- US dollar is the world’s reserve currency and Federal Reserve is the central bank of central banks.
- US dollar’s dominating position implies that the Fed’s monetary policy decisions have direct and immediate consequences for the rest of the world.
- Appreciating US dollar against other currencies has a weakening effect on US economy and a limiting impact on monetary policy capabilities of the central bank.
Expectations of a ‘normalized’ rate-hiking cycle in US are premature and any increases in the base rate will remain gradual and subject to a sharp reversal.
- Global money supply will keep expanding.
- Commodity markets are at their multi-year bottoms and offer unique diversification opportunities.
- Gold and silver are essentially currencies with limited additional supply.
Key developments (01/2018-03/2018)
Spark in stock market volatility
US yield curve continues to flatten
Oil price continues to rally, furthering inflation growth expectations
With tax cut effects already priced in the first quarter of 2018 saw no major catalysts to drive equities significantly higher at the start of the year. As stretched equity valuations and compressed credit spreads are set to adapt to the end of central banks’ easy money regime, a stock market correction was long overdue. Fundamentals continue to favor increased volatility ahead and the first quarter’s coordinated promotion of goldilocks and synchronized global growth mantra only emphasizes the absence of noteworthy catalysts for the months ahead. Whether financial deregulation will prove to be a game changer or not remains a question.
In the meantime, rising debt service costs alongside historical maximums in US corporate and consumer indebtedness are accompanied by a significant decline in bank lending. Driven to a large extent by the flattening yield curve and tightening lending standards, diminishing access to easy money is about to put the US economy to a test. Disconnected from the reality of repaying their debt with operating cash flows, companies all over the world are about to face the consequences of unproductive borrowing (including buybacks and debt refinancing) as the world’s central banks begin their coordinated hiking process. Following another widely expected 0.25% rate hike in March by the Fed, the yield curve continued to flatten.
Despite rising towards the 200-day moving average and reaching its 3-month high of 78.84 basis points in mid-February, the spread spent the rest of the quarter in a downtrend and closed at 46.879 basis points – a 5 basis point decrease from the last publication. Should this dynamic continue at current pace (our base scenario), we are set to reach the point of inversion somewhere in the second half of 2018, a development that would significantly increase the probability of an economic recession in 2019. With a widening fiscal deficit, intensifying trade tensions and rising borrowing costs, the US economy has no option other than to accelerate its debt issuance going forward, resuming current dollar depreciation.
The market seems to have figured this one out by now and is pricing the US dollar lower against other fiat currencies as well as many key commodities, including oil. By the end of March, WTI crude prices closed at $64.94, failing to break the resistance in January’s high of 66.66. Obviously, the declining dollar story is not the only thing pushing this market higher, however, should the ongoing oil and base metals uptrend transmit into the rest of the commodity complex, we could see oil much higher than what the consensus is predicting right now. Should oil rally significantly, inflation is likely to follow suit, forcing the Fed to take an even more hawkish stance for 2018 and beyond.
There has been little change in the precious metals’ technical outlook in the first quarter of 2018. The key levels stay mostly the same, price dynamics remain similar and the medium-term targets are the same as before. We remain committed to our conclusion that we could be on the verge of major technical break-outs in the precious metals complex. Should gold trade significantly above $1350, platinum above $1030 and silver above $17,50, this would indicate major technical level breaks for all three major PMs.
Throughout the first quarter, silver’s downside price action was predominantly limited to support around the levels of 16.20-16.50, while the key support levels of 15.5-16.5 remain critical. We have previously highlighted the importance of these levels on numerous occasions and they remain critical for further upside. While the metal has spent most of the quarter fighting its way through the 200-day moving average, a strong break through $17,5 and a monthly close above would significantly increase the probability of our $21-23 medium-term bullish target. A sustained break below $15,5 would force a revision of our medium-term bullish bias.
No significant change in gold technicals either: the pair remains in a constructive uptrend with $1180-1200 support zone being key. $1400 is the first upside target, closely followed by a technical projection at $1475.
As expected, platinum continued its consolidation in the $900-$1020 region. Given continuing changes in industrial usage, we suspect that platinum could continue under-performing its counterparts in the complex unless the metal regains its popularity on the Chinese jewelry market. On a cautionary note, a monthly close above $1030 could see a range break-out, possibly leading to a quick rally to as high as $1170.
|Silver||$16.50||$15.50||$17.5||$18.20||$21 - $23|
Base case scenario
|There has been no change in the long-term bull trend in precious metals against the US dollar - a stable tendency since early 2000s. Fundamental base for further price gains remains unchallenged while current price levels are attractive for long-term bullish positioning.||Our base case scenario for the coming quarter is as follows: gold to trade at $1400, silver at $18,5-19,5, while platinum is likely to stay range-bound in a broad $850-1050 zone.|
Disclaimer: the Author of this research is Paul Melamed, Member of the Board of AS "Aquarium Investments" IPS (legal address Baznicas Street 20/22-30, Riga, Latvia, investment manager’s license 06.03.07.252/358, supervising authority Financial and Capital Market Commission, Latvia (official website: www.fktk.lv), further called Company). The Author of this research follows recommendations provided in personal transactions and the Company follows recommendations provided in private portfolio management and fund management.
Analysis of historical price changes allows for provision of a reasonable judgment about future price changes of a given security, however, suggested market scenarios may not come true. The Author of research and the Company are not liable for any direct or indirect damages (including lost profits), as well as any penalties related to forecasts. Any decision you may take should be fully based on the assessment of personal financial circumstances and investment objectives. The Company also draws your attention to the fact that market securities and financial instrument transactions involve risk and require appropriate knowledge and expertise.
The information presented hereby was obtained from sources that are considered to be trustworthy, issuers are being examined according to their most recent available financial data but accuracy and completeness of such information provided are not guaranteed.