Renewed risks driving a new regime: outlook for base & precious metals Nicky Shiels, Metals Strategist September 2019
Contents Macro-Economic Backdrop Pages 3-6 2019 and the macro backdrop: a tale of two halves Pg. 4 Summer 2019: What happened – hot & cold wars emerged Pg. 5 Trade & the Fed: Copper and Gold are financialized proxies Pg. 6 Precious Metals Outlook Pages 7-16 Gold technicals – respected Pg. 8 Short-term outlook: Fed rate regime shift, trade & geopolitics Pg. 9 Medium term outlook: Bond bubbles, deficits, negative rates & asset dislocations Pg. 10-12 Known Gold flows: Investors vs Central Banks & physical Pg. 13 Short & Long-term Gold Outlook: factors for an upside repricing Pg. 14 Silver Outlook: fundamentally oversupplied, but some upside potential Pg. 15-16 Copper Outlook Pages 17-27 The short-term outlook & drivers: macros usually trumps micro Pg. 18-20 Short-term fundamentals: frustration to supply-side dynamics Pg. 21-22 Longerterm fundamentals: Supply outlook and project pipeline Pg. 23-24 Contending with cycles Pg. 25 Short-term Price Outlook: macro destabilized copper, it will take macro to reprice Pg. 26 Appendix Pages 27-33 Summary table: bullish vs bearish drivers for Gold & Silver Pg. 28 Summary table: short & long-term bullish vs bearish drivers for Copper Pg. 29 Full Global Copper Supply-Demand Table , 2009-2023 Pg. 30 Longer-term Copper Demand – “E - Copper” in a Green World Pg. 31 List of Macro Uncertainties Pg. 32 Commodities as an asset class: performance when needed Pg. 33 Scotiabanks Commodity Group: Product & Capabilities Offering Pg. 34 2
2019 and the macro backdrop
2019 and the Macro Backdrop: A tale of two halves • 1H 2019: Macro assets performances, then (2018) vs now (2019) YTD 2018 2019 Low volatility, complacent regime • +17% US Equities Precious Metals Sustained Fed pause after the January FOMC • DM Equities (ex-US) Energy Risk assets trend EM Gov Bonds ($ den) • US H.Y Corp Bonds US I.G Corp Bonds 4% Industrial Metals EM Equities US Gov Bonds Commodities DXY US 3m T-bills • Summer 2019 -- macro inflection point -22 -17 -12 -7 -2 3 8 13 18 23 28 % Source: Scotiabank Commodities Strategy, Bloomberg, ICE BofA ML Source: Scotiabank Commodities Strategy, Bloomberg, ICE BofA ML Trade, geopolitics & Fed change course marking several • turning points Outsized repricings in global bonds, commodities & • some equities (but not the US$) • 2H 2019: Higher volatility, anxious regime • Havens continue to trend • 4
Summer 2019: What happened - Hot & cold wars emerged Q2’19 & Q3’19 marked several major turning points in trade, geopolitics/politics & monetary policy : TRADE TENSIONS May 2019: last minute collapse of US/China trade deal; post-FOMC tariffs GEOPOLITICAL TENSIONS June 2019: Iran / North Korea / Middle Eastern tensions, HK protests, Saudi Oil attack CURRENCY WAR July/Aug 2019: yuan breach of 7-threshold marks a new front; threat of FX intervention MONETARY POLICY WAR Aug 2019: the ‘first responders’ to the Fed cut by more than expected; alternative monetary policy tool explored given limits 5
Trade & the Fed: Copper and Gold become financialized proxies • Key “haven/cyclical “commodity ratios spiked in the summer 2019 to reflect renewed macro fear and the potential impact of trade on growth • Gold/Copper ratio pricing in recessionary Fed cuts (of further ~200bps), which isn't occurring. Divergence is due to gold premium pricing in a Fed policy mistake together with threat of further trade/geopolitics, • Copper (and now Gold) being financialized to depict US/China trade war AND the global fight of nationalism vs globalism • However, the two superpowers still far apart on core structural issues with dissimilar time horizons Moral Hazard problem: The feedback loop between Fed policy and trade protectionism Trump’s Protectionism Weakened Weak Institutions Congress Damaged Fed Easing Growth Source: Scotia Economics 6
Precious metals outlook
