May 14, 2020
First a quick update on the Physical Metal situation. The good news is that there is still product available to buy, there is more inventory coming back online, and premiums over the paper price are falling. The bad news is that the improvement in supply levels is largely confined to the coins; cheaper bars >10 oz. remain relatively non-existent. Premiums also remain high, especially in Silver. Then there is the question of geography. The lowest prices are in the United States, the highest in Europe. Below is the change in the minimum premiums for coins and bars compared to a week ago:
Switching to the bigger picture, Fed Chairman Powell said yesterday that "negative rates is not something we are looking at." He added: "there are fans of negative rates, evidence of effectiveness of negative rates very mixed.” The immediate reaction of the markets was a dip in stocks and precious metals and a rise in bond yields. However, this was short-lived and we’re seeing a reversal since. The market is fully aware that when push comes to shove, Powell will capitulate on negative rates. Furthermore, even if we don’t see negative short-term rates, we could see negative bond yields.
Why does this matter? Because precious metals and miners are inversely correlated to real yields, i.e., nominal bond yields less inflation. If bond yields fall and inflation remains the same, real yields fall also and typically Gold and Silver rise. Even if inflation falls, too, but at a slower pace than bond yields, real yields fall. If inflation rises as bond yields fall, such as in a stagflationary scenario, then real yields would plummet. This is another reason why stagflation is an ideal environment for Gold, Silver, and the miners, just as it was in the 1970s.
10-Year real yield courtesy of Quandl.com:
Meanwhile, the 10Y real yield is at -45 basis points, its lowest point since 2012/13. There is the risk of a spike higher if stocks rebound and set new all-time-highs and money flows out of bonds into stocks, pushing yields higher. However, given that the Fed has repeatedly stated since the October 2019 FOMC that “Yield Curve Control (YCC)”—or simply put, capping yields—is in their tool box, any spike in yields will have a ceiling. Unless inflation falls, this means that there is a floor in precious metals and miners’ prices as real yields peak and fall. Said a different way, there is an asymmetric risk to the upside in Gold, Silver, and the Miners if the Fed caps bond yields.
As for the debate about whether we are experiencing deflation or inflation, the answer is far more nuanced. We are seeing deflation in everything that people don’t need, i.e., consumer discretionary products and services, like cars, household appliances, jewelry, etc. On the contrary, inflation in necessities like food is soaring. The latest CPI figure clearly illustrated that. While the headline and core numbers were deeply negative, signaling deflation, the worst nightmare for the Fed—food inflation— grew 2.6% in April, the highest rate in thirty years. This is when unemployment is soaring. Why? Because people need food to live regardless of their situation, and given the current lockdown of the economy, they’re hoarding it for fear of what happens next. Simply, inflation in what everyone needs is soaring, whereas we’re seeing deflation in everything we don’t need. Which is more important to people? It’s obvious. Whereas the Fed pays little heed to this, focusing instead on the drop in prices to further justify their massive and increasing money-printing operation.
At the same time, there is the growing risk of further escalation between the U.S. and China on the trade front due to the COVID-19 outbreak. Supply shocks that have been limited to certain sectors like meat are likely to become more widespread. Again, if supply falls faster than demand, especially as the Fed is printing money on steroids and spreading it left, right, and center, then inflation is a foregone conclusion. Couple that with a cap on bond yields and watch real yields plummet. The ideal scenario for Gold and Silver.
Whether we get negative rates or not, real yields are already deeply negative, and absent a short-term spike in yields, they are likely to go even lower—much lower—to new record levels. When that happens, there won’t be any physical Gold and Silver available anywhere and the miners will be heading to Mars to mine for more metals. It will certainly be economical to do so.