Lending standards for credit cards and other consumer loans also became more restrictive, as the Fed raised interest rates and the economic outlook darkened. Yet U.S. consumers continued to seek out more credit cards this year even as the Federal Reserve aggressively lifted borrowing costs. Application rates for credit cards “remained robust” this year, reaching 27.1% in October, up from 26.5% a year earlier and above the pre-pandemic level of 26.3% in February 2020, according to the New York Fed’s most recent credit access survey. However, the increased rigid policy by the commercial banks will likely affect the economy with a lag, as business and household borrowers find it more difficult to obtain credit and eventually scale back their spending. The tightening of lending standards by the banks, and the impact that will have on the economy, means the Fed might not have to raise rates as much as feared to restrain demand and rein in elevated inflation. He expects the central bank to eventually increase rates to about 5%, from its current target range of 3.75% to 4%. Banks told the Fed they had tightened lending standards on commercial and industrial loans for a variety of reasons, including a more uncertain or a less favorable economic outlook and a reduced tolerance for risk. A large number also cited decreased liquidity in the secondary market for such loans and less aggressive competition from other banks or nonbank lenders. The industry set aside $13.05 billion in the third quarter for expected credit losses, up from $10.95 billion in the second quarter, according to S&P Global Market Intelligence data. It was the sixth straight quarter that provisions for loan losses were increased, S&P said.

4. Some positive news shows U.S. mortgage rates retreated sharply for a second week, hitting a two-month low and providing a bit of traction for the beleaguered housing market. The contract rate on a 30-year fixed mortgage decreased 23 basis points to 6.67% in the week ended Nov. 18. according to data released Wednesday. Rates have plunged nearly a half percentage point in the past two weeks, the most since 2008, as recession concerns mount. The slide in borrowing costs helped stir demand as the group’s index of applications to buy a home climbed 2.8%. That marked the third-straight increase since the gauge stumbled to the weakest level since 2015. The pickup in demand has allowed the overall measure of mortgage applications to rise for a second week, but it still remains depressed overall. The index of refinancing activity edged up from a 22-year low. The housing market has been pummeled this year by a rapid rise in mortgage rates.

5. An update on FTX has claimed that a “substantial amount” of FTX Group’s assets “have either been stolen or are missing,” an attorney representing the firm told a bankruptcy court Tuesday. The wild-west days of crypto markets are back again as the large trading houses that once thrived on arbitrage price gaps pull back in the wake of FTX’s collapse. That’s opening profitable opportunities for anyone that still dares to trade. Prices for essentially identical assets on various platforms are diverging in a clear sign the dominoes are still falling across the crypto trading world. The gap between the funding rates of identical Bitcoin futures on Binance and OKX, for instance, has been as wide as an annualized 101 percentage points and remained at least 10, compared with mostly single-digit gaps last month. It’s a throwback to the early days of crypto, when speculators, including former FTX’s Sam Bankman-Fried himself, found easy money simply by buying one asset on an exchange and selling it for more on another. It’s a lucrative form of quantitative trading, which uses algorithms to profit from these price gaps. But as more sophisticated Wall Street converts entered the crypto markets, those differences shrank, making it harder to make money on the strategy. Now with FTX’s demise sending chills through cryptocurrency markets, these players are shrinking positions or even closing shops, causing this mispricing to stick around for longer. Unlike in traditional markets where hedge funds borrow through prime brokerages, crypto traders must put collateral directly on exchanges. So, when FTX began to restrict withdrawals, hordes of retail and professional speculators essentially lost access to much of their assets available for trading. Any recovery now is dependent on a slow and winding bankruptcy process. On the largest exchange Binance, the funding-rate gap between Bitcoin futures against Binance USD and those against Tether has widened to an average 15 percentage points on an annualized basis since Nov. 9, compared with nearly nothing in October. (The funding rate is an interest payment that’s used to keep perpetual futures in line with the spot price.) Traders now must decide whether to write off their exposure to FTX or create a so-called side pocket that separates those assets from the main fund. However, the contagion risk is elevated. So, for those who dare to trade this market a conservative approach is needed.

