2018 precious metals performances - scotiabank · 2020-07-28 · 1 january 2, 2019 commodities...

1

January 2, 2019

Commodities Strategy | Gold & Silver Outlook

CONTACTS

Nicky Shiels

Commodity Strategist (Metals)

212-225-6724

Commodities Derivatives

[email protected]

Gold and Silver Annual Short-term Outlook Gold closed 2018 down 1.5% while Silvers 9% losses joined most other commodities including base metals and energy and other key macro asset classes broad declines in 2018. It was a year which started with strong hopes of synchronized global growth, an outlook for a lower $ and a relatively calm, steady outlook for most economies as political risks were underestimated . That abruptly changed mid year as trade tariffs proved to be more bite than bark, cracks emerged in emerging markets, fears developed over slowing corporate earnings and Q3’18 saw outsized price falls first across base and precious metals, then Q4 delivered a large blow to overweight consensus trades in everything from Oil to US equities (FAANG) and bitcoin. That wasn't enough… Unhealthy technical breaks in US equities, a far more hawkish Fed meeting pre-Christmas, thin liquidity, and finally US politics (a partial US government shutdown) all worked together to drive the worst December in US stocks since the Great Depression Gold and Silver price performance in 2018 is not surprising in light of the persistently perky US$, which appreciated almost 5%, the lack of convincing investor subscription and a hiking hawkish-leaning Fed muddying an already uncertain global growth profile amongst both EM and DM countries. Overall, Scotiabank equity research expects Gold to average slightly around the forward curve and the streets outlook in 2019, with Silver to average decidedly higher vs these other estimates. Gold and Silver prices in the last 2weeks of 2018 have already taken out most forecasts for 2019; a good and early start which should continue into the seasonally strong Q1 period. Global political and geopolitical risks have become mainstays (and no longer tail risks) since 2016 at a time when business cycles are maturing and recession talks grow forcing investors to search for a stable, cheap, un-political hedges against increased geopolitical uncertainty, a weaker $, fragile global risk/macro and a sustainably higher volatility environment

Gold & Silver Summary Table—page 2 The $ outlook and Gold & Silver forecasts — page 3 Gold: Macro backdrop: how we got here—page 4 The Fed & US outlook—page 5 The political and geopolitical outlook —page 6 Debt & deficits—page 7 Investor interest—page 8 Official Sector demand & global supply—page 9 Physical investment & jewelry demand: India—page 10 Physical investment & jewelry demand: China—page 11 Silver Outlook—page 12 Silver investment & physical demand—page 13 Silver supply—page 14

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2018 Precious Metals Performances

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Silver

Platinum

Palladium

Source: Scotiabank Commodities Strategy, Bloomberg

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January 2, 2019


Gold driver General Outlook

$ outlook bullish

Macro short-term mildly bullish

Macro medium-term neutral-bearish

Technicals mildly bullish

Market positioning neutral-bullish

Physical demand neutral-bearish

Central Bank demand mildly bullish

Silver driver General Outlook

$ outlook bullish

Macro short-term mildly bullish

Macro medium-term bearish

Technicals mildly bullish

Market positioning neutral

Physical demand neutral

Good structural support with (typical & atypical) CBs quietly accumulating Gold & diversifying at highest pace in

~3yrs

Comment

see above. Note, a sustainably lower $ trend is relatively more bullish Silver vs Gold

see above. Silvers industrial characteristic implies it should be less elastic to large macro de-risk episodes

see above. Silver will asymmetrically fall (more so than Gold) if/when $ and general market liquidity withdraws, if

EM underperforms DM due to hawkish-leaning Fed

constructive base formed <$15 but short-term momentum indicators still negative and MA remain an overhang.

ETF's are toppy and a large overhang unable to draw in safe haven flows, but COT paper positioning is very

underweight

Industrial fabrication demand has flat lined for 3 years; Indian jewelry and coin/bar demand remain price

sensitive

Extreme paper short positioning almost fully unwound (neutral), but net COT positioning still very under owned

with upside for paper longs to increase positioning. Recent ETF additions is stickier interest & constructive

Stable-to-weaker Indian demand is offset by modest increases in Chinese jewelry & investment demand; with

higher prices in both $ and local (INR, CNY) terms, physical demand is either compressed or deferred

Comment

Core $ weakness in 2019 due to fading of relative US growth outperformance (as effects of fiscal stimulus

declines), potential less hawkish Fed stance, reduction in overweight $ positioning and a refocus on US twin

deficits

Late cycle fears & new higher vol regime given unstable global equities & unresolved trade & political policies.

Q1 event risk includes potential "Fed pause" at March FOMC, US/China trade talks, Brexit vote, & Chinese lunar

NY. Upside oil risk & seasonally strong investor inflow period.

Lack of $ liquidity & tighter financial conditions as Fed continues hiking and other CBs (ECB) begin tightening

with large Fed & corporate issuances in 2019. Gold has not (yet) internalized any structural themes, like swelling

twin deficits, and a rise of protectionism globally, which is $ negative

Floor at $1200 is both confirmed and respected. Momentum turned positive with 50 DMA crossing over 100 DMA.

Summary Table:

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January 2, 2019


The $ outlook and Gold & Silver forecasts

Our core $ house call on the $ for 2019 is for the DXY to average 89.4, a material drop from the current levels of around ~97; peak dollar is simply behind us. This view is not wrong and also mirrors the general streets outlook on a weaker $ in 2019, which underpins plenty of bullish metals and commodities calls.

The underlying driver for upcoming $ weakness is the 1) the fading of US fiscal stimulus, 2) stalling of US growth or “US exceptionalism” as monetary policy starts to bite, 3) a reduction in overweight $ positioning as most positive news on relative US growth & monetary policy is al-ready priced in

In the longer-term, the $ should continue to come under renewed pres-sure as markets refocus on the accumulation of dual current account and fiscal deficits and the fact that its relatively “expensive” vs other G-10 currencies on purchasing power terms.

