The Precious Metals Week in Review – January 13th, 2023

1. The world economy looks to be transitioning to a more difficult era where interest rates will be higher, geopolitical tensions greater and uncertainties more pronounced. That’s the message that emerged from this year’s annual meeting of the American Economic Association. Economic luminaries, including former US Treasury Secretary Lawrence Summers, ex-International Monetary Fund chief economist Kenneth Rogoff and former Bank of England policymaker Kristin Forbes, warned of perils ahead. On the way out is an era of ultra-low interest rates and rapid Chinese growth. Investors and policymakers will instead confront a new world where an intensifying US-China rivalry and dangerous debt blow-ups are more the norm. The warnings of longer-term trouble come as investors are growing somewhat more hopeful of the Federal Reserve’s ability to rein in sky-high inflation without causing a recession. The failure of most forecasters to see the persistent inflation coming out of the pandemic has led to much soul-searching and questioning of the assumptions in economic simulations that have guided policy for many years. “Our track record at understanding inflation is really, really bad,” the University of California, Berkeley, Professor David Romer said. “The range of plausible outcomes over the next year or two years is very, very wide,” including having inflation either fade or become embedded in the economy. Some aspects of the conference itself showed how the profession is struggling to adapt to a new reality.

2. Ten ‘mega threats’ are hurtling towards the world including war, debt crises, and a demographic ‘time bomb’ that could make investors flock to gold, hence causing the yellow metal’s price to rise to $3000/oz. by 2028, according to Nouriel Roubini, CEO of Roubini Macro Associates and Professor Emeritus at NYU Stern School of Business. “Over the next few years, I would expect that gold could have high single-digits into low double-digits rates of return, I expect around a 10 percent gain per year over the next five years.” Inflation, stagflation, and a trend towards ‘de-dollarization’ will be the main drivers. “If the rivals of the US have to diversify away from dollar assets because we weaponize the dollar and sanctions can be imposed, then the only international reserve asset that cannot be seized by the US and the West is not the dollar, Euro, yen, or pound,” he said. “It can only be gold.” Roubini, also known for correctly predicting the 2008 financial crisis before it occurred, said that a “stagflationary depression” could begin in 2023, which would cause both stocks and bonds to decline. “If I am right, that we will have a hard landing, that inflation is going to be persistent, and that central banks are in a dilemma, [then] both equities and bonds will do poorly,” he predicted. “Gold should do better because… it is a hedge against inflation. It is also a hedge against financial instability, and a hedge against social, political, and geopolitical stability.”

3. US equities face much sharper declines than many pessimists expect with the specter of recession likely to compound their biggest annual slump since the global financial crisis, according to Morgan Stanley strategists. Michael Wilson said that while investors are generally pessimistic about the outlook for economic growth, corporate profit estimates are still too high, and the equity risk premium is at its lowest since the run-up to 2008. That suggests the S&P 500 could fall much lower than the 3,500 to 3,600 points the market is currently estimating in the event of a mild recession. “The consensus could be right directionally, but wrong in terms of magnitude,” Wilson said, warning that the benchmark could bottom out around 3,000 points, about 22% below current levels. Wilson was ranked No. 1 in last year’s Institutional Investor survey and is not alone in his view that earnings expectations are too optimistic. One of the factors driving Wilson’s bearish view is the impact of peak inflation. US stocks rallied somewhat last week amid signs that a modest ebbing in price pressures could give the Federal Reserve room to potentially slow its interest-rate hikes. Wilson, however, warned while a peak in inflation would support bond markets, “it’s also very negative for profitability.” He still expects margins to continue to disappoint through 2023. Deutsche Bank Group AG strategists led by Binky Chadha also expect US earnings to decline in 2023.

4. Global markets have yet to price in fully the reopening of China and copper exporters are set to benefit from the world’s second-biggest economy returning. For sectors like copper (and silver) where supply constraints remain and inventory levels are low, there is ‘a good underpinning’ for higher prices. Key exporters such as Chile, Peru, the Republic of the Congo, and Zambia will get a boost. Copper prices in London rose to their highest since June this week, fueled by optimism that China’s reopening will spur demand in the world’s top consumer of the metal. Industrial metals broadly are advancing as investors bet on property-sector stimulus measures in China to increase the need for building materials.

