Sailing into uncharted financial waters

Monday, 1 July 2019
Adelaide, Australia
By Bernd Struben

  • Did you take note?
  • OPEC’s costly game

Is it just me, or is time speeding up?

In what seems like little more than the blink of an eye, it’s a new financial year.

We also have the first Tuesday of a new month knocking on our door.

This, of course, has rate watchers perched on the edge of their seats.

As you likely know, the Reserve Bank of Australia (RBA) opted to cut the cash rate from 1.5% to a new historic low of 1.25% last month.

The big question now is, will the RBA cut rates again when they meet tomorrow?

The majority of investors are expecting RBA governor Philp Lowe to slash another 0.25% off rates. According to The Age, financial markets on Friday had priced in a 70% chance of a cut.

And most mainstream economists agree. The median forecast in The Australian Financial Review’s latest economists’ survey points to a cut tomorrow followed by a second 0.25% cut later this year. That would bring the cash rate down to 0.75%.

This morning, I ran a quick survey of Port Phillip Publishing’s own editors and analysts.

True to their contrarian natures, the majority of our editors think the RBA will hold fast for the moment.

Only one editor believes the RBA will cut rates tomorrow. And it’s the only cut he expects this year.

Seven editors think the RBA will pause tomorrow but cut the cash rate inside the next few months.

I’m with them. It makes sense for the bank to wait for the government’s income tax cuts to get the green light before its next move.

If we’re right, that could see the ASX sell off Tuesday afternoon following the RBA’s announcement.

Remember, a 70% chance of a cut is already priced into the markets. Equities tend to rise with expectations of cheaper money…and fall when that carrot is unexpectedly snatched away.

Either way, we’re already deep into uncharted territory here. With a cash rate of only 1.25%, the RBA is almost out of firepower. And the commercial banks will struggle to pass on the full amount of any additional cuts.

We’ll get back to some of the potential pitfalls you should be keeping an eye on tomorrow.

For now, we turn to the markets.

But first…

Did you take note?

In Thursday’s Port Phillip Insider, I did my best to read the tea leaves for the then upcoming G20 Summit.

Here’s an excerpt:

Xi and Trump almost certainly won’t announce any great new deal on Saturday. But I do expect they’ll make friendly noises and indicate that trade negotiations will recommence post haste.

Some of that optimism is already priced into the markets. But investors are hedging their bets. Trump prides himself on his unpredictability, after all.

Adding it all up, if Trump and Xi — and Trump and Putin — emerge from the G20 pointing to brighter days ahead (as I believe they will), global markets should rally. At least for a few days.

Nimble traders, take note.

You can see how that’s working out in Asian markets below. US and European markets should also enjoy a strong start to the week (overnight our time).

Markets

Over the weekend, the Dow Jones Industrial Average closed up 73.38 points, or 0.28%.

The S&P 500 closed up 16.84 points, or 0.58%.

In Europe the Euro Stoxx 50 index finished up 31.31 points, or 0.91%. Meanwhile, the FTSE 100 gained 0.31%, and Germany’s DAX closed up 127.77 points, or 1.04%.

In Asian markets Japan’s Nikkei 225 is up 437.73 points, or 2.06%. China’s CSI 300 is up 2.47%.

In Australia, the S&P/ASX 200 is up 38.23 points, or 0.58%.

On the commodities markets, West Texas Intermediate crude oil is US$59.52 per barrel. Brent crude is US$65.80 per barrel. That puts Brent down a few cents per barrel and WTI up a few cents since I last wrote to you on Thursday.

You may be wondering why oil prices aren’t rocketing higher after the weekend’s developments. We’ll attempt to address that below…

Turning to gold, the yellow metal is trading for US$1,392.54 (AU$1,983.39) per troy ounce. Silver is US$15.20 (AU$21.65) per troy ounce.

In the world of cryptocurrencies, one bitcoin is worth US$10,877.55. That’s down 21.4% since hitting a high of US$13,844 on Saturday. The other major cryptocurrencies have followed bitcoin lower.

Is this a good time to ‘buy the dip’? Or do bitcoin and its virtual cousins have further to fall? You can get all our up-to-date crypto investing advice here.

In the world of fiat currencies, the Aussie dollar is worth 70.21 US cents.

OPEC’s costly game

So why haven’t crude prices gone through the roof?

After all, there are at least three forces propelling oil higher.