A risk to this bullish $ outlook is the $s ability to dominate and reaffirm its role as a reserve and safe haven currency post 2016; it internalized relative growth outperformance and monetary policy instead of the subsequent political uncertainty which kick-started a global shift to pro-tectionism— that didn't derail $ strength despite the views of many post 2016s US election. Subsequently, given the recent troubled develop-ments across the pond (Brexit saga, Italy's economy and sustainability over its public debt, Frances struggle to implement structural reforms and overall slower Euro-zone growth), the markets are reminded that the $ has been the best dirty shirt

Thus, before sifting through internal Gold and silver dynamics, using their 2 year weekly correlation (Gold & DXY of –76), with the DXY at 89.4, the regression-implied Gold price is $1322. Note, Silvers 2 year weekly correlation with the $ is an unimpressive 0.01 so a similar ap-proach isn't deserving

Overall, Scotiabank equity research expects Gold to average slightly around the forward curve and the streets outlook, with Silver to aver-age decidedly higher vs these other estimates. Overall, Gold and Silver prices in the last 2weeks of 2018 have already taken out most fore-casts for 2019; a good and early start which should continue into the seasonally strong Q1 period.

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Current cash Q4'18 Q1'19 Q2'19 Q3'19 Q4'19

Gold forecasts: the crowd, analysts, the curve & Scotiabank

Forward Curve

Gold Participantforecast*

Average Analystsforecast**

Scotiabankannualized 2019forecast

* Average LBMA delegate price forecast for Gold at 2019 LBMA conference** Average of all banks' analysts forecasts as listed on Bloomberg*** Annualized forecasts will be updated on January 14 2019

Source: LBMA, Bloomberg, Scotiabank Commodities Strategy

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Current cash Q4'18 Q1'19 Q2'19 Q3'19 Q4'19

Silver forecasts: the crowd, analysts, the curve & Scotiabank

Forward Curve

Silver Participantforecast*

Average Analystsforecast**

Scotiabankannualized 2019forecast

*average LBMA delegate price forecast for Gold at 2019 LBMA conference** Average of all banks' analysts forecasts as listed on Bloomberg*** Annualized forecasts will be updated on January14 2019

Source: LBMA, Bloomberg, Scotiabank Commodities Strategy

4

January 2, 2019


Macro backdrop: how we got here

Gold closed the year down 1.5% while Silvers 9% losses joined most other commodities including base metals and energy and other key macro asset classes broad declines in 2018. It was a year which started with strong hopes of synchronized global growth, an outlook for a lower $ and a relatively calm, steady outlook for most economies as political risks were underestimated. That abruptly changed mid year as trade tariffs proved to be more bite than bark, cracks emerged in emerging markets, fears developed over slowing corporate earnings and Q3’18 saw outsized price falls first across base and precious metals, then Q4 delivered a large blow to overweight consensus trades in everything from Oil to US equities (FAANG, Bank stocks) and bitcoin. That wasn't enough… Unhealthy technical breaks in US equities, a far more hawk-ish Fed meeting pre-Christmas, thin liquidity, and finally US politics (a partial US government shutdown and turbulence & interferences be-tween the Fed, Treasury Sec. Mnuchin and Trump/White house) all worked together to drive the worst December in US stocks since the Great Depression.

Gold and Silver price performance in 2018 is not surprising in light of the persistently perky US$, which appreciated almost 5%, the lack of con-vincing investor subscription and a hiking hawkish-leaning Fed muddy-ing an already uncertain global growth profile amongst both EM and DM countries. Golds performance in Q4’18 is historically fair given the resur-gent macro volatility and fragile equities, highlighting Golds portfolio benefits; it begrudgingly rallied but should remain contained within its $1150—$1350 comfort zone. The VIX (which arguably has put in a ra-ther steady rally despite Decembers equity bloodbath) and the DXY are currently the core drivers of Gold pricing in this new late cycle regime, where investors and macro prices are on edge and skittish

Silvers positive response to the macro developments is somewhat un-fair as it should shoulder much of the negative moves in risk assets and base metals while running into oversupply. Silver didn't source on any safe haven related flows that Gold managed to secure (via ETFs), but the thin liquidity, seasonally quiet period for corporate activity and rela-tive price underperformance ensured Silver prices outperformed in De-cember driven by auto-pilot computerized trading.

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EM equities

DM Equities (ex-US)

Commodities

US Equities

Precious Metals

EM Gov Bonds ($ denoninated)

US H.Y Corp Bonds

US I.G Corp Bonds

US Gov Bonds

US 3m T-bills

DXY

%

Macro asset performances in 2018: cash was king...

Source: Scotiabank Commodities Strategy, Bloomberg, ICE BofA ML,

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January 2, 2019


The Fed & US outlook:

Gold is largely not a commodity but trades as a complex macro asset that internalizes various currency, interest rate and risk appetite metrics. The Feds December meeting was an important inflection point this year, as it not only laid out the expected 2019 hiking path, but it also man-aged to solidify a top in risk assets while Powells decision continues to draw in fresh criticism from the President to well respected investors. The Fed raised rates to 2.5% and lowered its forecast to 2 hikes in 2019 (from 3x) as largely expected by the market, but Powell was stubbornly hawkish reaffirming his commitment to further rate hikes and did not see the Fed changing its “autopilot” quantitative tightening stance.

