Gold Rally Strengthens on Rate Cut, Silver Follows

Events were positive for gold and silver bullion in July, culminating in the Federal Reserve’s interest rate cut of 0.25% at its July 31 FOMC (Federal Open Market Committee) meeting, its first cut in 11 years.  Any hope that this would be a “one and done” type rate hike has quickly been dashed with the latest trade war salvo. The long-term picture remains firmly intact. Gold continues its rise as the market adjusts to this new central bank easing cycle. As of yesterday’s close, Monday, August 5, gold stood at $1,467, gaining 14.14% YTD.

Month of July 2019

Indicator 7/31/19 6/30/19 Change % Chg Analysis
Gold Bullion $1,414 $1,410 $3.54 0.3% Consolidating in a bullish flag; heading higher.
Silver Bullion  $16.26  $15.31  $0.95  6.2%  Broke out of three-year trend; target ~ $20.
Gold Equities (SGDM)1 $23.05 $21.13 $1.92 9.09% Outperforming GDX in 2019.
DXY US Dollar Index2 98.52 96.18 2.33 2.4% Expecting range-bound trading activity.
U.S. Treasury 10 YR Yield 2.01% 2.01% 0.01% 0.5% Heading lower; target 1.60%.
German Bund 10 YR Yield (0.44)% (0.33)% (0.11)% (33.3)% Secular decline; target -1.00%.
CFTC Gold Non-Comm Net Position3and ETFs (Millions of Oz) 103.6 101.9 1.67 1.6% Persistent accumulation; ETF holdings at all-time high.

 

The ECB has already announced its intention to lower rates and signaled another new quantitative easing (QE) program as early as September. Thus far, the main economic weakness has been centered on manufacturing and trade which impacts Europe and China more so than the United States. European manufacturing activity has slowed to its lowest level in 11 years. China, at the epicenter of the trade war, saw its purchasing managers index (PMI)4 fall below 50 in July (PMI readings above 50 indicate expansion, while those below 50 signal contraction). China’s PMI has contracted for three straight months, despite the ambitious fiscal and monetary stimulus programs that have been in place since mid-2018.  Most global economic indications continue to point to even more weakness in 2019’s second half.

Reason to Own Gold? Negative Yielding Bonds

Since the 2008 credit crisis, German Bund 10-year yields have been in a secular downtrend and did not experience a cyclical rally like U.S. Treasury 10-year yields. Eurozone 5y/5y inflation swaps (a great measure of growth expectations) also confirm the persistent downtrend in growth expectations. With the ECB (European Central Bank) about to lower rates and preparing for another QE program, German Bund 10-year yields look poised to move even lower. While the Eurozone accounts for the bulk of negative-yielding bonds, we expect the total amount of negative-yielding bonds globally to surge over the next few years. This is one of the primary reasons to own gold. If we use a target of -1.00% on German Bund 10-year yields and run a simple multiple regression analysis with other related variables, we get an R-square of 80% (great fit) and a forecast of $19.4 trillion of negative-yielding bonds (the current level is $13.6 trillion).

Figure 1. German Bund 10-Year Yields in a Secular Decline

German Bund 10-year yields have been falling since the 2008 credit crisis, and we expect a break to approximately -1.00%, with scope for even lower levels.

fig 1

Source: Bloomberg as of August 1, 2019.

Figure 2. Nearly $20 Trillion in Negative Yielding Debt

If German Bund 10-year yields decline to -1.00%, our multiple regression model indicates that approximately $19.5 trillion of negative-yielding debt will be reached.

Fig 2

Source: Bloomberg as of August 1, 2019.

Figure 3. U.S. Treasury 10-Year Yields are Heading Lower

Similar to the prior rate cycle, yields are breaking below a cyclical recovery channel as the fed funds rate is lowered. We expect a target of 1.60% before a bounce. Longer-term yields remain firmly in a secular downtrend.

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Name Last Change
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Resource Commodities

Name Last Change
Gold 1506.60 0.05%
Silver 17.13 0.18%
Copper 2.58 2.584
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Oil 56.34 0.23%
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