FINANCIAL STORMS AHEAD / MACLEOD FINANCE

Financial storms ahead

Financial instability is about to get much worse making the short-term outlook for gold and silver uncertain, but long-term being reaffirmed. It is a buying opportunity for the brave.

Alasdair Macleod

Following Trump’s presidential statement last night, it is clear that the US is holding back from retaking Hormuz. 

This means that oil, LNG, and more importantly restrictions of downstream products and their knock-on price effects will worsen for an indefinite time. 

In the short-term, prospects for gold and silver markets are clouded by the consequences for global bond yields and market participants’ reactions.

This week’s market action

Until this morning, gold and silver were enjoying a reasonable rally while the broader markets appeared to be under the impression that in the war against Iran America’s proposals to end it would get some traction. 

But markets appeared to be ignoring Iran’s denials that any talks were taking place.

Consequently, President Trump’s address to the nation last night was a disappointment for markets still adjusting to the inflationary implications of a likely prolonged closure of the Hormuz Straits, and Houthi statements that the Bab el-Mandeb straits at the entrance to the Red Sea and therefore Suez would be closed as well.

In early European trading this morning, most of this week’s rally in gold and silver were wiped out. 

Gold was at $4620, up a net $130 from last Friday’s close and silver at $71.20 was up $1.45. 

Trade on Comex was subdued ahead of the Good Friday holiday in Western Europe.

Understanding the outlook

It is clear that investors and dealers in Western capital markets are struggling to grasp the implications of the Iran war for precious metals. 

It is the classic clash between Keynesian theory and the classical economics which preceded it. 

The Keynesians focus on the inflationary consequences of higher energy prices and the likely consequences for interest rates and bond yields, concluding that higher yielding currencies disadvantage holders of non-yielding physical metal. 

Classicists are more aware of the consequences for the purchasing powers of fiat currencies, which are ignored in the Keynesian and macroeconomic canons.

The two approaches define the chasm between G7 economies and the Asian powerhouses and their peoples. 

Western markets suppressing derivative prices end up moving physical metal to China, India and elsewhere. 

Increasingly, this is the chart which the Asians understand, and Westerners ignore:

Over the last 26 years, the dollar has lost 93.7 cents on the dollar of its purchasing power measured in real money which is gold in everyone’s common law. 

The trend has accelerated, particularly since covid in 2020. 

The implications of Hormuz and Bab el-Mandeb being closed are that consumer prices will begin rising significantly in the not-too-distant future, which more correctly expressed is that the purchasing powers of all G7 currencies will decline at an accelerating rate.

While Western capital markets dealing in intangible paper have yet to fully appreciate the consequences, Asian holders are selling currencies for physical gold and silver. 

Consequently, despite roughly halving, silver remains in backwardation and gold is in short supply in China, where banks are rationing investment bars.

The belief that higher interest rates and bond yields will disadvantage non-yielding assets such as physical metal ignores the attack on currencies’ credibility. 

The bullion banks will be waking up to this, with the death of the petrodollar accelerated by Iran reportedly permitting only oil paid for in China’s renminbi to pass through Hormuz.

The Gulf states’ dollar savings are likely to be sold down for obvious reasons, and global trade’s reserves of dollars are undoubtedly too high for a non-petrodollar outlook. 

At a time when G7 debt is rapidly rising, bond yields are heading higher exacerbated by lack of foreign buyers turning sellers.

Economic impacts of the Gulf closure are unquestionably negative, and debt traps are being sprung on government finances. 

The FRED chart below shows how bad it is for US government finances and it’s about to get much worse:

As a line item in government accounts, interest payments are becoming the largest. 

Long-term yield trends for the dollar’s 10-year treasury note should ring alarm bells for all forms of dollar credit:

The post-covid rupture of a 40-year downtrend in T-bond yields should not be taken lightly. 

US Treasury debt outstanding soared due to covid lockdowns, with US CPI inflation peaking at 7.3% in mid-2022. 

The cost of government price subsidies and of support for the economy could dwarf the debt consequences of Covid. 

The Hormuz crisis may have an even greater inflationary impact than covid, in which case the yield on the 10-year note will go significantly higher than 5%. 

Four of the G7s already have their 10-year bond yields hitting new post-covid highs.

Gold and silver impact

Returning to markets for gold and silver, bullion banks and market makers in derivatives will be desperate to close down their positions as much as possible. 

So far, in this they have succeeded reasonably with silver’s open interest on Comex being the lowest for over 20 years, and gold’s for 12 years.

In conclusion, higher bond yields, which is an imminent danger will undermine all forms of credit in western markets. 

In the short-term, this is bound to create uncertainty for gold and silver prices, largely due to market confusion. 

But for buyers of physical gold and silver who have the nerve to add to their positions, it presents an opportunity unlikely to be repeated.