The US economy is already hitting the Feds dual mandate but they need to refrain from overtightening and steer a soft-landing. Gold is a hedge against Powells ability to master what historically is pretty tough given 2 base Fed risks: 1) the Fed applies a 2019 rate hike cycle that matches 2018s stellar growth profile, not 2019s steady (not great) growth which will continue to inject volatility into risk assets just as late cycle and recessionary fears grow louder calling for a Fed pause, 2). The Fed sustainably pauses: We’ve been here before—in Q1’16 plum-meting oil prices and US equities dragged down growth and inflation expectations which was enough for the Fed to swing from expecting 4x hikes in 2016, to only fulfilling 1 rate hike in Dec’16. Overall, Gold can mildly rally in a quantitative tightening cycle if the Feds outlook creates enough uncertainty to global risk assets and/or if the Fed remains be-hind the inflation curve ensuring real rates remain close to zero. Gold will suffer if theres certainty around QT and confidence for a soft-landing increases.

Theres been plenty of references to Americas economic cycle—by mid-year, it could break its record for the longest uninterrupted expansion since 1860, but note 1) its not the strongest cycle (Bloomberg noted that the current cumulative GDP is 23% during this cycle, vs 43% in the late 1990s cycle), 2) theres already been 2 intra-cycle “resets” in 2011 and 2016 that recalibrated risk and leverage lower (ie: 2018 could be the 3rd reset), and 3). Commodities—especially metals—are not exhibiting typi-cal late-cycle rallies (i.e.: recessionary calls are too early and we’re clos-er to mid-cycle than late with upside potential across metals). Regard-less, conventional late cycle bear markets typically don’t take months, but years to play out, which argues for a sustainably higher volatility en-vironment.

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2019 Hikes: The Fed vs the Market - much less tightening priced in

The Markets*2019 rate hikeforecast, LHS

Feds 2019 ratehike forecast,LHS

Gold Price, RHS

* Implied probability of no. of hikes, using FedFund futures 2019 (F9-F0) curveFeds 2019 rate hike = 2019 dot plot median - Fed funds rate


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The first 60 days after each FOMC

Golds short-term performance after each Fed hike - December hikes usually mark a bottom

Dec 2015, hike to 0.50%

Dec 2016, hike to 0.75%

Mar 2017, hike to 1%

June 2017, hike to1.25%

Dec 2017, hike to 1.50%

Mar 2018, hike to 1.75%

June 2018, hike to 2%

Sept 2018, hike to2.25%

Dec 2018, hike to 2.5%

*Prices indexed at 100 at the start of every hiking FOMC


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January 2, 2019


The political and geopolitical outlook: the same, but likely more uncertainty

The global war against globalism arguably started in November 2016; now merely 2 decades after walls were torn down in Europe, governments are being partially shutdown over building a new wall, and populist waves are spreading not contract-ing (through Italy, Mexico and Brazil for example), .

Trade war = Cold war: As FT reported, US executives and analysts have now shift-ed their focus from (the historic) tax reform to trade war concerns like tariffs, high-lighting the rising anxiety over Trumps foreign policy. There has been standoffs not only between the US and China, but also Canada, Mexico, South Korea and Europe, and its still unclear the price the US (and others?) will pay for weaponizing tariffs. Plenty are looking for a “deal” or trade outcome in Q1’19 between China & US to provide direction, which is possible, but theres also a better chance this is a sustained cold war despite the fact that both parties view China as a strategic threat.

In 2019, Trump faces larger constraints at home with the Democrats controlling the House. The US political system and the new intake of representatives post-midterms is arguably now more ideologically divided than ever before and Decem-bers partial government shutdown is simply a preview of gridlock ramifications due to dwindling partisanship. US politics is entering a particularly turbulent 2years giv-en the Democrats newfound clout with impeachment proceedings and investiga-tions into Trumps affairs to the potential for Mueller to discover any damaging evi-dence, all potentially on the cards. With both sides already combative after a sticky start (gov shutdown), this creates an environment for further (uglier?) Trump back-lashes on targets ranging from his opponents to the Fed, especially if his perceiva-bly favorite barometer (US Stocks) continues to crumble.

Brexit & EU changing of the guard: Britain is (supposed) to leave the European Union in March 2019 which should be followed by political retaliations and eco-nomic ramifications, while the EU is due to get a new ECB head, a new commis-sion and a new parliament that creates some uncertainty over how European lead-ers will handle the indebted nations like Italy (and France).

Election years: Some large nations hold nationwide elections in 2019—India, Nige-ria and Indonesia (together accounting for the 1/3rd of the worlds population) all vote, adding to political uncertainty risk as the hope lies that these nations liberal-ize more despite the spreading protectionist backdrop .

Overall, rising geopolitical risks are no longer a tail risk, and are becoming more frequent but also less ‘tradeable’ by the human/discretionary actor given the rise of big data and HFT. Gold is a stable, cheap, un-political (currency) hedge against uncertainty surrounding Brexit, key elections in large/important countries, EU par-liamentary elections and the US-Sino trade dispute, in 1H’19.

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Gold vs Global Uncertainy Index

GlobalEconomicPolicyUncertainty(GEPU)_pppadjusted, LHS

Gold price,RHS

*quantifies the GDP_weighted average of national Economic, Policy & Uncertainty (EPU) Indices for 20 countries. Each EPU reflects reflects the relative frequency of own-country newspaper articles that contain a trio of terms pertaining to the economy (E), policy (P) and uncertainty (U)

Source: Scotiabank Commodities Strategy, Bloomberg, Economic Policy Uncertainty http://www.policyuncertainty.com/index.html

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January 2, 2019


Debt & deficits: a structural theme for Gold may come home to

roost

The world, as a whole, is more indebted today than before the finan-cial crisis as defined by the BIS’s recent stat of global debt at 217% of GDP (+20% since 2007, whereas EM debt is up 50% by the same metric), fueled by government and corporate borrowing.

