The Precious Metals Week in Review – December 9th, 2022

1. On Monday treasuries sold off as stronger-than-expected U.S. economic data added fuel to traders’ bets on how high Federal Reserve interest rates might ultimately go. Stocks kicked off the week with losses which continued throughout the week and bond yields climbed as a U.S. services gauge rose unexpectedly. This fuels speculation that the Federal Reserve will keep its policy tight to fight stubborn inflation. All major groups in the S&P 500 retreated, with Tesla reporting the electric-vehicle giant plans to lower production at its Shanghai factory. Tuesday saw Apple weighing heavily on the market, with the S&P 500 falling for a fourth straight session. Meta Platforms fell 6%. The dollar saw a back-to-back advance, while oil tumbled. The pullback in U.S. debt markets drove yields of the curve up by around 10 basis points, with the 10-year rate jumping to 3.58%. Swaps showed a similar increase in expectations for where the Fed terminal rate will be, with the market indicating a peak of close to 5% in the middle of 2023. The Treasury market was already under pressure Monday ahead of key data on services and factory orders that showed a healthier economic picture, and the move extended on the back of those figures. Markets could continue to be choppy as the end of the year approaches and along with it the final Fed meeting of 2022 on Dec. 13-14. Markets continue to price a half-point increase for that gathering, little changed from before the most recent data, which would represent a slowing in the pace of tightening.

2. The Federal Reserve hasn’t had much success so far in wrestling down sky-high inflation, but its monetary tightening campaign is having a major impact in deflating asset bubbles that swelled during the pandemic.

• The cryptocurrency market — once valued at $3 trillion — has shrunk by more than two-thirds.
• Investor-favored technology stocks have tumbled by more than 50%
• Red-hot housing prices are falling for the first time in 10 years.

Most importantly, and surprisingly, all this is occurring without upending the financial system. “It’s astonishing,” said Harvard professor Jeremy Stein, who as a Fed governor from 2012 to 2014 paid special attention to financial stability issues. “If you told any one of us a year ago, ‘we’re going to have a bunch of 75 basis-point hikes,’ you’d have said, ‘Are you nuts? You’re going to blow up the financial system.” But a broader financial blowup can’t be ruled out. The current episode, for now, marks a sharp contrast with the bursting of the U.S. property-price bubble that triggered a deep downturn from 2007 to 2009, and the tech-stock meltdown that helped push the economy into a mild recession in 2001. So, the full financial fallout from the Fed’s inflation-fighting crusade may not be clear quite yet. Not only are more rate hikes in the pipeline, but the central bank continues to shrink its balance sheet, through so-called quantitative tightening. Given the potential for bigger financial pitfalls, Harvard’s Stein cautioned against taking too much comfort from the relative calm seen so far.

3. There’s a hidden risk to the global financial system embedded in the $65 trillion dollar debt being held by non-U.S. institutions via currency derivatives, according to the Bank for International Settlements. In a paper with the title “huge, missing and growing,” the BIS said a lack of information is making it harder for policymakers to predict the next financial crisis. In particular, they raised concern with the fact that the debt is going unrecorded on balance sheets because of the accounting practice on how to track derivative positions. The findings, based on data from a survey of global currency markets earlier this year, offer a rare insight into the scale of hidden leverage. Foreign-exchange swaps were a flashpoint during the global financial crisis of 2008 and the pandemic of 2020 when dollar funding stress forced central banks to step in to help struggling borrowers. To understand how the system works, consider a Dutch pension fund buying assets in the US. As part of the transaction, it will often use a foreign-currency swap to exchange euros for dollars. Then, when it’s closed out, the fund will repay dollars and receives euros. For the length of the trade, the payment obligation is recorded off-balance sheet, which the BIS calls a “blind spot” in the financial system. It’s that blur that puts policymakers at a disadvantage, according to BIS researchers Claudio Borio, Robert McCauley, and Patrick McGuire. “It is not even clear how many analysts are aware of the existence of the large off-balance sheet obligations,” they wrote. “In times of crises, policies to restore the smooth flow of short-term dollars in the financial system, for instance, central bank swap lines, are set in a fog.” For researchers at the BIS, it’s the sheer scale of the swaps that are worrying. They estimate that banks headquartered outside the U.S. carry $39 trillion of this debt, more than double their on-balance sheet obligations and ten times their capital. “There is a staggering volume of off-balance sheet dollar debt that is partly hidden, and FX risk settlement remains stubbornly high,” said Borio, head of the monetary and economic department at the BIS.

