A lot of analysts are calling for this Friday’s (3rd September) Non Farm Payroll to shape the direction of the markets and specifically the dollar and gold and silver's trajectory for the remainder of 2021. While we perceive this event as important, we certainly see other factors as far more significant.
A big miss on the jobs front would mean the Fed would have to delay their tapering plans (delay from when I hear you say, as no date has been given). Fed Chair Jerome Powell made it clear previously that they wouldn’t make the same mistake that caused the last taper tantrum and would give sufficient notice before tapering begins.
At Jackson Hole there was neither a timeframe stated, nor the size of the tapering. Who knows what the market is pricing in. If the taper goes from $120bn a month to $115bn, then one would expect the dollar to plummet, and the metal to shine as the expectation would be for more to be cut. Conversely, halving it would have the opposite effect (as implausible as this scenario may be initially) but would almost certainly destroy the markets. What we expect to see is a timeline laid out by the Fed to give traders and investors more certainty.
Powell has also mentioned on several occasions the term “maximum employment” and how decisions cannot be made until we return to that. This is why we still maintain that if Powell is to be believed and his conditions to taper met, we are a long, long way from it actually starting. The worst thing the Fed can do is rein in too early and they know that. The opposite is not true, as there won’t be a “too late”—that ship sailed many years ago.
If we take the Fed and central bank’s other tool of interest rate control, then the statement from Powell couldn’t have been more bullish for the metals and negative for the dollar. Conditions have not been met for rate rises and there is no link to tapering. Perhaps Powell is a gold bug after all, I mean why else are they smashing the price down all the time?
So what else will reposition the direction of gold and silver? With all the macro guidelines at play, good old supply and demand seems to have been forgotten about, and for some time, although not by us here I hasten to add. Of course with the direction into the next few weeks such data release of Fed and NFP have always been market movers for the metals, but they move the paper markets, not physical.
Reports recently suggested that ETF and gold derivatives have dropped by 8.5% year-on-year. This is a bearish indicator for some analysts who argue that proves the demand is not there for gold. When one considers Basel III rules on unallocated paper gold and derivatives, and how these will come into effect in the UK by the start of Q1 2022, then this can only be seen as quite the contrary.
When we see the huge buying of physical gold by central banks across the globe, then this can only be seen as bullish. When we consider there hasn’t been a significant gold mine discovery in the last 30 years, we start to understand that gold’s supply is tightening. Once we remove the so called 100/1 supply of paper vs physical (and this process is well underway, by the way) then we shall see just how tight the supply really is. Yes we are still not far off three figures of claims for every one oz of gold traded. What a farce.
If we look at silver (which is nearer 300/1 on the paper vs physical travesty), and its current futures price hovering around $24/oz we have to consider whether the same factors are at play. Is this really fair value, when you cannot get anywhere near this price for physical?
Silver has always outperformed gold on a percentage basis when the bull is running at full pace. Gold tends to drag it along initially, then sends it a sling shot higher. We saw evidence of this last year during the huge rally in a short space of time. It is still our belief that late Q3 and into Q4 prices will be heading higher, and the main reason for this, is fundamentally nothing has changed, when other interlinking markets are expecting and have priced in the opposite.
The basis for the markets to continue pushing higher is all about liquidity. The big players are insanely leveraged—that is of no surprise to anyone. The markets need and love liquidity—especially if it arrives via money printers.
The continuation of this however, brings a very interesting scenario to the forefront. You see, Basel III regulation was designed to prevent a repeat of the credit crisis of 2008 when a major player in the market collapsed, never to be revived. The Net Stable Funding Ratio is designed to prevent the reckless lending, and end the days of big banks use of huge margin. Basel III hates leveraged liquidity.
To explain this further under the NSFR, you may only lend against what you have on your balance sheet, specifically backed against Tier 1 Assets (paper money, treasuries and now physical gold amongst a few others) and the NSFR clarifies this as “The amount of available stable funding relative to the amount of required stable funding,” i.e., for every £1 the bank has on the assets side of their balance sheet (in Tier 1) they may only lend £1.
What this change will do is seriously dry up liquidity within the markets, and this is something the Fed can ill afford to happen. Every time there has been a wobble, they have stepped in and injected cash. However, and this is a big however, something has to give. With the BIS being pushed into a more rigorously strict guidance on compliance by the likes of Russia and China, this could turn into a political and financial nightmare. Not only is the Fed trapped, but they may be unable to step in to prevent a crash. A Mexican stand off between the fed and the BIS. Where’s the popcorn?
We must be careful with the term “crash” however, as it is not to be used lightly and is also not a guarantee in today’s climate. While everyone realizes the stock markets are way overvalued, there is every possibility they trade sideways to down for the foreseeable and we enter into a prolonged bear market. It is also worth pointing out that there has only ever been one market crash that caused a bear market and that was in 1929 that kicked off the Great Depression.
So in summary, the fractional reserve banking system is broken, and liquidity will be a worry hence the printing of money across the globe by central banks. If we believe reports, then it would seem that certain banks have 10% of cash for every 90% they lend. The equivalent of you going into a bank and asking for a 90% mortgage. If every customer was to line up at the banks to get their money out—which is what we saw in 2008—then there would be a lot of angry customers.
The world we live in has been built on debt and it’s out of control. Again, this is what Basel III—and specifically the NSFR—was designed to stop. It’s enforcement is both paramount and indispensable. And yes, there is a Basel IV which lays out even more stringent rules for the banks, but more on that in upcoming articles.
So where does all this leave gold and silver? The answer hasn’t changed, and in our view won’t for years to come. I have said on many an occasion that you should follow what the big money is doing, and that big money has been buying physical gold. The latest COT report shows net longs increased by nearly 30%, with net shorts shrinking. Voila.