5. Some Americans could end up paying more for their gasoline thanks to a plan by seven Midwestern state governors to boost the use of corn-based ethanol. Their request is under review by the federal government. If adopted, it could be good news for corn farmers throughout the region. But it would also force oil refiners supplying the Midwest to provide a specialized gasoline grade and construct new storage tanks and other infrastructure. That has the potential to increase costs, which would likely be passed on to consumers already squeezed by soaring inflation. Prices at the pump are seen rising by at least 2 cents per gallon in affected states, though some industry groups say the costs could be much higher, especially if the change is implemented this summer leaving little time to supply adequate inventory. That risks undoing some of President Joe Biden’s historic efforts to tame runaway gasoline prices, which his administration regards as a major political threat. The average cost of a gallon of regular is now well below the $5-plus peak seen last summer. But prices have been creeping higher again recently, gaining more than 19 cents in a two-week period that ended Friday after a winter storm disrupted oil refining. US oil refiners have cited a slew of operational and policy constraints, including capacity cuts made during the pandemic, as reasons why they could do relatively little to boost gasoline supply last year when fuel costs jumped. Another point to consider they did not mention would be their record profits seen last year. The change also could isolate the Midwest’s fuel supply from the rest of the country, much like what happens in California, historically home to the highest retail prices in the country, because of its boutique grade. Though the Midwest is expected to have more gasoline than it needs this summer, it still often relies on the Gulf Coast for swing supplies, as much as 11% of the region’s consumption in July.

6. Russia’s invasion of Ukraine is a multidimensional war. There’s the hideous and bloody military conflict. And there’s the grueling and costly economic battle, fought above all in the energy market. Gas molecules and oil barrels are weapons just as tanks and drones are. We now have a year’s worth of data to quantify the energy weapons deployed, and the tally is stark: In 2022, barrels from the West were higher than Russia by almost 3-to-1. First, the Russian data: The country’s total oil production — including crude, condensates, and natural gas liquids sank by about 122 million barrels from last year’s peak in February, just before the invasion. The international response to the decline in supply was overwhelming. The US and its allies, under the umbrella of the International Energy Agency, released about 314 million barrels from strategic petroleum reserves. Put simply, for each Russian barrel lost from the market in 2022, key IEA members added almost 2.6 barrels from emergency stockpiles. The bulk came from America, roughly 222 million barrels over the year. The rest, in two portions, flowed from Germany, Japan, France, Spain, the UK, and a few others. The near 3-to-1 ratio shows that the US and its allies used their strategic reserves far beyond what was needed to replace the physical shortage created by Russia. They tapped extra barrels to push prices down. They were not just fighting Russia, but the OPEC+ cartel, too. All’s fair in war.

7. In the week ending January 7, the advance figure for seasonally adjusted initial claims was 205,000, a decrease of 1,000 from the previous week’s revised level. The previous week’s level was revised up by 2,000 from 204,000 to 206,000. The 4-week moving average was 212,500, a decrease of 1,750 from the previous week’s revised average. The previous week’s average was revised up by 500 from 213,750 to 214,250.

8. Data from the quarterly Dallas Fed Energy Survey suggest increasing activity overall among exploration and production companies, supporting the forecast for growth in U.S. crude oil production. After drawing over 221 million barrels of oil from the Strategic Petroleum Reserve (SPR) in 2022, Washington is having a tough time refilling it with the Department of Energy (DoE) rejecting the first offers on the grounds that they failed to benefit taxpayers. As of Friday, Brent Crude was trading at $84.96 a barrel with WTI (West Texas Intermediate) at $79.45.

9. The Euro continues to march higher in January to trade at $1.08, the highest level since April last year and receiving help from a softer dollar. This is as investors expect the Fed to slow the pace of rate increases after the US CPI report pointed to another slowdown in inflationary pressures. In Europe meanwhile, preliminary estimates showed price pressure eased more than expected, with the annual inflation rate in the Eurozone hitting a four-month low. However, excluding energy, inflation continues to hold at record levels.

10. The Japanese yen appreciated past 130 per dollar, its strongest levels in over seven months after data showed that the US inflation eased further in December, fueling bets for a less aggressive tightening from the Federal Reserve. The yen was also lifted by growing speculations about the Bank of Japan’s possible shift from an ultra-easy policy after it unexpectedly doubled the ceiling of the tolerance band on 10-year JGBs in December.