This year, rising interest rates have tested the ability (and the curren-cies) of South Africa, Turkey, Argentina and Brazil to repay dollar-denominated debt while the US’ tax cuts will push the US budget deficit to 6% of GDP in 2019 (a metric more closely associated with a country fighting a recession or a war). As of Nov ‘18, the US pays 10x more than any other G-7 country (Italy is 2nd) a day to service its debt load while the IMF warned in June that now (at higher growth rates) is the time for US policymakers to address the gnawing struc-tural debt problem before the next crisis hits. Rising rates—led by the Fed, thee global Central Bank—and climbing debt is bringing to light these deep-seated concerns both in the US and abroad.

The US twin (budget and CA) deficit is a core reason for expected $ weakness and the thinking that the Fed will be ’handcuffed’ from rais-ing rates too high. But while the inability for Congress to balance the Federal budget is worrisome, a larger structural concern is that the large driver of these deficits is the unrestrained growth of mandatory entitlement spending, at a time when our largest trade foe (China) is whom the US is reliant on for funds.

China: Chinas deleveraging campaign will be put on hold as it fights the impact of the trade war by cutting corporate taxes (in 2019) and making it easier for cities to issue infrastructure bonds. Total debt in China already exceeds that of the US and has more than quadrupled since 2007 (at around ~320% od Chinese GDP in 2018) fueled by shadow banking and real estate.

Overall, while the increasing ‘short-termism’ amongst investors has ensured its been rather easy to look through the public debt issue largely in the US, history reminds us that the confluence of risky and unpredictable policies, excessive borrowing and higher interest rates pose a toxic threat. Gold is a real asset and currency hedge against unchecked and massive US and global debt growth...

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Global debt doubled led by Government and Corporate borrowing

Household

NonfinancialCorporate

Government

financial

Source: Scotiabank Commodities Strategy, Bloomberg, Institute of International Finance

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Gold vs US Public Debt: Gold floored at $1200 with US Debt >100% of GDP

Gold Price, LHS

US Debt as a % ofGDP, RHS

. *US Total Public Debt Outstanding


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January 2, 2019


Investor interest: early signs of interest and inflows

ETF investors added almost 3m oz of net Gold to positioning in 2018,

after clawing back the Q2 & Q3 outflows and more in Q4. While paper

(COT) positioning put in large net outflows of almost 13m oz; its largest

annual set of outflows the past 10years.

However, since US equities toppled in the beginning of October, inves-

tor interest has decidedly shifted gears. The daily pace of global ETF

accumulation since then is a healthy +70K oz / day. In addition, the

unseasonal nature of these inflows (on average the last 10years, ETF

have bled out ~570k oz in December, vs the 2.25m oz of inflows in Dec

‘18) is both interesting and constructive.

This year saw the longest stretch of sustained net short positioning

(since the data began in 2006) as investor sentiment toward gold

soured mirroring the upbeat US growth and $ outlook. However, De-

cember marked a key inflection point as net positioning swung net long

for the first time since the June 18 Fed hike which kick-started a broad

shunning of all metals.

This recent development—the ability for broader market participants to

rotate out of riskier assets and into Gold (and not only cash or $) as

either a safe haven or late-cycle hedge is constructive as we continue

to see sustained equity volatility and a high probability of US equity

weakness in 2019 (all else equal).

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Gold ETF Holdings vs SPX; Golds a hedge for Q4 equity outflows

ETF GoldHoldings,LHS

SPX, RHS

Source: Bloomberg, Scotiabank Commodities Strategy

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COT Paper positioning in Gold and the $ hit extreme levels in 2018

net $positioning*,LHS

NetmanagedMoney Goldpositioning,RHS

*DXY positioning is aggregate net managed money positioning across EUR, CAD, GBP, JPY & CHF


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January 2, 2019


Official Sector demand: becoming more active and more supportive

Central Bank activity kicked it up a notch in 2018, with 10.8m oz accumulat-ed in the first 10months; on an annualized basis that’s ~13m oz, the highest annual buying pace since 2015 and one which more than offsets total in-vestor outflows so far (ETF + COT length of 5.6m oz).

Emerging Markets (who traditionally have a much smaller share of FX re-serves in Gold) have been avid Gold purchasers in 2018 – China, Turkey, Mongolia, Russia, India and Kazakhstan have all seen consistent activity this year. And this trend, especially amongst China, Russia and Turkey is expected to continue in 2019, with new/atypical CBs also adding

Global political and geopolitical risks have become mainstays (and no long-er tail risks) since 2016 at a time when business cycles are maturing and recession talks grow. Gold is an anti-globalization hedge, an “anti-USA” hedge; its completely a-political and fits in well with “de-dollarization” poli-cies some developing nations are adapting to so theres an increasing likeli-hood that support from Central Banks for Gold in 2019 grows. Russia, once a top 10 holder of US gov debt, sold most of its Treasury holdings (from >$100bn to <$15bn) and diversified against “America” in 2018, as telling example of this thinking.

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Global Central Bank holdings vs Gold prices: supportive not bullish (yet?)

Gold price,LHS

Global CBHoldings,RHS

Source: Scotiabank Commodities Strategy, Bloomberg, IMF

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Annual Central Bank vs investor activity -- what investors lost in 2018, CBs more than made up for

InvestorFlowsYTD, LHS

netCentralBankpurchases/sales,LHS

annualGoldPerformance, RHS* Central Bank net flows as of Ocotber 2018, data is annualized

** Investor Flows is defined as net Global ETf flows and net CFTC COT paper flows

Source: IMF, Bloomberg, Scotiabank Commodities Strategy

Annual correlation between CB + Investor Flows and Price Performance = +0.73

Supply: primary & secondary

Gold prices historically have an asymmetrical ‘response’ to physical sales vs physical purchases; its relatively more reactive to the latter because it fos-ters and supports general sentiment, another driver for Golds outlook. Thats probably because primary and secondary short-term flows are rather opaque whereas one can track consumer, import stats, CB activity and investor flows on a regular basis.