6. The political landscape in Washington is set for the coming years with Democrats in control of the White House and Senate, while Republicans will control the House of Representatives. Investors and business leaders often look forward to periods of divided government, but, if history is any guide, this gridlock may be far from a major stocks win over the next 12 months. The last time the United States had this split control, which occurred from 2011 through 2016, the S&P 500 returned 5.9% in the 12 months following the 2010 midterms and 3% after the 2014 elections. This was far lower than the returns after other divided midterm results. Still, the more significant historical lens shows that chaos in Washington rarely matters in the long term. Usually, the 12 months following midterm elections are great for stocks. A U.S. Bank report recently noted “uncertainty resolves after the midterm election” and gains can follow. The researchers crunched the numbers since 1962 and found that the stock market tends to “underperform in the 12 months leading up to midterm elections and overperform the 12 months after.” The last time stocks declined in the 12 months following a midterm was during the Great Depression. While stocks also had a below-average year in the 12 months following the 2014 midterm elections, the main factors that held prices down in that era were a collapse in oil prices and a slowdown in China. In fact, even in those chaotic years from 2011 to 2015, investors who stayed steady through the difficulties made out with 15.9% annual returns over the entire four-year period, according to the data.

7. It’s now clear that the great quantitative easing experiment was a colossal policy mistake as there’s no convincing evidence that central banks’ purchases of trillions of dollars of bonds and other financial assets helped any economy. Many think it’s time central banks acknowledge it for the failure it was and retire it from their policy arsenal as soon as they’re able. Since the global financial crisis of 2008, an integral part of central banks’ playbook in the U.S., the U.K., and the European Union has been QE, the practice of buying up long-term bonds and mortgage-backed securities. QE is supposed to work by lowering long-term interest rates, which boosts demand and increases lending and risk-taking. There is little to show in terms of the economic benefits, but there are plenty of costs. Central banks now find their hands tied as they try to curb inflation with interest rate increases and quantitative tightening, which means no more long-term bonds and mortgage-backed securities purchases. But they’re finding that ending QE can itself be a threat to financial stability. That was supposed to be an emergency measure, but it went on for years. QE was followed by QE2 and then QE3 as the Fed became fearful that stopping would crash the bond markets. About a decade later, just as the Fed’s balance sheet finally started to shrink, along came the pandemic and the biggest QE ever. It lasted well after the immediate crisis passed, even as inflation and the housing market started to heat up. Looking objectively at the evidence, it’s still unclear that all this bond buying ever did much for the economy. As Ben Bernanke once said, “The problem with Quantitative Easing (QE) is that it works in practice but not in theory.” Ending QE won’t be easy. Central banks now have enormous balance sheets that will take years to whittle down. And as we see in the U.K., when a central bank stops buying bonds, it can throw markets into chaos. Now that QE has become the norm, the next time there is a recession market will expect more QE, and if it doesn’t happen that could cause more trouble in the debt market. That’s why central banks need to admit QE was a mistake. Their credibility is already at stake after they underestimated inflation. Now is the time to take a hard look at monetary policy over the last decade and rethink what worked and what didn’t. Otherwise, we’ll be stuck with QE forever.

8. Applications for U.S. unemployment benefits rose last week to a three-month high amid a wave of layoffs at technology companies, a sign of cooling in a tight labor market. Initial unemployment claims increased by 17,000 to 240,000 in the week ended Nov. 19, Labor Department data showed Wednesday. The median estimate in a Bloomberg survey of economists called for 225,000. Continuing claims, which include people who have already received unemployment benefits for a week or more, rose by 48,000 to 1.55 million in the week ended Nov. 12, the highest since March. That was also the sixth weekly increase in a row.

9. Oil markets weakened in November, with many widely watched metrics flashing warning signs and dragging futures prices lower. As the red flags proliferated, Brent traded at nearly $87 a barrel on Friday after hitting $82.31 on Monday, the lowest intraday price since January. With no U.S.-centric economic data for the rest of the week due to the Thanksgiving holiday, volatility may remain subdued unless we see further clarification around the Russian oil price cap as well as possible OPEC member statements addressing the rumored production increase earlier this week.