In the seemingly never-ending guessing game of what future interest rates will/should be, news on Thursday broke that the Federal Reserve policymakers are on track to downshift to smaller interest-rate increases at their next meeting. This follows a further cooling in US inflation. Philadelphia Fed President Patrick Harker said rate hikes of a quarter-percentage point “will be appropriate going forward,” following bigger increases throughout most of 2022. Consumer prices rose 6.5% in the 12 months through December, marking the slowest inflation rate in more than a year. So-called core inflation, which excludes food and energy, was up 5.7% over the same period, the smallest advance in the year. Both figures matched median forecasts. While moderating inflation paves the way for a slower pace of rate increases in 2023, the market’s expectation of rate cuts later in the year is still at odds with Fed guidance. Policymakers have emphasized the need to hold rates at an elevated level for quite some time and cautioned against underestimating their will to do so.

Federal Reserve Chair Jerome Powell looked to draw a line around how far the central bank will use its powers to promote a greener economy, vowing it will not be a climate regulator. “The Fed does have narrow, but important, responsibilities regarding climate-related financial risks,” Powell said Tuesday at a forum in Stockholm. “But without explicit congressional legislation, it would be inappropriate for us to use our monetary policy or supervisory tools to promote a greener economy or to achieve other climate-based goals. We are not, and will not be, a climate policymaker.” The Fed chair is three weeks away from the next meeting of the Federal Open Market Committee, which last year raised its benchmark lending rate from near zero to a range of 4.25% to 4.5% to battle high inflation. Officials are eyeing raising rates to above 5% this year. Powell said the Fed’s independence has served the public well and added that the central bank “must continuously earn it” by achieving its goals and supplying transparency to the public and Congress. Powell said the central bank should “stick to our knitting,” and not “wander off to pursue perceived social benefits that are not tightly linked to our statutory goals and authorities.” He added that restoring price stability can require unpopular measures such as slowing the economy.

In a follow-up to a story that we covered several months ago, China’s government is protecting some of its chipmakers by spending lavishly to shore them up, just as weak demand is making it hard for chip manufacturers across the globe. But China’s semiconductor industry also faces a problem that its counterparts elsewhere don’t have to worry about: unremitting hostility from the US government. Beijing could try to spend its way out of that problem, too, but there may be things about cutting-edge semiconductor production that money cannot buy. China’s chip industry has always lagged behind the US, and it has relied on Western technologies for the most advanced semiconductors, chipmaking equipment, and knowledge. After years of mounting tension, the Biden administration spent much of 2022 coming up with ways to cut off China from such technology, as it tried to slow down its advancement in chips, artificial intelligence applications, and military tech. The US’s effort to keep advanced tech out of Chinese hands increases pressure on President Xi Jinping’s government to build up China’s chipmaking capabilities. “They are really concerned about this chip embargo,” says a professor at the University of California at San Diego. “Their long-run response is that they will nurture their own chip industry.” Of course, it’s possible that US policies could backfire by giving China a useful political foil while only delaying the inevitable when it comes to the technology itself. “They can make life difficult for three or four years,” says one venture investor in China. “But it’s penny-wise and pound-foolish. They will lose the market in China.” In the end, the struggle between the US and China over advanced technologies is an endurance game. The US will have to keep its own fractious political class pulling in the same direction while also persuading Japan, the Netherlands, and other key allies to continue to go along with its plans. Geopolitics could be tricky going forward. China, meanwhile, has generally demonstrated an ability to stick to a long-term plan even when it entails periods of discomfort.

Volatility should be expected to remain high as investors will be closely watching the Federal Reserve for hints on upcoming monetary policy direction. Many investors have redoubled their efforts to ensure that their portfolios are sufficiently diversified in the hopes that they will be able to withstand corrections in multiple market sectors. Many of these investors have included physical precious metals as part of their diversification plans, given their long history as a hedge against both inflation and during times of economic turmoil. Remember, the key to profitability through the ownership of physical precious metals is to own the physical product and hold it for the long term. Always remember that you should never overextend your ability to maintain ownership of your precious metals over the long run.

Trading Department – Precious Metals International Ltd.

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