Nonetheless, supply is one half of the balance sheet, and a large structural force that needs to be addressed. Primary gold supply has grown for 13 con-secutive years, before dipping in 2017 and resuming its trend to new record high of 3300 tonnes in 2018 (GFMS) , with mine output set to retreat slightly in 2019 by 2%.

Scrap contributes ~30% of total supply and is very price sensitive so with higher prices (expected in 2019) this should to attract additional inventories.

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January 2, 2019


Physical investment & jewelry demand: Indian Gold demand still supportive

In the 1st 9 months this year, Indias gold imports were down 13% and GFMS esti-mates that domestic Gold demand was down 8% YoY, due to 1). changes in regu-lation (the introduction of the Goods and Services tax last year which provided greater oversight by authorities to check compliance standards), 2). changes to import criteria by the Government of India in Q4’17 for nominated agencies, 3) the impact of a weaker INR on local demand (it lowers purchasing power) since it ei-ther compresses or defers near-term Gold demand

However, imports stats aren't an exact picture of true Indian Gold demand. Overall jewelry demand still remains robust post monetization, which is being increasingly supplied by internal scrap/recycled material (scrap supply was up 64% in the 1st 9 months of 2018), and unofficial (smuggling) imports. This is due to a shift in tastes as the gold accumulated by the post Independence generation is passed on to younger family members who prefer to recycle and refine these into more modern pieces. As such, official demand from the ROW (imports) has remained largely flat-to-lower for 3years now

Looking ahead to 2019, physical Indian demand should continue to be stable over-all, after a potentially weaker Q1.

In April-May 2019, India holds general elections, with Modis BJP party looking increasingly less invincible (last year BJP lost a number of key state elections). The uncertainty and campaign period in the lead up to general elections every 5years has usually been deemed to be associated with weaker demand.

Scotia has the INR strengthening somewhat toward 68 by Q4’18, so while theres less chance of any fear-related buying (extreme currency weakness reinforces the structural reason engrained in consumers to hold Gold), its weak enough on an historical basis and strong enough on a cyclical basis to not limit local purchasing power and meaningfully decrease consumption.

Indias relatively high current account deficit makes it vulnerable to any oil price strength (which could subsequently threaten/induce higher import duties on Gold as was the case in 2013). That is not likely to be an issue in 2019; despite our call for higher oil prices, its coming off a relatively lower base and isn't averaging the levels seen pre-2014 when oil importing CA deficit EM countries were negatively affected.

Industrial demand:

Decent demand by the electronics sector, semi-conductor production (memory space) in 2018 was somewhat offset by the persistent decline in dental applica-tions which is driven by substitution to cheaper and more attractive porcelain al-loys.

-15

-10

-5

0

5

10

15

20

Jan-1

8

Jan-1

8

Jan-1

8

Feb

-18

Ma

r-1

8

Ma

r-1

8

Apr-

18

Apr-

18

Ma

y-1

8

Ma

y-1

8

Ma

y-1

8

%

XAU/INR performance Jan-May over Indias general election years - investor strength finds no further physical demand

support from March

2014

2009

2004

Average[2014, 2009,2004, 1999]

Source: Scotiabank Commodities Strategy, Bloomberg,, GFMS

200

300

400

500

600

700

800

900

1000

China India

ton

nes

Jewelry demand in China & India

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

20151

2016

2017

2018**annualized

Source: Scotiabank Commodities Strategy, GFMS

11

January 2, 2019


Physical investment & jewelry Gold demand: Chinese Gold demand picking

up

The trend in 2018 has been of steady Chinese demand, with jewelry demand in the first 3 quarters registering 464 tonnes, up almost 8% over the same pe-riod last year. Gold imports from key Gold hubs—a proxy for overall incremen-tal demand—rose 28% in the first nine months (China imported 1,065.2 tonnes of gold from HK, Switzerland, UK, Australia and Singapore combined). A volatile and unforgiving year in Chinese equites (a bear market in Shanghai Comp from Q4’18) and a weaker yuan helped spur jewelry inflows, but not investment inflows.

The trade war between the US and China and subsequent uncertainty around the yuan outlook, global (and Chinese) growth and potential easing measures as a response to the impact on tariffs, has a mixed outlook for Gold. On one hand, the negative impact on sentiment boosts Golds appal as a safe haven and as a hedge against any expectation that the PBOC loses control of the psychological yuan 7 handle vs the US$. Alternatively, the PBOC may inter-vene further, or at least retain the 2017 level Gold import quotas handed out to banks, in order to provide further protection of the local currency if trade ten-sions sour in Q1’19, which’ll limit the ability to make Gold purchases in near-term. Ultimately, as evidenced with Indian demand trends , any increase in regulation by the authorities on gold ownership merely kick-starts smuggling and drives an underlying bid by the people to own even more of the ‘forbidden’ metal in the longer-term.

Ultimately, Chinese investor demand (as proxied by the trend in Asian Gold ETFs) is quite cyclical, momentum driven and highly dependent on volatility (and to some extent) yuan weakness; if dollar/yuan 7 handle breaks that will be a sentiment circuit breaker for most metals in the near-term (lower metals prices), but should see large fear-related hedge buying from a range of Chi-nese participants after the initial shock, since Gold (and precious metals) is still viewed as the ultimate EM currency hedge. The strong ETF inflows in 2016 (35 tonnes, more than doubling holdings) as the yuan depreciated >7% (vs the US$) after the shock Aug ‘2015 devaluation, is a sound example of the willingness to use gold as an investment option against extreme currency moves.

Chinese jewelry demand, is on the other hand, expected to rise modestly in 2019 by 3% (GFMS) as some recent structural and marketing changes carries over from 2018; larger fabricators—who’re more likely to support the industry as a whole—have upped their market share and there's been a shift toward lower content gold pieces.

