It is by now well known that after several weeks of intense government propaganda, the Gold Initiative in Switzerland failed rather spectacularly (78% voted against keeping the Keynesian dunderheads running the SNB in check). The propaganda machinery got into full swing a few weeks ago when the “yes” vote unexpectedly started developing a lead in the polls. Obviously, the intense bombardment of Switzerland’s voters with stories about the alleged calamity of slightly reducing the power of the country’s monetary bureaucrats has worked rather well. The panic of the bureaucrats is understandable: Swiss bank assets relative to GDP are the highest of any industrialized country, and have in fact long ago attained Cyprus-like proportions. The central bank probably believes it needs to be in a position to bail the country’s banking behemoths out in the event of another crisis, and anything that threatens to reduce its room to maneuver even in the slightest must be fought tooth and claw.
However, we hereby officially declare the CHF a garbage currency. While it still has one major factor going for it – namely the relatively high degree of economic freedom in Switzerland – it is garbage in every other respect one can possibly think of (irrespective of the fact that fiat confetti printed elsewhere isn’t any better). As Eric Schreiber recently pointed out, the CHF has become little more than a derivative appendage of the euro. Although Swiss voters have rejected accession to the EU twice already, the government has engaged in a kind of “stealth accession”, with the CHF-euro peg only the latest step in an ongoing effort to integrate the country with the EU.
The pegging of the CHF has had the effect of increasing the Swiss money supply more than that of any other major currency area since 2008. Moreover, the main asset held as the theoretical “backing” of this huge money supply is the euro, which is a currency the very survival of which remains in question. That is however not all that is worth pointing out in this context. Not only has the CHF money supply exploded into the blue yonder, but in purchasing power parity terms it is undoubtedly one of the most overvalued currencies on the planet.
Here is a list of prices paid in Zurich on a wide range of items and here is a comparison of these prices with those paid in Vienna, the capital of neighboring Austria (which itself is by no means a cheap place to live; as an aside, Austria has the highest CPI rate of change in the euro area). As can be seen, the cost of living in Zurich is about twice that of Vienna. As mentioned above, Switzerland’s high degree of economic freedom does deserve a premium – but these prices are just crazy. It is even more crazy in this context that the mandarins running the SNB are worried about “deflation”.
No doubt the CHF will once again catch a bid in the next global financial/economic crisis (which is probably going to happen fairly soon), but it won’t be deserved. We would strongly recommend not to overweight the currency, resp. to avoid it altogether. Since the CHF doesn’t pay any interest anyway, one is far better off with gold, which is not “backed” by euros and the hollow promises of a government.
Obviously, one could have adopted a more constructive stance regarding the CHF if the gold initiative had succeeded, since then there would at least have been an assured minimum gold cover. Nevertheless, traders should probably focus on the fact that the currency looks quite oversold against the US dollar. A short to medium term rally could therefore well be in the works soon. What we wrote above is only an assessment of the perception of the CHF as a “safe haven” asset. That seems no longer deserved, as the CHF lacks the essential qualities such an asset should have.
Wild Gyrations in Gold and Commodities
Since Friday last week, the gold market has moved from raising the level of despondency among the few remaining bulls to fresh heights to kicking newly minted bears where it really hurts. As we have previously pointed out, a yes vote in the Swiss referendum would at best have had a short term psychological effect on the market. In terms of the effect the actual, additional incremental demand would have produced, 300 tons of buying per year are like a drop in the ocean for the gold market. In short, the referendum was irrelevant to the gold price in fundamental terms, but it was reasonable to expect it to have a psychological effect.
As it has turned out, the effect turned into a typical “sell the rumor, buy the news” scenario. Gold was weak for most of the past week, and declined rather sharply in the two trading days preceding the referendum. After the “no” vote became a fact, there was an initial knee-jerk continuation of the selling squall in Asian trading on Monday morning, but it has reversed rather spectacularly, with gold reaching a multi-week high on the COMEX a few hours later:
A 30 minute chart of the action in the most active February gold futures contract over the past week. Gold has regained the important $1,180 level, after breaking through it for the second time late last week – click to enlarge.
As you can see from our chart annotations, we also mention last week’s capitulation in the crude oil market as an influencing factor. In fact, it is hard to tell what had more of an effect on the gold price, in spite of the fact that crude oil has very little to do with gold. These are after all two completely different markets, but there are a few ways in which they are linked. The first link is monetary inflation and its effects on prices and currency exchange rates. Rising US inflation expectations, which usually coincide with expectations of looser monetary policy, will tend to weaken the US dollar and raise the prices of all sorts of “hard” assets in a kind of feedback loop. Recently, this feedback loop has worked in the exact opposite direction: inflation expectations have been declining sharply, a further tightening of the Fed’s monetary policy was/is expected, and the US dollar has consequently been strong, pressuring commodity prices. Weaker commodity prices in turn have lowered inflation expectations further, and so forth.