4. Silver is potentially setting up for gains as silver will play a vital role in the global shift towards New Energy. Silver mining was hit hard during the Covid-19 crisis. Mining operations shut down, mine developments were suspended, and exploration projects were put on ice. In fact, in Mexico, the world’s largest silver producer, all mines were shuttered during the spring of 2020. And the silver market didn’t have to wait long to experience the negative consequences of these policies. In 2020, silver mining output reportedly fell by 5% year-over-year. In 2021, supply issues and rising demand produced a silver market deficit of 48 million ounces. And earlier this year, the Silver Institute published estimates that the silver market could reach a shortage of 194 million ounces in 2022. That’s up four times from the prior year, creating the biggest deficit in decades. This comes as silver demand is projected to reach an eight-year high this year, at over 1.21 billion ounces. That’s up 16% from last year. The use of silver by industry, for jewelry, and bars and coins for investment were all forecasted to reach record levels in 2022. Now, a deficit is not proof that a commodity will soar as deficits may not catch up with a given commodity immediately. Most silver is mined as a side product from zinc, copper, or gold, which is why its price does not always react logically towards the supply and demand picture. Therefore, silver lives this somewhat quiet life until it doesn’t anymore, and when it finally moves, it is known for strong dynamic moves. The demand side for silver comes closer to copper than anything else on the industrial side, and it shadows gold on the investment side. This is until it takes the lead itself, which tends to happen in the final phases of precious metals runs. Maybe the needed trigger on the investment side will arrive after many retail investors have been burned on crypto and will be looking elsewhere.

5. Contagion from the messy implosion of Sam Bankman-Fried’s crypto empire is spilling into the world of decentralized finance after a hedge fund was declared in default on almost $36 million of loans. Orthogonal Trading said on Tuesday that it had been “severely impacted by the collapse of FTX and associated trading activities,” making it unable to repay a $10 million crypto loan. That prompted the entity that runs the lending pool to issue a notice of default for all the fund’s active borrowings. The default is the latest example of crypto hedge funds getting stung by the swift implosion of FTX in November. FTX was a favored trading venue for institutional crypto investors, and several hedge funds have been cash trapped on the site after it filed for bankruptcy. Orthogonal Trading’s default hints at just how widely contagion the demise of FTX and Bankman-Fried’s trading house Alameda Research is spreading. In total, Orthogonal Trading had taken out $31 million of loans in the USDC stablecoin and another $4.9 million denominated in a token called wrapped Ether. It now accounts for the majority of M11 Credit’s loans, up from 14% at the start of September. “Rather than cooperating with us and disclosing their exposure, they attempted to recover losses through further trading, ultimately losing significant capital,” M11 Credit said in a statement, adding that it had been informed by Orthogonal Trading on Dec. 3 about its inability to repay the $10 million. Orthogonal Credit, a related party that it says operates “structurally separate” from Orthogonal Trading, said on Monday that it was “shocked and dismayed” by the event and was unaware of its sister entity’s woes. “We are speechless by the extent of the exposure and liquidity position of Orthogonal Trading’s book of business,” Orthogonal Credit said.