First there’s Iran. Tensions with the US continue to heat up after Iran exceeded the limits on its stockpiles of enriched uranium. If it looks like a shooting war is becoming more likely in the oil rich Gulf, you’d expect crude to sell at a premium.

Then there’s the pause in the US–China trade war. Trump and Xi’s sideline meeting at the G20 in Osaka offered a glimmer of hope for successful negotiations down the track. Any easing in the trade dispute should increases the demand for crude.

Finally there’s OPEC+.

Despite my forecast to the contrary, it appears that Russia (the plus member) will support extending the cartel’s current production cuts for at least six months. OPEC+ is meeting in Vienna today and tomorrow. We’ll know the finer details soon.

With all that in mind, why is WTI still trading below US$60?

The answer, once more, lies in the flood of oil coming out of the US.

See for yourself:



chart image
Source: EIA /Bloomberg
Click to enlarge

The US Energy Information Administration (EIA) reports that US output, already at record levels, surged another 2.1% in April. And the trend of ever increasing US oil production looks set to continue.

From Bloomberg:

Crude output from the Permian is expected to jump 50% by 2025, according to BloombergNEF. ESAI Energy forecasts crude and condensate from the Bakken, another prolific play, will surpass record output into next year.

Confirmation of extended production cuts from OPEC+ in Vienna could see oil trade higher this week.

But by keeping prices artificially high, the cartel is only aiding US producers’ bottom lines. And this all comes with a hefty price tag for the Saudis.

How hefty?

This headline, from Bloomberg, sums it up, ‘OPEC Oil Curbs Slash Saudi Economic Growth by More Than Half’.

Like the little Dutch boy with his finger in the dike, OPEC can at best delay a massive crash in crude prices. Keep an eye on 2020 for the member states’ resolve to unravel.

Moving on from black gold to the real deal…

Has gold lost its lustre?

Things looked good for gold on Thursday. As you can see below, following on a strong performance through most of June, gold closed at US$1,423.44 per ounce.



chart image
Source: Bloomberg
Click to enlarge

At time of writing, gold is trading for US$1,392.54 per ounce, or AU$1,983.39.

That’s down 2.2% in US dollar terms.

The loss is slightly more in Aussie dollars, as our dollar strengthened some against the greenback over the weekend. It’s worth noting, though, that even with this modest pullback gold is still trading within a whisker of its record highs in Aussie dollars.

It’s also worth noting that gold soared 11.3% in the 30 days leading up to last Thursday’s recent peak. Following that kind of run, it’s only natural to see a correction.

This one looks to have been driven by the calming noises emanating from the G20 Summit regarding trade negotiations. Not to mention Trump’s impromptu visit onto North Korean turf to usher Kim Jong-un back over the DMZ for a friendly chat.

Gold tends to rise as investor anxiety rises and fall when nerves are soothed. That’s why you’ll hear it referred to as a ‘haven asset’.

Of course, this is all water under the bridge. Or ‘news’, if you will.

What matters now is where the gold price is headed next.

The well-known signs are indicating gold should keep tracking higher this year. Signs like the US Fed and other major central banks lowering interest rates further…always a nice tailwind for gold. Not to mention that the central banks themselves — notably in Russia and China — are ramping up their own gold purchases, adding to demand.

Like I said, these are the well-known signs every mainstream analyst is tracking.

But there’s another crucial piece to this puzzle. It’s a piece that our editorial director Greg Canavan brought to my attention last week. And it’s one that no one else appears to be aware of.

But they should be.

Because if Greg’s right, gold could be on track to topple its 2011 all time highs of US$1,920 per ounce.

Greg’s still finishing up his last bits of research on this one. And putting it all down on paper. He expects to have it ready for your eyes early next week.

Stay tuned…

Cheers,
Bernd

PS: Before you go, I just wanted to mention something that’s coming soon from our friends at Agora Financial Australia. It’s the brainchild of their publisher, James Woodburn. On 8 July, next Monday, he’ll be hosting a special trading series with a former Morgan Stanley wealth manager. He’s kindly agreed to open up this series, free, for paid Port Phillip Publishing subscribers.

What’s it about? Well, I’ll have more details in tomorrow’s Port Phillip Insider, but for now let me just leave you with a hint. James calls it an ‘ASX algo-edge’, and it could mean up to seven-times the potential returns from the biggest, most liquid stocks on the ASX.

As I said, there will be more details tomorrow, so watch this space, but if you’d like to secure your seat now, you can do so here.