Is This the Next Rotation to Profit From?

Wednesday, 12 August 2020
Melbourne, Australia
By James Woodburn


Well, the expected correction hit precious metals overnight.

And when I say hit, I mean really hit.

Yesterday afternoon, the spot price of gold finished the Asian trading session around US$2,020. By this morning it had plunged to US$1,910 an ounce.

That’s a solid fall of 5.4%.

But it doesn’t even compare to silver. It plunged nearly 14% over the same timeframe. They don’t call it the devil’s metal for nothing.

What does all this tell you?

Well, if you’re a regular reader of The Insider, this correction won’t have come as a surprise. As I wrote on Monday:

For now though, watch for a correction in precious metals stocks. But the message is, don’t get shaken out of your positions. Because this could be the pause that sets things up for a much bigger move in the months and years ahead.

And if you subscribe to Shae Russell’s Hard Money Trader, this won’t have come as a surprise, either. As she wrote last Thursday:

As you know, I’ve been quite steadfast in my opinion on gold not cracking the US$2K mark this year. Even as it became increasingly obvious in the last four trading days that it was going to go through.

Look, I’m not disappointed that gold has proven me wrong. As a gold bull it’s pretty hard to complain with the yellow metal hitting these exciting new highs.

Although this short-term momentum will wear thin in the next couple of weeks. Gold is up 12% in less than three weeks. If you’re looking to top up on the physical stuff, hold off. As I pointed out last week, the gold price tends to fall shortly after a crazy price spike.

Generally, the next 4–12 weeks will present an even better buying opportunity. The trick is to be patient.

And resolute, I should add. It’s one thing to say you’re going to buy on a correction when everyone is loving gold, but another to actually do it when it’s going the other way.

You’re in good hands with Shae though. She’s one of the best in the gold business.

While the overnight falls might feel extreme, as Shae mentioned, the precious metals have been on a relentless tear these past few months. The gold price, for example, is only back to where it was in late July.

Here’s a chart of the gold futures price (slightly different to the spot gold price). From around mid-July, it went vertical, rising from US$1,800 to around US$2,060 an ounce in a few weeks.

Port Phillip Publishing

Source: Optuma

[Click to open in a new window]

Vertical price rises ALWAYS correct. It’s just a question of how far they run before the correction kicks in.

While we can’t be certain this is indeed the start of the correction, it looks like it is. I would guess that prices will fall back to at least US$1,800 and maybe US$1,700 an ounce during this correction.

Whatever the number, we’ll find out soon enough.

What I’m interested in is WHY gold is doing what it’s doing. What signal is it sending? What forces is it responding to?

As I’ve been saying recently, gold has been trading as a monetary asset (not a commodity). It has tracked the movement of the 10-year US Treasury yield. Last week, the yield on this benchmark financial asset hit an all-time low.

But overnight, the yield jumped sharply, in its largest one-day move since June.

There was no obvious reason for the move. So for now, we wait to see what the follow through is.

Here’s one thought though.

These defensive assets may be responding to light at the end of the tunnel. As the global economy continues to open up, capital will flow into more cyclical and economically sensitive assets. It already has, of course. The NASDAQ is at all-time highs and the S&P 500 is very close to making new all-time highs.

But most of those gains have been concentrated in the large tech stocks. In a world of lockdown and/or restricted movement, these tech plays are seen as defensive assets…even if they’re trading at 70 times earnings…or whatever it is.

So if bond yields rise and gold continues to sell-off, you could also see the NASDAQ, in particular, continue to correct.

Who would’ve thought the NASDAQ would ever be a defensive play?

Just another absurdity of 2020.

Meanwhile, in Australia, 2020 hasn’t missed us either.

Here, the resources sector is the defensive one, while the banks are on the nose.

That’s the conventional view.

But for how much longer?

The Commonwealth Bank of Australia [ASX:CBA] reported full year results today. Cash profit came in at $7.3 billion, down 11.3% on the prior year. 60% of the profits came in the first half, with COVID-related writedowns hitting profit in the second half. 

The result was below expectations. But what is interesting is the market reaction. CBA’s share price is down around 0.7% at time of writing, but the other banks are all up around 2%.

This tells you the result was a good one for the sector as a whole. Banks are still generating profits and dividends, albeit at a reduced level. But CBA had a premium valuation going into the result, while the other banks were much cheaper, even accounting for their lower profitability.

(I pointed this out to subscribers of Crisis & Opportunity last month. Out of the Big Four banks; CBA was the only one trading above a conservative estimate of ‘intrinsic value’.)

It is the strong performance of these ‘other’ three banks today that is preventing deeper falls in our market. The ASX 200 is only down 0.4%, while BHP is down 0.75% and RIO 1.35%. 131 stocks are down, while only 62 are up.

Perhaps this is the start of a rotation from resources to financials? From a valuation perspective, it looks primed for a turn. Have a look at the chart below. It shows the relative valuation of financials and resources.

Port Phillip Publishing

Source: Optuma

[Click to open in a new window]

Right now, financials (relative to resources) are as cheap as they’ve been in years. As I explain in this report, if China takes a structural growth hit in a post-COVID world, that trend will turn.