6. A portfolio manager and Wall Street veteran Stuart Simonsen noted recently that gold’s breakout year was followed by a fairly dull twelve months. And then, after reaching another all-time high in March this year due to Russia’s invasion of Ukraine, it again retraced from $2,070 to just above $1,780. The thing to keep in mind is that all markets are highly volatile right now, and gold, despite its astonishingly low beta of 0.10, is no exception. In a time of high volatility, even relatively stable assets can display dramatic changes in price. Beta (β) is a measure of the volatility of an asset compared to the market as a whole (usually the S&P 500). Assets with betas higher than 1.0 can be seen as more volatile than the S&P 500. Assets with betas lower than 1.0 are less volatile than the S&P 500. In other words, price swings are less dramatic. Central banks around the world are tightening monetary policy and are forecasted by various analysts to continue until mid-2023. ABN Amro’s analysts, for example, believe that the Federal Reserve will be forced to reverse course and start cutting interest rates as soon as the second half of 2023. Which is considered by many to be way too soon for inflation to no longer be a problem. Consider it took over a decade to finally bring inflation under control during the stagflation crisis of the 70s-80s. Together with lower real yields on bonds (after inflation), ABN Amro says the policy turnaround could conceivably bring gold back to $1,900 over the short term. Fiat currencies depreciate by nature, and any effort by central banks to hasten things tends to bring on massive bull runs in the gold market. Look at the example of savings accounts as an easy way to lose purchasing power (but not money) due to inflation in what should be a straightforward wealth-preservation vehicle. Gold investors usually don’t have such worries as gold’s price fluctuates up and down, as opposed to typically simply going down. The World Gold Council reported record purchases by the official sector in Q3, yet 300 tons were unaccounted for. For example, in July, China reported an eightfold increase in purchases of Russian gold. Nikkei Asia reports that China has dumped $121.2 billion in U.S. Treasuries this year. And it’s not just China: countries around the world are not only buying gold at a record pace, but they’re dumping Treasuries to do it. Lombardi Letter’s Moe Zulfiqar speculates this could potentially bring gold to $3,000 much quicker than expected.

7. In technology news Israeli startup RepAir raised $10 million to help scale up its technology to suck planet-warming carbon dioxide out of the air. RepAir is one of a handful of companies looking to build technology that performs a process known as direct air capture, which takes CO2 from the air and stores it safely out of the atmosphere. It’s potentially a key tool for getting rid of excess greenhouse gas emissions that are causing global warming, alongside the much larger effort to prevent them from ever entering the atmosphere in the first place. RepAir currently has a working prototype that’s about the size of a shoe box, which it operates in a laboratory near Haifa, Israel. With that proof of concept, the company plans to scale up with the money raised from investors including the venture arms of European oil and gas giants Shell and Equinor. “Direct air capture has to be part of the solution to the climate problem. It’s an essential element on top of shifting to renewables and eliminating emissions at the source,” said RepAir’s co-founder and CEO Amir Shiner. “The name of the game is to scale up as quickly and economically as possible.” Carbon capture technologies that trap emissions at the smokestack have been developed for decades by the oil and gas industry. But direct air capture is a relatively emerging technology promoted to remove air emissions more reliably than offsets based on forests, the benefits of which are hard to verify. The world’s largest direct air capture plant, built by Swiss startup Climeworks AG, started up last year in Iceland with a capacity to draw in 4,000 tons of CO2 a year. While the company is currently focused on its development phase in Israel, it plans to expand next year into the U.S., where President Biden’s climate bill, the Inflation Reduction Act, offers as much as $180 per ton in subsidies for projects that isolate least 1,000 tons a year.

8. In the week ending December 3, the advance figure for seasonally adjusted initial claims was 230,000, an increase of 4,000 from the previous week’s revised level. The previous week’s level was revised up by 1,000 from 225,000 to 226,000. The 4-week moving average was 230,000, an increase of 1,000 from the previous week’s revised average. The previous week’s average was revised up by 250 from 228,750 to 229,000.

9. Crude oil prices are about to book a week of sizeable losses, during which market movements erased all gains Brent and West Texas Intermediate had made since the start of the year. Crude oil is languishing with the WTI futures contract near U.S. $76.50 bbl. “Oil has been dragged lower by broader recession fears that accompany global monetary policy tightening,” says Vishnu Varathan, head of Asia economics and strategy at Mizuho Bank. “And given the lags in monetary policy, a ‘wall of tightening’ may hit the global economy yet.” It has also been reported that Russia is selling crude oil to Asia at above the $60 level set by the G7 price cap that was put in place on Monday.

