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General Market Commentary
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General Precious Metals
Sprott Precious Metals Watch, April 2017 - Trey Reik
At Sprott, our investment thesis for gold is significantly long-term in scope. We believe gold’s methodical advance since 2000 has had more to do with the growing disconnect between productive output (GDP) and ever-inflating claims on that output (debt and equity valuations), than with short-term fluctuations in variables such as CPI-type inflation or interest rates. Because we view gold as a highly productive, portfolio-diversifying asset until such time as these gaping imbalances are finally resolved (through default or debasement or both), we are generally loath to focus on short-term projections for gold markets. However, the current alignment of fundamental, technical and quantitative factors underpinning gold markets has become so asymmetrical to the upside, we have developed high confidence for an imminent and potentially significant rally in precious-metal valuations.
Post-election advances in market-sentiment measures are now clashing head-on with intransigent U.S. realities of excessive debt, dismal productivity, structural under-employment and chronic economic stratification. In short, the Trump-induced reflation trade is dying a quick death amid epic (mis)positioning. In this report we provide a short precis of our updated reasoning for an allocation to gold, followed by a visual tour of our “top-ten” list of technical and quantitative factors we see powering gold’s developing advance.
In our 2017 Investment Outlook, we made the case that excessive U.S. debt levels all but preclude significant Fed tightening. We suggested that, with total U.S. credit-market debt of $66 trillion atop U.S. GDP of only $18.8 trillion, any sustained increase in fed funds target rates would catalyze immediate upticks in a wide array of financial-stress measures, as well as surging default rates in sketchier components of the U.S. debt pyramid. To us, the greatest shortcoming of consensus economic analysis has been failure to recognize the cumulative and corrosive damage which eight years of ZIRP and QE have inflicted on the market dynamics of nearly every global industry. By artificially depressing interest rates for so long, global central banks have destroyed time preferences, inflated sales by borrowing from the future, and completely distorted legacy sales practices and consumer buying habits. The U.S. has evolved into a “zero-down, zero-percent” society, for everything from cars to leaf-blowers, to jewelry to big-screen TV’s. Manufacturing supply chains have expanded across the globe, enabled by the reduced cost-of-time in a ZIRP world. The day of reckoning for trillions-of-dollars-worth of uncompetitive U.S. businesses (and credits) has been postponed by the palliative of illusory (ZIRP) financial conditions. As the Fed attempts to migrate from the zero bound, these profound economic changes will not be reversed without significant pain and dislocation.
No industry has been more disfigured by the Fed’s easy-money policies than the U.S. automobile industry. During the past eight years, cheap Fed credit has engrained zero-percent financing gimmicks at the very heart of U.S. automobile consumption. Contemporary auto-financing terms have evolved towards borderline ridiculous (record average principal balances, ever-lengthening loan periods, rising prevalence of negative-equity trade-ins). Lured by skinny “cost of money” calculations, lease penetration-rates roughly doubled in the five years through 2016. Even used-car pricing has remained remarkably buoyant amid such ample cheap credit.
Many will view as coincidence that key metrics in the U.S. auto industry have suddenly frayed amid the Fed’s December/March (FOMC) two-step. March U.S. vehicle sales slumped to 16.53 million SAAR (versus 17.3 million estimate), despite a 15% year-over-year increase in new-car incentives, to a record $3,768 per car, or 10.4% of average suggested retail (JD Powers). The all-important NADA used-car price index fell 3.8% in February, its sharpest decline since November 2008. Lease volumes have quickly reversed, coincident with accelerating rates of lease turn-ins, exacerbating the used-car pricing picture. Morgan Stanley (3/31/17) estimates the confluence of reinforcing factors now afoot in auto markets could lead to a 50% collapse in used-car pricing during the next five years.
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