The Precious Metals Week in Review – February 3rd, 2023

1. Investors flocking to the equity rally will be disappointed as they’re in direct defiance of the Federal Reserve, according to Morgan Stanley strategists. “Better price action in stocks has started to convince many investors they are missing something — compelling them to participate more actively,” Michael Wilson wrote in a note. “We think the recent price action is more a reflection of the seasonal January effect and short covering after a tough end to December and a brutal year.” Earnings are worse than expected, especially on the margins front. “Secondly, investors seem to have forgotten the cardinal rule of ‘Don’t Fight the Fed.” Officials at the US central bank are poised to raise their benchmark federal funds rate by a quarter percentage point on Wednesday, dialing back the size of the increase for a second-straight meeting. Yet, a Fed that’s unwilling to pivot to a more dovish stance “coupled with the reality of the worst earnings recession since 2008 is being mispriced once again, in our view,” Wilson said. “We think this should lead to the final leg of this bear market in short order.” Strategists at JPMorgan Chase also said investors should sell the rally even if markets keep moving higher. Fundamental confirmation for the next leg higher might not come, and weaker earnings, as well as activity, could weigh on equities.

2. Physical investment in gold from retail investors and central banks was the dominant theme for 2022 as the market saw the most significant growth in roughly 10 years, according to the latest report from the World Gold Council. On Tuesday, the WGC published its fourth quarter and full-year Gold Demand Trends report, which highlighted ‘vigorous’ bullion purchases from retail consumers and unprecedented purchases from central banks. In total, annual global gold demand jumped 18% last year to 4,741 tons, “almost on a par with 2011, a time of exceptional investment demand,” the report said. The full-year gains were helped partly by record demand in the fourth quarter of 1,337 tons. Retail investors did most of the heavy lifting as the global bar and coin demand rose to a nine-year high of 1,217 tons, up 2% from 2021. The report said that total investment demand rose 10% to 1,107 tons last year. The report said that bar and coin demand in the second half of the year was particularly strong, achieving two successive quarters of demand in the region of 340 tons for the first time since 2013. “The need for wealth protection in the global inflationary environment remained a primary motive for gold investment purchases,” the report said. Gold’s stable performance in 2022, despite strong headwinds from rising rates and a strong dollar for most of the year, has reignited investor interest. Continued weakness in the US dollar, growing recession risks, a continued high bond-equity correlation, and elevated geopolitical risk form the backbone of a positive tactical case for gold in 2023. There are still a lot of opportunities for investors to use gold as a hedge and diversification tool.

3. Chancellor Olaf Scholz is using a trip to Latin America to help Germany secure additional supplies of the lithium that car giants like Mercedes-Benz Group and Volkswagen need for their electric-vehicle batteries. Chile is the world’s second-largest supplier of lithium after Australia and much of its output is currently gobbled up by China. Scholz, who met with Chilean President Gabriel Boric on Sunday, wants a larger share of Europe’s biggest economy, according to people familiar with the plans. Part of Germany’s strategy to get Chile on board is to have more of the production process based locally and to help make extraction and processing less damaging to the environment. “There are states that think that all raw materials come from China, but this is not true. Many raw materials in fact come for example from Argentina or Chile, get shipped to China, are processed there, and then sold again,” Scholz said. In Buenos Aires, Germany and Argentina signed a memorandum of understanding on Saturday that is intended to secure Berlin’s access to the country’s rich Lithium resources.

4. The memory-chip sector, famous for its boom-and-bust cycles, had changed its ways. A combination of more disciplined management and new markets for its products, including 5G technology and cloud services, would ensure that companies delivered more predictable earnings. And yet, less than a year after memory companies made such pronouncements, the $160 billion industry is suffering one of its worst routs ever. There’s a glut of chips sitting in warehouses, customers are cutting orders, and product prices have plunged. It’s been a swift descent from the industry’s pandemic sales surge, which was fueled by shoppers outfitting home offices and snapping up computers, tablets, and smartphones. Now consumers and businesses are holding off on big purchases as they cope with inflation and rising interest rates. Makers of those devices, the main buyers of memory chips, are suddenly stuck with stockpiles of components and have no need for more. Already, Samsung and its rivals are losing money on every chip they produce. Their collective operating losses are projected to hit a record $5 billion this year. Inventories, a critical indicator of demand for memory chips, have more than tripled to record levels, reaching three to four months’ worth of supply. “Chip equipment companies’ sales are plunging by around 30% to 50%. This is not a normal situation,” said Greg Roh, head of technology research at HMC Investment & Securities.