10. The Euro has steadied against the U.S. Dollar on Thursday as the market ponders the path of Fed rate hikes and technical resistance levels remain overhead for now. The EUR/USD ran to a five-month high to start this week but was unable to overcome the late June peak of 1.0615 and the 260-day simple moving average (SMA) when traded at 1.0595. These levels may continue to offer resistance. The Euro gained after better-than-expected Euro wide GDP figures showed a 0.3% QoQ expansion for the third quarter rather than the 0.2% that had been anticipated. This gave an annual read of 2.3% YoY to the end of September, above the 2.1% forecast.

11. The Japanese Yen is slightly weaker so far despite the GDP narrowly beating forecasts. Annualized GDP was -.08% for the third quarter instead of -1.1% as predicted. USD/JPY had a look above the breakpoint of 137.67 but was unable to sustain the rally after making a high of 137.86. Treasury yields have added a couple of basis points (bps) so far this week after dipping around a dozen bps across the curve. The U.S. Dollar is broadly stronger through the Asian session after sliding in North American trade. Fears of a recession in the U.S. continue to swirl after commentary this week from several senior financial executives sounding the alarm for an economic slowdown in 2023.

Climate change is a real difficulty. More than a century of carbon emissions is warming the planet and likely causing floods, droughts, fires, and other events that are threatening livelihoods and upending economies. But the war on fossil fuels that are the source of those carbon emissions is causing its own forms of chaos. Oil, natural gas, and other types of carbon-based fuel will be essential for decades, yet the pace of investment in future capacity is declining in the United States and other western nations. Chronic shortages are becoming likely. There’s plenty of carbon in the ground, but energy firms no longer want to risk the long-term investments needed to get it out. Brenda Shaffer, a professor at the Naval Postgraduate School, said at a recent conference: “The world is experiencing the worst energy crisis since World War II. The factors contributing to this are long-term underinvestment in oil and gas, public finance denial of investment in fossil fuels, market design, and energy policies around the world.” The transition to renewables and low-carbon energy that U.S. and European policymakers are pushing is part of the problem. But the bridge from fossil fuels to renewables is missing a few spans, which could mean energy shortages and skyrocketing prices until green energy is potentially widespread. While many governments are creating strong incentives to adopt renewables, they’re not safeguarding supplies of the fossil fuels that meet 80% of the world’s energy needs today. And renewables aren’t coming online fast enough to offset the shortfall of oil and natural gas.

In advanced economies, costly energy will likely slow growth and perhaps contribute to recessions. In the developing world, energy shortages may worsen famines and trigger catastrophes. The energy war between Russia and the West continues, and a drop in Russian oil exports could also push prices up. The political band-aid of American releases of oil from the U.S. national reserve is due to end soon, further tightening the supply. Self-imposed limits on western production will make the United States and Europe more dependent on other nations that prefer high prices over ample supplies. There’s a shortage of diesel, which is pushing the price of the fuel that powers long-haul trucks and farm machinery close to record highs. U.S. natural gas prices this year have hit the highest levels since 2009. That means expensive heat and electricity this winter. But the energy economy is massive, involving trillions of dollars of infrastructure devoted to carbon fuel over the last hundred years. It can’t change nearly as fast as the green-energy advocates would like. And some green-energy technologies won’t pan out as the minerals needed, such as lithium, nickel, and cobalt, come from China, Russia, or other nations unfriendly toward the United States and the West. This raises the same problem as relying on Saudi Arabia or Russia for oil.

Even with the aggressive adoption of renewables, carbon fuel will remain dominant for decades. “We’ve underinvested,” Abhi Rajendran, director of oil markets research for Energy Intelligence, said at the Dallas Fed conference. “We’re underwater on the supply side. It’s a recipe for higher prices. It’s going to be a bumpy couple of years.”

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. As tensions continue to escalate and macroeconomic and geopolitical uncertainties increase, perceptive investors take added steps to help ensure that their portfolios are well-diversified in case of a drastic downturn in the global economy. Such investors have continued to add physical precious metals as part of a well-diversified portfolio as the entire precious metals sector has outperformed the Dow over the past year. These investors continue to stick to their plans to add physical precious metals to their portfolios whenever temporary price dips present themselves at a discount. 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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