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

0

20

40

60

80

100

120

To

nn

ss

Asian Gold ETFs total holdings vs North American ETFs - steadily increasing market share

Asian GoldETF TotalHoldings

Asian GoldHoldings asa % of NorthAmerican

Source: Scotiabank Commodities Strategy, Bloomberg, World Gold Council

-30%

-20%

-10%

0%

10%

20%

30%

40%

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18*

Chinese & Indian jewelry demand growth

*annualized

Source: Scotiabank Commodities Strategy, GFMS

12

January 2, 2019


Silver:

Outlook:

Silver still remains very inexpensive vs Gold, despite putting in almost 9% gains in December ‘18 as equity volatility boosted most precious metals.

Structurally, Silver remains oversupplied due both to a mix of primary & by-product production and a buildup of known and unknown invento-ries, which support the view for the Gold/Silver ratio to average near the top-end of the range (80-85).

The confluence of the Feds quantitative tightening program which cur-rently is undermining risk assets and the cyclical underperformance of EM Stocks VS DM, has kept silver subdued and poses a headwind going forward if the Fed leans hawkish which’ll negatively impact EM assets.

Tactically, 3 potential upside drivers lie in wait for Silver, 1). The cycli-cal low price and low vol environment (4 years trading below $20) is constructive for new uses / technology to be developed, 2). Paper po-sitioning remains under-owned 3). Silvers is the better outperformer vs Gold (lower GC/Si ratio) in a sustainably bearish $ downturn, given its historical high-beta profile.

70

80

90

100

110

120

130

30

40

50

60

70

80

90

De

c-9

9

De

c-0

0

De

c-0

1

De

c-0

2

De

c-0

3

De

c-0

4

De

c-0

5

De

c-0

6

De

c-0

7

De

c-0

8

De

c-0

9

De

c-1

0

De

c-1

1

De

c-1

2

De

c-1

3

De

c-1

4

De

c-1

5

De

c-1

6

De

c-1

7

De

c-1

8

Relationship between the $ and the Gold/Silver ratio

Gold/Silver,LHS

DXY, RHS


0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

$14

$19

$24

$29

$34

$39

$44

$49

$54

EM vs DM growth proxy - Silvers performance contingent on an uptick in EM stocks

Silverprices,LHS

EM / DMStocks*,RHS

* MXEF Index / SPX Index


13

January 2, 2019


Investment demand:

ETF holders liquidated over 9m oz in 2018, mostly all occurring in December as equity markets rattled long only holders and Silver failed to attract similar safehaven inflows witnessed in Gold ETFs. That’s the 3rd worst annual liqui-dation over a 10 year stretch. Given that total holdings are still sitting at rather lofty levels (~515m oz, only 35m oz or 6% below peak holdings seen in 2017) and the fact that, so far, Silvers failed to attract discretionary safehaven in-flows, the 2019 ETF outlook doesn't look too rosy, if macro assets continue to de-risk. Silvers other ‘hope’ is for momentum type paper players to enter…

Paper investors also largely shunned Silver in 2018, liquidating over 70m oz, which is slightly less than the average outflow years. Similar to the ‘ investing’ style in Gold, most of these outflows were driven by fresh short interest, ra-ther than fresh longs. Given that COT positioning in 2018 reached a net short (almost net short a total of ~240m oz in Sept 2018), like Gold, there is upside potential for these extreme bearish views to thaw as investors pare back their strong $ bets and/or if Silver manages a convincing technical breakout to pique interest. Currently, Silver paper investors own ~10m oz, almost 1/12th the size of the average length carried the past 10years.

Physical demand:

Physical demand in 2018 fell slightly to 970m oz (-2% YoY) according to GFMS but they expect this to rise back up to 990m oz in 2019 largely driven by a rebound in Indian jewelry demand and demand for silver bars and coins. 2018 was a very downbeat year in which coin sales from the US Mint were down 20%, but sentiment considerably improved in H2’18 as silver was viewed as a cheap alternative to Gold amidst the macro rout

The US-Sino trade dispute has really taken a toll on silver fabrication in solar panels (Trumps introduced import tariff on solar panels and washing ma-chines in the beginning of the year; later China retaliated with their own measures even after their subsidies in place have been exhausted given that renewable energy growth targets were achieved in 2018). Silver use in solar plunged 15% in 2018 and GFMS expects another 9% fall (to ~72m oz) in 2019. While the solar industry only accounts for 12% of industrial demand, it was the key marginal / swing physical ‘darling’ 7+years ago, and highlights the ability of industrial uses to quickly come and go.

-300mn

-250mn

-200mn

-150mn

-100mn

-50mn

mn

50mn

100mn

150mn

200mn

250mn

2018201720162015201420132012201120102009 oz

Silver investment demand - rather standard outflows for 2018

Annual COTFlows

Annual ETFFlows


Current Investor holdings: 10m oz (10yr average 112m oz)

Current ETF holdings: 515m oz (10yr average 478m oz)

-400

-200

-

200

400

600

800

1,000

1,200

1,400

2016 2017 2018 2019

mn

oz

Silver physical & paper demand

COT + ETF

IndustrialFabrication

Silverware

Coins & Bars

Jewellery

Source: Scotiabank Commodities Strategy, Bloomberg, GFMS

14

January 2, 2019


Supply:

Mine supply rose marginally in 2018 to 998m oz (the uptick in primary production alone was 13.4m oz or 2%). However GFMS expects mine supply to fall 2% (or 14.4m oz) in 2019 due to their expectation that by production (lead/zinc) and primary production should fall given output challenges and production delays particularly in China.

Silver M&A deal activity rose almost 80% in 2018 (~$640bn) which is a key risk to this outlook as more ounces could hit the market if the focus doesn't shift to profitability (vs volume creation).

