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Dollar Hitting All-Time High; Gold Recovering From Recent Tumble

Written By: Ivan Martchev 

There are not very many all-time highs in today’s market, other than the trade-weighted exchange rate of the U.S. dollar, which on Friday registered a fresh all-time high. The previous U.S. dollar trade-weighted index was for goods only and was discontinued in January. The new one is for “goods and services” and has gained in an appreciable amount in the past month. I think this is a U.S. dollar short squeeze.

There is a record amount of dollar borrowing, primarily by emerging market economies. The borrowing level, according to the Bank of International Settlements, is over $12 trillion. In a pandemic shock, as quarantines set in, those borrowings have to be serviced. As commodity prices are in a freefall and global trade is interrupted because of the pandemic, this record level of borrowings becomes a problem.

The COVID-19 pandemic has had the same effect on global trade that the Smoot Hawley Tariff Act of 1930 had on global trade in the 1930s: It collapsed global trade by better than 50%. I always thought the hard landing in China would cause a freefall in commodity prices, but in this case, it seems to be a manufactured quarantine that is causing a global recession and a resulting collapse in commodity prices.

A supply shock is a supply shock, whether it comes in the form of a quarantine or a steep tariff. In this case, the quarantine is a combination of a supply shock and a demand shock at the same time.

The bright side of the story is that it could be over relatively soon if the “flattening of the curve” that our quarantines target is achieved in the spring months, while Smoot Hawley took a couple of years to repeal.

The best case scenario is that of South Korea, where the number of new cases has been decreasing dramatically over the past month and even the number of sick people has been going down over the past two weeks as the number of recoveries is increasing. It is curious that the mortality rate in South Korea is very low, at 1.16%. Since many cases are asymptomatic, they may never know they got the virus. That number could be as high as one third of all cases. That means the mortality rate in South Korea is probably well below 1%, whereas the normal flu mortality rate is 0.1%.

The problem with this pandemic is that even if it is ultimately five times deadlier than the flu, it causes serious issues for older people and people with pre-existing conditions, which would overwhelm the healthcare system, causing us to manufacture a quarantine recession in order to stop it.

Gold is Doing (Comparatively) Great

Despite the all-time highs in the trade-weighted dollar, gold bullion is doing great. There is some pullback in the price of gold, but nothing out of the ordinary and nothing like what happened with the other precious metals – silver, platinum, and palladium, which are all down dramatically. The primary reason is that gold bullion is the only truly “precious” metal, while the other three are primarily industrial. That is why silver is below where it was in early 2016, when gold bullion was around $1,100, not today’s $1,500.

I doubt that gold bullion will weaken further, even if the dollar gains, which is a function of when the quarantine-based recession ends, which could be in just two quarters. Gold is being driven by deficit spending, low or negative real interest rates, and overall stress in the financial system. Sure, gold could decline further in a liquidation of financial assets due to margin calls, but I doubt it will stay down.

The present liquidation panic in stocks is driving down the price of gold miners, which are priced as if gold bullion were near $1,200. The smaller-cap the gold mining stock, typically the bigger the sell-off. This, I am sorry to say, is normal, but liquidation in the stock market is very different from selling in the more professional commodity markets, which affects the price of gold bullion. Still, since I do not believe there is a meaningful downside for gold bullion from here, I believe this is an opportunity for investors in the gold mining sector as they will be the first to rebound when this panic is over.

Related: The Black Swan is Covered in Oil

Equities Contributor: Ivan Martchev

Source: Equities News

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