The second link between oil and gold prices is through investment funds that are focused on commodities. If they are forced to sell one major commodity (due to redemptions or margin calls), they often have to sell other commodities as well. In this context we would note that the recent closing of a major commodity fund (see this article at Zerohedge) should probably be seen as a contrary indicator, although it may actually take a few more victims before one can make a definitive pronouncement with regard to this.
In fact, the sharp decline in crude oil prices mainly affects the profit margins of gold mining companies, since energy is one of their major input costs (crude oil has declined rather noticeably against gold in recent weeks). Gold mining margins should continue to improve.
It is interesting that the capitulation of speculators in crude oil last week (up until recently, they have stubbornly held on to a major net long position in WTI futures) has led to oil reaching its most oversold weekly RSI readings since the 1986 price crash (h/t Steve Saville). Also noteworthy in this context: the trigger events accompanying the recent decline in oil prices are strongly reminiscent of what happened in the mid 1980s as well. Not only was OPEC, resp. Saudi Arabia, widely regarded as a trigger of both declines (in 1986, Saudi Arabia announced it wanted to retake market share by increasing its production, this time around it refused to cut production), but in the years preceding both declines, non-OPEC supply was rising sharply. In the 1980s it was North Sea crude oil production that added to global supplies, this time around it was US production from fracking. Of course, there is also a noticeable decline in demand growth at present, with Europe, Japan and China all suffering low, or even negative economic growth.
Still, it seems the price decline in crude oil is quite overdone in the short to medium term, and crude oil has duly reversed course on Monday as well.
In this context, note also the intra-day spike in the Russian ruble on Monday, which also ended by producing what looks suspiciously like a reversal candle – although it still ended the day more than 4% weaker (below is a 5-hourly chart):
USD-RUB, 5 hourly candles: after spiking to new highs (new lows for the ruble), the market seems to have put in a short term reversal – click to enlarge.
Numerous commodity markets have suffered sharp declines recently, and another one worth mentioning is copper. Copper has recently broken below the $3/lb. level, which has provided strong support for several years. The copper price is poised above a technical abyss as a result, as there is little by way of support underneath current levels – $2,80 may perhaps offer a little bit of support in the short term, but if that level break as well, much lower levels will likely become feasible price attractors:
A Premise that Could be Questioned
Fundamentally, the current weakness in industrial commodities is well justified, as a number of major pillars of the previous bull market have fallen by the wayside. However, one should be careful not to get carried away too much in the short to medium term. The US dollar is not only egregiously overbought and over-loved, but is seems highly likely to us that the premise on which its recent strength is based could soon be questioned by market participants. In other words, the idea that the Federal Reserve will soon “normalize” its interest rate policy seems to have been milked for all it’s worth, which is not much.
Compared to previous post WW2 recoveries, the US economy’s performance obviously remains quite weak, and it probably won’t take much to push it over the next cliff. Let us not forget, not too long ago the press was brimming with bold pronouncements about the “recovery in Europe” and the “imminent recovery in Japan” – neither of which has worked out thus far (a sign that the economy’s pool of real funding is likely in grave trouble in both regions).
Therefore, perceptions about future Fed policy could change once again, in which case the “strong dollar-weak commodities” feedback loop could begin to move in the other direction for a while. This is especially likely in view of how overbought the dollar and how oversold many commodities have become.
To summarize: a chance to once again transform the CHF into a proper “safe haven” asset has been missed, and as a result one should look at the currency with the suspicion it so richly deserves based on its fundamentals. Gold has regained an important support/resistance level, but we will have to wait and see whether there is “follow through” buying before we can declare that the retest of the recent lows has indeed been successful.
One reason to remain cautious for now is the fact that many other commodities are technically in very weak positions, even though all of them appear short term oversold. While gold is unique in that it is a monetary and not an industrial commodity, its price trend is often linked with that of other commodities for the reasons discussed above. However, should perceptions about Fed policy change, gold will be a prime beneficiary, and will be the first financial asset to react.
A small addendum to this: overnight, Moody’s has cut the sovereign rating of Japan. Declining confidence in government debt as a rule tends to be gold-friendly, especially when the debtberg concerned is a giant one in a major economic region.
Charts by: BarCharts, StockCharts