Silver prices, being relatively subdued both on an historical basis and vs Gold, aren't at attractive hedging levels for producers to lock in forward sales. However, the swelling contango forward curve and Silvers by-product nature creates a structural headwind going forward as both producers capitalize on the curve for appropriate financing purposes and fundamental investors remain sidelined.

$-

$0.20

$0.40

$0.60

$0.80

$1.00

$1.20

830

840

850

860

870

880

890

900

2014 2015 2016 2017 2018 2019

M o

z

Silver forward contango vs primary production

Primary MineProduction,LHS

SilverForwardCurve*, RHS

* Silver 1year forward curve = fardated (12 month) futures price - nearterm (2 month) futures price


Primary 2018 52%

Gold By-Product 2018

14%

Lead/Zinc By-Product 2018

26%

Copper By-Product 2018

7%

Other By-Product 2018 1%

2018 North American Silver production by source metal - almost ~50% is byproduct production

Source: Scotiabank Commodities Strategy, Bloomberg, GFMS

15

January 2, 2019


The information contained in this presentation is being provided for information and discussion purposes only. An investment decision should not be made solely on the basis of the contents of this

presentation. This presentation is being provided upon the express understanding that no representation or warranty, express or implied, is made, or responsibility of any kind accepted, by The Bank

of Nova Scotia, Scotiabank Europe plc, or any of their respective affiliates (“Scotiabank”TM), their directors, agents or employees with respect to the completeness or accuracy of the information, con-

clusions and opinions provided herein, or as to the achievement or reasonableness of any projections, targets, estimates, or forecasts and nothing in this presentation should be relied upon as a prom-

ise or representation as to the future. Past performance or simulated past performance is not a reliable indicator of future results. Forecasts are not a reliable indicator of future performance.. This

presentation has not been prepared (i) by a member of the research department of Scotiabank, or (ii) in accordance with the legal requirements designed to promote the independence of investment

research. It is considered a marketing communication for regulatory purposes and is solely for the use of sophisticated institutional investors. This presentation does not constitute investment advice or

any personal recommendation to invest in a financial instrument or “investment research” as defined by the UK Prudential Regulation Authority and the UK Financial Conduct Authority, and its content

is not subject to any prohibition on dealing ahead of the dissemination of investment research.

The information contained in this presentation reflects prevailing conditions and our judgment as of the date of the presentation, all of which are subject to change or amendment without notice, and

the delivery of any such amended information at any time does not imply that the information (whether amended or not) contained in this presentation is correct as of any time subsequent to its date.

Scotiabank undertakes no obligation to update or correct any information contained herein or otherwise to advise as to any future change to it. Scotiabank does not provide any applicable tax, ac-

counting or legal advice and in all cases independent professional advice should be sought in those areas.

This presentation incorporates information which is either non-public, confidential or proprietary in nature, and is being furnished on the express basis that this information will not be used in a manner

inconsistent with its confidential nature or be disclosed to anyone other than as may be required by law or to those who have been informed of the confidential and proprietary nature of this presenta-

tion. This presentation and its contents are strictly confidential to the person to whom it is delivered and may not be copied or distributed in whole or in part or disclosed by such persons to any other

person without the prior written consent of Scotiabank. This presentation and the information contained herein remain the property of Scotiabank.

This presentation is not and shall not be construed as an offer, invitation, recommendation or solicitation to sell, issue, purchase or subscribe any securities or bank debt in any jurisdiction or to enter

into any transaction. Nothing in this document contains a commitment by Scotiabank to sell, issue, purchase or subscribe for financial instruments, or securities, to provide debt or to invest in any way

in any transaction described herein, or otherwise provide monies to any party. Any participation by Scotiabank in any transaction would only be provided in writing after satisfactory legal, financial, tax,

accounting and commercial due diligence, as well as being subject to internal approval processes. Any transaction implementing any proposal discussed in this document shall be exclusively upon

the terms and subject to the conditions set out in the definitive agreement related thereto.

This presentation is not directed to or intended for use by any person resident or located in any country where the distribution of such information is contrary to the laws of such country. Scotiabank, its

directors, officers, employees or clients may currently or from time to time own or hold interests in long or short positions in any securities referred to herein, and may at any time make purchases or

sales of these securities as principal or agent. Scotiabank may also have provided or may provide investment banking, capital markets or other services to the companies referred to in this presenta-

tion.

TM Trademark of The Bank of Nova Scotia. Used under license, where applicable. Scotiabank, together with "Global Banking and Markets", is a marketing name for the global corporate and invest-

ment banking and capital markets businesses of The Bank of Nova Scotia and certain of its affiliates in the countries where they operate, including Scotia Capital Inc., Scotia Capital (USA) Inc., Sco-

tiabanc Inc.; Citadel Hill Advisors L.L.C.; The Bank of Nova Scotia Trust Company of New York; Scotiabank Europe plc; Scotiabank (Ireland) Designated Activity Company; Scotiabank Inverlat S.A.,

Institución de Banca Múltiple, Scotia Inverlat Casa de Bolsa S.A. de C.V., Scotia Inverlat Derivados S.A. de C.V. – all members of the Scotiabank Group and authorized users of the mark. The Bank of

Nova Scotia is incorporated in Canada with limited liability. Scotia Capital Inc. is a member of CIPF. Scotia Capital (USA) Inc. is a registered broker-dealer with the SEC and is a member of the NASD

and SIPC. The Bank of Nova Scotia is authorised and regulated by the Office of the Superintendent of Financial Institutions of Canada. Scotia Capital Inc. is authorised and regulated by the Invest-

ment Industry Regulatory Organization of Canada. The Bank of Nova Scotia and Scotiabank Europe plc. are authorised by the UK Prudential Regulation Authority. The Bank of Nova Scotia is subject

to regulation by the UK Financial Conduct Authority and limited regulation by the UK Prudential Regulation Authority. Scotiabank Europe plc is regulated by the UK Financial Conduct Authority and the

UK Prudential Regulation Authority. Details about the extent of The Bank of Nova Scotia 's regulation by the UK Prudential Regulation Authority are available upon request. Scotiabank Inverlat, S.A.,

Scotia Inverlat Casa de Bolsa, S.A. de C.V., and Scotia Derivados, S.A. de C.V., are each authorized and regulated by the Mexican financial authorities.

