Well, that was a fizzer. The Swiss gold referendum failed miserably. Which wasn’t surprising in itself, but around 80% of voters said no to the proposal to increase Switzerland’s gold reserves and protect the value of the Swiss Franc.
Gold sent a decent signal that that would be the outcome on Friday. It fell about US$20 an ounce ahead of the referendum.
But the referendum is a side issue. Gold’s fall was more in response to the huge oil price fall over the past few days. On Friday, the price of Brent crude fell another 3.5%. It’s now US$70.15.
Commodity prices generally trade in some sort of unison. Price ratios are held together by a vast web of derivatives induced correlations, and when the price of one commodity falls another will often follow.
Gold and oil have a strong relationship, as do gold and silver and the other precious metals. Silver and copper, both seen as measures of industrial demand, also trade in similar directions at times.
So oil wasn’t the only commodity hit (again) on Friday. Gold, silver and copper all fell heavily too.
From a bigger picture perspective, much of this commodity price rout has to do with speculative capital flows and movement back into the US dollar. As all commodities are priced in US dollars, a stronger dollar translates into a weaker commodity price.
Let’s have a look at how the US dollar is doing…
As you can see in the chart below, it’s been on a relentless upward move over the past few months. However, the new highs made during November weren’t as convincing as those made in October.
You can see that by looking at the waning momentum indicators at the top and bottom of the chart. Often (but not always!) this ‘non-confirmation’ suggests a correction is possible.
And looking at how far the US dollar index is above both the 50 and 200 day moving averages, a decent correction would not surprise at this point. That would be good for commodity prices.
But the trend in this US dollar bull market is a strong one. So any respite for commodities will be short lived.
This is all related to the unwinding of global speculative capital. For years, ultra-easy US monetary policy promoted the flow of capital out of dollars and into emerging markets and commodities. Because most emerging markets are commodity-producing nations, these trends were self-reinforcing.
This had an extra beneficial effect on Australia. China’s peg to the US dollar (which means China must print additional yuan to offset the inflow of dollars into the country) provided the fuel for its historic credit boom.
On Friday, the Financial Times reported that wasteful investments in China had amounted to an incredible $6.8 trillion.
‘“Ghost cities” lined with empty apartment blocks, abandoned highways and mothballed steel mills sprawl across China’s landscape – the outcome of government stimulus measures and hyperactive construction that have generated $6.8tn in wasted investment since 2009, according to a report by government researchers.’
Wow…that is a misallocation of resources on a grand scale. But it’s a misallocation that ‘benefited’ Australia while the process was in full swing — namely, through the production and importing of iron ore and coking coal at record prices.
But now that bubble has popped. The carnage really got underway when the Fed first suggested it was done with its policy of QE and would start winding it down. As a result, the iron ore price has halved in the past 12 months, and the companies at the smaller end of the industry are fighting for survival.
It won’t get any easier for them either with more low cost supply lining up to hit the market in the years ahead. The afr.com reports that Rio is set to go ahead with its US$20 billion Simandou project in Africa.
The project is still years away, but there’s low cost supply hitting the market as far as the eye can see. The juniors are dead in the water.
Meanwhile, the silent movement of capital goes on. It’s a ‘risk-off’ movement of capital too, masked by the relentless rise in the major US stock averages. Check out this chart of the Dow below.
Following the strong rally in the second half of October, the index has refused to correct lower. Instead, it’s eked out tiny daily rises within very narrow trading ranges.
This suggests constant buying support and not much desire to sell. It looks as though global capital wants to seek refuge in large US stocks, away from the volatility going on elsewhere.
But the Dow is overbought and overstretched. The odds favour a pullback and consolidation.
The point to take away though is that the real action is occurring in the currency and commodity markets (commodities being a leveraged currency in the eyes of speculative traders). The price action of the large US stock averages conceals this.
Soon enough, the volatility will return to US equities. The rumbles under the surface tell you that.
For Markets and Money