As 2020 draws to a close this is perhaps the last busy week for the year. From next week on, liquidity will dry up as everyone huddles around the Christmas tree ready to see this year in the rear-view mirror.
Hedge funds and investors tend to unwind portfolios and positions into December as fundamentals rarely make sense and no one is really interested in trading big positions. We saw what unwinds can do to markets in November as all consensus long positions of the year (technology) got sold off hard and the popular shorts (energy, financials) were bought back. Books were squared and 2021 bets were placed on such things as Covid-19 recovery baskets full of cyclicals and cheap value names.
Amid this portfolio unwind precious metals also were unsuspecting victims as their popularity decreased once a vaccine was on the horizon. Gold is down 10% from $2,060 to $1,860 today and silver is down 14% from $29 down to $25 today, but it fell as low as $22.
It is entirely short-sighted to think precious metals are dependent on the Covid vaccine recovery trade. These two trades are mutually exclusive. The vaccine does lead to global economic recovery hopes and higher yields as seen in the U.S. 10-year yield now trading at 0.93%, up from 0.5%. But this jump in yield is not the entire picture as it is the real yields that matter more. Given inflation has been nudging higher, real yields have not moved that much. They are flat to down small, which tends to be supportive for gold and silver.
Moreover, everyone is so engrossed in chasing the oil sector and commodity cyclicals that they seem to be underweight the precious metals that are deemed as boring. The problem with that rationale is that if one ignores each commodity's specific fundamentals and focuses too much on the macro picture, one may miss out.
China has been one of the strongest influences on base metal prices this year. Ever since the pandemic hit its first quarter China has been aggressively ramping up infrastructure spending, which has led to much higher copper, iron ore, steel and other base metal prices.
The price of oil has been in a perennial decline due to oversupply for the past few years. It is normalizing a bit, but there is still a long way to go. Seasonally speaking, precious metals rally in December. There is typical seasonal jewelry demand that sparks gold interest. Prices for physical silver are trading at around a 30% premium. The paper market is distorted but eventually plays catch-up, which it has been slowly over the last few days. More importantly, sentiment is at extreme lows.
Central banks the world over have been pumping more and more money into the system, in different ways, and they are far from done. Just recently the European Central Bank (ECB) announced another 500 billion euro extension of asset purchase. The Federal Reserve increased its balance sheets by $4 trillion this year, and there is more still to be done as it currently buys $120 billion per month of Treasuries.
Even with a vaccine, asset prices may rally, but the real economy is in dire need of more fiscal support. Just because inflation has not occurred in the past does not mean it won't this time, especially in light of the sheer magnitude of global central back liquidity. This has and is going to be one of the biggest fundamental drivers for gold and silver.
The Federal Reserve will announce the outcome of its December Federal Open Market Committee (FOMC) meeting here on Wednesday afternoon. Rates cannot go any lower, but there could be hints of further asset purchases or of longer-term duration. The Fed is far from done. The longer it takes to gain fiscal support from Congress, the longer the Fed will provide support to the market.
The dollar is already trading at $90 on the U.S. Dollar Index (DXY) and has firmly broken the summer range of $92.50 to $94.50. Traders are focusing on cryptocurrencies, salivating at the prospect of making 100%-plus while ignoring the potential opportunities for gains of 40% if not more in silver. We must be careful in switching our screens off too early as the sleeping giants can make their moves as the world hibernates. Nothing is more infuriating than seeing an asset class break higher when everyone has sold out and given up on it.