10. The Euro was little changed at $1.04, close to its highest since early July, on expectations of a narrow interest rate gap between the ECB and the Fed. The monetary policy meeting accounts from the ECB showed policymakers remain committed to raising interest rates to bring down inflation, even in the case of a recession. The Euro this week was also supported by figures showing the contraction in Euro Zone business activity eased slightly in November.

11. Japan’s inflation hit its fastest clip in 40 years in October, an outcome that further stretches the credibility of the central bank’s view that continued stimulus is needed to secure stable price growth. Core inflation has now exceeded the Bank of Japan’s 2% price target for seven straight months. The Japanese yen appreciated past 140 per dollar, marching toward its strongest levels in nearly three months after the latest Federal Reserve meeting minutes showed that a majority of U.S. policymakers agreed it would likely soon be appropriate to slow the pace of interest rate hikes.

Tighter Federal Reserve policy is raising households’ interest-rate burden, leading to a rapid decline in excess savings and underscoring the likelihood that hawkishness has peaked. The pandemic rise in excess savings was probably the most rapid increase in wealth ever seen. A combination of a collapse in demand and huge government transfers led to an estimated peak of $2.3 trillion (about $7,100 per person in the U.S.) in excess savings being accumulated by the middle of 2021. But after the feast comes famine, and excess savings are being run down swiftly as inflation causes prices and interest rates to rise. These excess savings act as a buffer to a recession as they dampen the feedback loop of a decline in spending, leading to a fall in income, which means less spending, and so on. In nominal terms, households have to repay an estimated $1.75 trillion each year, or almost 10% of disposable income. This burden will get worse as more income is eaten up by rising prices.

The Fed estimates that excess savings have dwindled to $1.7 trillion (as of mid-2022), a 26% drop in a year. The stock of excess savings is likely to fall at an increasing pace as the lagged effects of rising interest rates bite. The Bureau of Economic Analysis defines the flow of savings as disposable personal income, consumption, and other outlays. The savings rate reached as high as 33% in the depths of the pandemic, a previously unimaginable level, but since then has collapsed to a near-all-time low of 3.1%. The dissaving can be seen in the rapid decline in “excess disposable income,” i.e., disposable income above its pre-pandemic trend. It is back to flat based on a 30-year trend line, signifying that excess savings are no longer being bolstered by excess income because people are spending more and pandemic-related transfer payments from the government have ceased. Savings are being increasingly stressed by rising debt repayments. Consumer and mortgage debt interest rates are rising. The recession buffer is being wiped out, leaving the U.S. economy in a more fragile position and raising the likelihood the Fed has reached its peak in its aggressive war on inflation, for now.

European gas prices are plunging from the peaks reached over the summer, but businesses and households will have to wait for relief from the squeeze from soaring inflation. Benchmark futures dropped below €100 ($99) per megawatt-hour this week for the first time since June. This is due to better-than-expected progress in filling storage facilities and mild weather. They extended losses Tuesday, dropping as much as 6.8% to €92.40, down from as high as €342 in late August. And prices may fall even further in the coming days, given the unusually high temperatures in Europe which are delaying the seasonal increase in heating demand. But the slow pass-through to energy bills, and broader price increases across a variety of goods and services, means pressure on incomes will continue. A European Commission study says changes in wholesale natural gas prices are typically only partially passed on to consumers and can take up to 12 months to materialize. Plus, gas prices are still about three times the average for this time of year. The energy crisis sparked by Russia’s invasion of Ukraine led to an unprecedented surge in inflation across the continent, and governments are spending billions of euros to help consumers and businesses as their economies slip toward recession.

It is relatively common that what should be recognized as a warning flag of major trouble is often ignored until things get so bad that it is almost impossible not to notice. Geopolitical, economic, and environmental uncertainty can be expected to continue in the near term. Astute investors continue to seek out alternative investments for their portfolios to aid in diversifying them away from overexposure to any single asset class. Some are seeking out buying opportunities from temporary price dips to add more physical precious metals into their portfolios. Remember that one of the keys to profitability through the ownership of physical precious metals is to acquire the physical product and hold on to it for the long term without overextending your ability to maintain its ownership.

Trading Department – Precious Metals International, Ltd.

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