16

January 2, 2019


The information contained in this presentation is being provided for information and discussion purposes only. An investment decision should not be made solely on the basis of the contents of this

presentation. This presentation is being provided upon the express understanding that no representation or warranty, express or implied, is made, or responsibility of any kind accepted, by The Bank of

Nova Scotia, Scotiabank Europe plc, or any of their respective affiliates (“Scotiabank”TM), their directors, agents or employees with respect to the completeness or accuracy of the information, conclu-

sions and opinions provided herein, or as to the achievement or reasonableness of any projections, targets, estimates, or forecasts and nothing in this presentation should be relied upon as a promise

or representation as to the future. Past performance or simulated past performance is not a reliable indicator of future results. Forecasts are not a reliable indicator of future performance.. This presenta-

tion has not been prepared (i) by a member of the research department of Scotiabank, or (ii) in accordance with the legal requirements designed to promote the independence of investment research. It

is considered a marketing communication for regulatory purposes and is solely for the use of sophisticated institutional investors. This presentation does not constitute investment advice or any person-

al recommendation to invest in a financial instrument or “investment research” as defined by the UK Prudential Regulation Authority and the UK Financial Conduct Authority, and its content is not sub-

ject to any prohibition on dealing ahead of the dissemination of investment research.

The information contained in this presentation reflects prevailing conditions and our judgment as of the date of the presentation, all of which are subject to change or amendment without notice, and the

delivery of any such amended information at any time does not imply that the information (whether amended or not) contained in this presentation is correct as of any time subsequent to its date. Sco-

tiabank undertakes no obligation to update or correct any information contained herein or otherwise to advise as to any future change to it. Scotiabank does not provide any applicable tax, accounting

or legal advice and in all cases independent professional advice should be sought in those areas.

This presentation incorporates information which is either non-public, confidential or proprietary in nature, and is being furnished on the express basis that this information will not be used in a manner

inconsistent with its confidential nature or be disclosed to anyone other than as may be required by law or to those who have been informed of the confidential and proprietary nature of this presenta-

tion. This presentation and its contents are strictly confidential to the person to whom it is delivered and may not be copied or distributed in whole or in part or disclosed by such persons to any other

person without the prior written consent of Scotiabank. This presentation and the information contained herein remain the property of Scotiabank.

This presentation is not and shall not be construed as an offer, invitation, recommendation or solicitation to sell, issue, purchase or subscribe any securities or bank debt in any jurisdiction or to enter

into any transaction. Nothing in this document contains a commitment by Scotiabank to sell, issue, purchase or subscribe for financial instruments, or securities, to provide debt or to invest in any way

in any transaction described herein, or otherwise provide monies to any party. Any participation by Scotiabank in any transaction would only be provided in writing after satisfactory legal, financial, tax,

accounting and commercial due diligence, as well as being subject to internal approval processes. Any transaction implementing any proposal discussed in this document shall be exclusively upon the

terms and subject to the conditions set out in the definitive agreement related thereto.

This presentation is not directed to or intended for use by any person resident or located in any country where the distribution of such information is contrary to the laws of such country. Scotiabank, its

directors, officers, employees or clients may currently or from time to time own or hold interests in long or short positions in any securities referred to herein, and may at any time make purchases or

sales of these securities as principal or agent. Scotiabank may also have provided or may provide investment banking, capital markets or other services to the companies referred to in this presentation.

TM Trademark of The Bank of Nova Scotia. Used under license, where applicable. Scotiabank, together with "Global Banking and Markets", is a marketing name for the global corporate and investment

banking and capital markets businesses of The Bank of Nova Scotia and certain of its affiliates in the countries where they operate, including Scotia Capital Inc., Scotia Capital (USA) Inc., Scotiabanc

Inc.; Citadel Hill Advisors L.L.C.; The Bank of Nova Scotia Trust Company of New York; Scotiabank Europe plc; Scotiabank (Ireland) Designated Activity Company; Scotiabank Inverlat S.A., Institución

de Banca Múltiple, Scotia Inverlat Casa de Bolsa S.A. de C.V., Scotia Inverlat Derivados S.A. de C.V. – all members of the Scotiabank Group and authorized users of the mark. The Bank of Nova Sco-

tia is incorporated in Canada with limited liability. Scotia Capital Inc. is a member of CIPF. Scotia Capital (USA) Inc. is a registered broker-dealer with the SEC and is a member of the NASD and SIPC.

The Bank of Nova Scotia is authorised and regulated by the Office of the Superintendent of Financial Institutions of Canada. Scotia Capital Inc. is authorised and regulated by the Investment Industry

Regulatory Organization of Canada. The Bank of Nova Scotia and Scotiabank Europe plc. are authorised by the UK Prudential Regulation Authority. The Bank of Nova Scotia is subject to regulation by

the UK Financial Conduct Authority and limited regulation by the UK Prudential Regulation Authority. Scotiabank Europe plc is regulated by the UK Financial Conduct Authority and the UK Prudential

Regulation Authority. Details about the extent of The Bank of Nova Scotia 's regulation by the UK Prudential Regulation Authority are available upon request. Scotiabank Inverlat, S.A., Scotia Inverlat

Casa de Bolsa, S.A. de C.V., and Scotia Derivados, S.A. de C.V., are each authorized and regulated by the Mexican financial authorities.

2018 precious metals performances - scotiabank · 2020-07-28 · 1 january 2, 2019 commodities...

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