5. This Week in Crypto: Binance mishandles collateral and more crypto layoffs. The company admits to mistakenly co-mingling collateral. As was reported this week, Binance acknowledged that it had been mistakenly mixing the collateral it holds for some of its tokens in the same digital wallet as other types of funds. Reserves for almost half of the 94 coins that were issued, known as “B-Tokens,” are currently stored in a single wallet called “Binance 8” which also holds customer assets. The wallet contains significantly more tokens in reserve than would be required for the number of B-Tokens that was issued, indicating that collateral is being mixed with customers’ coins rather than being stored separately. “Binance 8 is an exchange cold wallet. Collateral assets have previously been moved into this wallet in error and referenced accordingly on the B-Token Proof of Collateral page,” a spokesperson said. “Binance is aware of this mistake and is in the process of transferring these assets to dedicated collateral wallets.” Digital assets are often only compatible with the blockchain they were built on, meaning developers have had to figure out ways that allow them to use tokens like Bitcoin elsewhere. Those B-Tokens are supposed to be backed one-to-one by locked reserves of the coins they’re based on, and reserves should be stored in dedicated wallets to keep them separate from customers and exchange funds. Crypto firms’ management of reserves, while a seemingly arcane process, has blossomed into a hot-button issue for the industry following the collapse of rival platform FTX in November. The FTX scandal has prompted a crisis of confidence in exchanges, with customers withdrawing their assets. In response, exchanges have moved to highlight holdings in so-called proof-of-reserve reports, some with added visibility supplied by blockchain data. This kind of operational issue is a challenge for these exchanges, especially now, at a point when both regulators and customers are paying super close attention to how this industry is managing its transparency. Meanwhile, layoffs continue across the crypto industry, with numerous companies shedding workers. Coinbase Global Inc., Blockchain.com, Genesis, and Crypto.com are among the companies embarking on a new round of layoffs. The four firms, along with exchange Huobi, crypto bank Silvergate Capital and Ethereum software firm ConsenSys, collectively are shedding thousands of jobs in the first two weeks of 2023, with a tally of more than 1,600 lost even before Crypto.com. The belt-tightening has also been impacting the tech and finance industries.

6. In the week ending January 28, the advance figure for seasonally adjusted initial claims was 183,000, a decrease of 3,000 from the previous week’s unrevised level of 186,000. The 4-week moving average was 191,750, a decrease of 5,750 from the previous week’s unrevised average of 197,500.

7. U.S. West Texas Intermediate crude oil futures dipped on Thursday, putting the March futures contract in a position to finish lower for the week. Weaker-than-expected economic data and a rebound in the U.S. Dollar are being blamed for the weakness. The market has been under pressure all week with the selling starting late last week in Jan. 27 when indications of strong Russian oil supply offset better-than-expected U.S. economic data, middle solid distillate refining margins, and hopes of a rapid recovery in Chinese. Contributing to the weakness this week has been another surge in US stockpiles, an interest rate hike by the Federal Reserve, worries about a global recession, and China’s recovery. As of Friday, Brent crude was $82.64 with WTI trading at $76.47.

8. EUR/USD came briefly above 1.10 this week before falling to just below 1.09 today. Economists note that the rate differentials continue to point toward a higher EUR/USD ahead. In the short-term, we see EUR/USD moving about sideways as markets reprice expectations on both the Fed and the ECB, however, it is clear the rate differentials continue to point toward a higher EUR/USD ahead.

9. The USD/JPY pair catches some bids during the early North American session and spiked to a fresh daily top around the 129.80 regions in reaction to the mostly upbeat US employment report details. The US economy added 517K new jobs in January and the jobless rate dropped to 3.4%. The underlying strength in the US labor market should allow the Fed to stick to its hawkish stance. This, in turn, provides a solid boost to the US Dollar and is seen as a key factor behind the USD/JPY pair’s sharp rally.

There was a time not too long ago when traders were betting that the Federal Reserve could start cutting interest rates at its meeting on Wednesday. This was back in the summer when one of those periodic bouts of euphoria was sweeping across markets because the academics had determined inflation would quickly subside and pave the way for the central bank to shift its focus to shoring up growth. There will be no cut, of course. The blockbuster January jobs report is likely to strengthen the Federal Reserve’s determination to raise interest rates above 5% and keep them high throughout the year — an outcome investors still are skeptical of. “Such a strong employment report probably means at least two rate hikes of 25 basis points, and I wouldn’t dismiss the possibility of a 50 basis-point hike returning on some Fed officials’ radar screen for the next meeting,” said Thomas Costerg, a senior US economist. For some market observers, there’s a sense they’re watching the same movie playing on a never-ending loop: Investors breathlessly push up asset prices in anticipation of a pivot in Fed policy, only to get crushed when Powell and his lieutenants remind them that it’s too soon to proclaim that inflation has been vanquished. “I’ve spent enough time around Wall Street to know that they are culturally, institutionally, optimistic,” Neel Kashkari, president of the Minneapolis Fed and a former investment banker said recently. He had a warning for investors too: If they doubt the central bank’s resolve to properly finish the job on inflation, even at the cost of putting millions of Americans out of work, they are mistaken. “They are going to lose the game of chicken; I can tell you that.”

The Fed is grappling with a market that doesn’t believe them, and so I think you have to think of the Fed as performative. In other words, expect more tough inflation-fighting rhetoric from Powell and the other members of the rate-setting committee. Both the Fed and Wall Street were blindsided by the inflation spike despite all the warning signs that the stimulus-fueled economy was giving off in the early days of the pandemic. As prices started to jump in 2021, Powell infamously kept insisting this was merely a “transitory” blip that would likely fade on its own as pandemic-induced supply chain kinks sorted themselves out. In the early summer of that year, they were betting the central bank would only nudge its benchmark rate a tick higher in all of 2022, bringing it to around 0.4%. Then, as Powell and company realized they were wrong and started frantically pushing rates higher, investors consistently underestimated the Fed’s willingness to inflict pain on the economy and markets. This revealed a fundamental flaw in the collective Wall Street mindset: Ever since the late 1980s, traders had been taught that the Fed was always there to prop up financial markets when things got really dicey. It would scrap plans to hike rates or maybe even start cutting them. “The Fed put,” they called it, and it was a fine (and highly profitable) principle to trade on during all those decades when inflation was tame. When that era suddenly and unexpectedly ended, so too should have blind faith in the Fed put.

Volatility should be expected to remain high as investors will be closely watching 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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