Short-Term Precious Outlook – technically respected DESPITE a resiliently strong & compressed US$, Gold makes a statement breakout • Gold hits record highs in 73 currencies indicating a global macro regime shift • Gold’s price in the majors (AUD, CAD, JPY, GBP, EUR) at peak, indicating a DM currency war against fiat • Technical Gold break aligns with shift in Fed policy entering new bull market 8
Short-Term Precious Outlook: Fed rate regime shift & more… Gold is a rate cut hedge and more…. Gold is very dependent on the pace of Fed easing • cycle Pricing not only a hedge to a ~2 Fed cuts within 6 • months, but also incorporates the threat of core “fear” (trade, political and geopolitical) drivers re- emerging Given current real rates & US$, Golds “fear • premium” is ~$180. Peak “fear premium” was $700 (in 2011) 2009 - 2019 (current) Real US 10 Nominal DXY (Geo) political risk is still underpriced into 2020 • Yields* Yields -0.71 -0.45 -0.43 10year monthly Correlation with Gold $ 1,390 Gold with current real yields $ 1,208 Gold with current DXY 0.61 # 0.39 Weights Gold with DXY/10yr weighted (40% DXY, $ 1,317 60% real) Fear premium* $ 182 Current Gold price $ 1,499 *10yr US Treasuries - 10yr Breakevens Source: Scotiabank Commodities Strategy 9
Medium-Term Precious Outlook: Bond bubbles & negative rates Easy monetary policies and recession fears driving a bond bubble 70% of all developed market debt is trading with real negative yields with the remaining 30% close to or below 1% • The pool of negatively yielding debt is ~$14tn (down from $17tn), almost double that of above ground Gold stocks. • Gold becomes a yielding asset ‘relative’ to negative yielding bonds; alternative high quality, liquid assets are attractive as a • portfolio diversifier. Without sustained growth, low and falling global yields are expected; risk of negative yields spreading to the U.S. and other DM • countries Negative yielding global debt vs Gold 18 $1,550 $1,500 16 Amount of $1,450 negative 14 yielding $1,400 Global Debt, 12 $tn (LHS, $1,350 $ tn 10 $tn) $1,300 8 $1,250 6 Gold price $1,200 (RHS) 4 $1,150 2 $1,100 0 $1,050 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Source: Scotiabank Commodities Strategy, Bloomberg 10
Medium-Term Precious Outlook: Deficits & debt The world is more indebted today than before the GFC amid a government and corporate borrowing binge • Total debt in China already exceeds that of the U.S. and has more than quadrupled since 2007 • U.S. budget deficit projected to surpass the $1tn mark in 2019 (highest apart from the few post GFC years) - on a dangerous fiscal path by missing a valuable opportunity to start managing debt during a time of growth and high employment • Ray Dalio (July, 2019): “There will have to be some combination of large deficits that are monetized, currency depreciations, and large tax increases, and these circumstances will likely increase the conflicts between the capitalist haves and the socialist have- nots” 11
Medium-Term Precious Outlook: Overbought havens or equities? With late cycle getting long, a strong disconnect between havens and risk assets US Treasury yields (and the yield curve) pricing in an imminent recession • US equities pricing in easier monetary policy, relative US outperformance & reflation • Commodities remains relatively underpriced vs risk metrics: real assets are under owned vs paper (equities) assets • Without sustained growth, low and falling global yields are expected • US yields are (even now) still too high vs the ROW; spread differential explains US$ strength • 12
Known Gold Flows: who is behind the repricing, who is not? Western investors & CBs buying at strongest pace in years, while Asia is dehoarding Strong physical selling from Asian Gold hubs • New Central Banks – especially EM CBs - looking to “de -dollarize / re-commodidize ” • Investors turned net bullish in 2019 *; sentiment improving from underweight base • Without equity market volatility and an unwind of the bull run, the larger equity / generalist investor remains underweight • Gold (holdings only 0.60% of SPX market cap, vs peak of >1.6%) 13
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