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LAWRIE WILLIAMS: Gold closes in on $1,650, equities nervous as virus extends its global grip

As we have been trying to warn readers for most of the past month, investors and funds are at last  beginning to understand that even if the Ncov-19 virus can be mostly restricted to Mainland China (which is already coming into doubt), the impact on the global economy could still be severe.  As a consequence equities have been turning down, the oil price is declining and gold and the other precious metals have been rising.  Indeed the gold price moved up through $1,650 briefly on Friday, before being brought back down a few dollars and ending the week at $1,643.

Latest virus news coming out of China looks to be a bit more encouraging if one can believe the Chinese official data on new virus cases, although the death toll is still rising alarmingly.  The equities markets may take some encouragement from that but there are some alarming statistics coming out from elsewhere.  South Korea and now Italy seem to be experiencing major clusters of virus cases.  It looks to be only a matter of time before similar clusters appear in other countries.  Some other nations may also be suppressing virus incidence statistics.

China seems to keep changing its infection counting criteria but deaths from the infection keep on rising and are now well in excess of those from the 2003 SARS virus – and they are beginning to expand outside China too, as are recorded infections.  South Korea is seemingly already badly infected and it now has the highest incidence of confirmed coronavirus cases outside Mainland China and the Diamond Princess cruise liner, while northern Italy is also the scene of a significant virus outbreak..  Somewhat surprisingly North Korea has not yet reported any confirmed cases, nor has Indonesia – two countries where there would seem to be a likelihood of significant numbers of cases occurring.

Undoubtedly a number of government administrations – of which the U.S. is high on the list -  will no doubt try to play down the likelihood of virus spread in an effort to maintain economic confidence and encourage suppression of the gold price – itself a well-recognised bellwether of financial strength – which may form a part of this, but if the virus continues to gain a grip outside China such efforts may prove to be in vain.  If the increasing incidence in Japan forces the unthinkable, and the summer Olympic Games have to be postponed or cancelled, the global market impact of such a move would likely be enormous.  We are not at this stage yet, but if Japanese virus cases keep on rising such a move cannot be ruled out – nor would the reluctance of some countries to allow their teams to travel there if the Games go ahead be ignored by the markets and the Games organisers.

Some industrial sectors will have already been significantly  adversely affected by the Chinese incidence and restrictions alone, and these include tourism (the Chinese nowadays are inveterate travellers and there has already been a fall-off in other tourism to potential virus hotspots), airline companies (there have been a plethora of flight restrictions and the costs to the industry are already said to run to billions of dollars), the tech sector (China is a major supplier and component manufacturer for mobile phones, computers and accessories), the cruise ship industry (the fate of travellers on the Diamond Princess is bound to put a big dent in forward bookings), the auto industry (Chinese car sales – the world’s largest market – is said to have contracted by 90% in the first half of the current month, while many manufacturers in the West rely on Chinese-made components to maintain output levels); mining (particularly base metals mining where China is the world’s largest consumer) and probably many more.  Some Chinese manufacturing plants are still shut down, or working at significantly reduced capacity, despite government moves to get people back to work in less affected areas, and if the virus spread continues even more could be impacted.

But while gold may benefit, at least initially, from safe haven investment and a likely transfer of investor interest from equities, there are also some potentially severe headwinds for precious metals.  Silver and pgms are nowadays very much industrial rather than true precious metals.  Silver may grab a ride on gold’s coattails initially, but the impact on pgms could be especially severe – not least given the huge initial fall in Chinese car manufacture – a major market for palladium in particular as an exhaust emission control catalyst.  Silver’s big current market is in solar panel manufacture and China leads the world in this so a slowdown or cessation of manufacturing there will be significant, although the closer relationship with gold may keep the silver price price rising for now.

But what if the Chinese downturn alone, and its impact on the global economy, triggers a severe global equities meltdown, which is a distinct possibility?  So much investment is bought on margin these days as ever-optimistic investors have been gambling on the bull market to keep on going.  But bull markets inevitably come to a sticky end and then there is a struggle to maintain liquidity by investors and funds.  Those wise enough to hold some of their investment in precious metals may be forced to sell at knockdown prices just to stay afloat.  That has happened in past major recessions (notably most recently in 2008) and history does tend to repeat itself.

And there are other headwinds for gold.  Consultancy Metals Focus is predicting a reduction in central bank gold buying in 2020 – Russia, the world’s leading central bank gold purchaser already seems to be cutting back - and gold demand in China – the world’s largest consumer – has also been falling dramatically.  It was sharply down in 2019 compared with prior years, and again heavily down in January, and that was before the full impact of the Ncov-19 virus on the Chinese domestic economy had been felt (See: China Gold Demand Down Sharply Due To Ncov-19).  February figures are likely to even be far worse given the extended Chinese New Year holiday and whole city lockdowns.  Indian demand seems to be weak also and tends to be price sensitive so will also likely be down.  Safe Haven investment demand may make up for some of this likely demand fall – gold-backed ETFs are still seeing inflows.  Luckily, perhaps, for the gold investor, the yellow metal is also not quite so sensitive to supply/demand fundamentals as other commodities.

So there are positives and negatives rearing up on the horizon, and which will win out is a moot question.  Perhaps positive initially, then negative if a global equities collapse materialises, and then positive again with gold in particular being first to recover and then possibly surge in price.  (Safe haven assets would normally recover far faster than equities in a serious recessionary scenario.)  Or maybe the virus will peak and be brought under control quickly which could ward off the worst case scenario noted above. 

However even the Chinese economic downturn to date will have been having a very substantial short term impact on global economic activity.  As we said in another recent article in a saying once attributed to the U.S. “When China sneezes the rest of the world catches a cold”.  And China is doing much more than just sneezing.  Even if the Ncov-19 virus is quickly brought under control (which doesn’t yet seem likely) the effects on global Q1 (and possibly H1) growth and economic activity will still be extremely serious.  The virus incidence to date has already cost some sectors billions of dollars and the longer the virus scare goes on the more severe its economic impact will likely be.

23 Feb 2020 | Categories: Gold, China

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