Complex Made Simple

The BP trade idea was a winner – and so was silver!

"Silver has benefited from the gold price pop, rising to $16.50 per troy ounce on the near-term COMEX contract as I write," says investment expert Matein Khalid.

"Silver – like gold – traditionally benefits from a rise in geopolitical tensions in the Gulf, US-China trade conflicts and no deal Brexit angst" "The sheer momentum of gold’s rise to six-year highs was the ballast that pushed silver prices higher in July" "Silver is at historically cheap levels relative to gold"

I had recommended the shares of BP, the UK oil and gas supermajor, at 520 pence in a column published in the regional financial media on July 23, 2019. I believed that BP’s EBITDA margins would be above the City’s consensus, thanks to its upstream output growth and cost cutting program. BP shares are up 18 cents or almost 4%, trading at 546 pence as I write. As I expected, BP chairman Bob Dudley also reaffirmed that the 6% dividend yield was rock solid, given the scale of free cash flow available for the div and share buybacks. This means another 10 pence payout on August 8th is certain. BP’s $10 billion asset sales program will also help reduce its balance sheet leverage ratios to Shell/Total levels, removing another source of City angst.

Ironically, since BP is a dollar revenue generator, it is an attractive hedge against sterling’s plunge on Boris Johnson/no deal Brexit risk. I expect a valuation rerating for BP and the potential for its shares to rise to 580 – 600 pence by next spring, especially if sterling plummets in the interim on the Halloween trade. I am pleased that our BP idea made money for investors since Centrica (owner of British Gas) and Gamesa both tanked after slashing their dividends. Let us hope my BP goose continues to lay golden eggs as long as Brent remains at $60 or higher.

Silver has benefited from the gold price pop, rising to $16.50 per troy ounce on the near-term COMEX contract as I write, its highest level in more than a year and up an incredible 5% in July alone. Is the white metal in an embryonic tactical bull market? This is iffy.

More by this author: The Federal Reserve’s coming interest rate shock on July 31!

One, the sheer momentum of gold’s rise to six-year highs was the ballast that pushed silver prices higher in July. Silver is at historically cheap levels relative to gold.

Two, silver also benefits from easing by the world’s Big Three central banks – the Federal Reserve, the ECB and the People’s Bank of China. Easy money reduces the opportunity cost of owning precious metals for investors. This is the reason gold and silver performed so well in July even though the risk of no deal Brexit and awful German factory orders/manufacturing PMI has taken the US Dollar Index to 98.

Three, while gold is primarily a monetary metal since the time of the ancient Pharaonic and Roman empires, silver demand derives from myriad industrial uses, including electric cars, space technologies and mobile phones. Manufacturing PMI in the US, China, Germany and Japan have been slowing since mid-2018 even as the IMF cut global growth forecasts to 3.2%. This had dampened investor interest in silver – until the July breakout. It appears investors now view silver as a higher beta proxy for gold and believe central bank monetary easing will offset the demand drag from slower economic growth. This explains the silver buying frenzy in July.

Four, the recent blowout rally in semiconductor stocks on NASDAQ has also benefited silver, a component in the chip production process.

More by this author: An autumn of destiny for the British pound and the Japanese yen

Five, silver – like gold – traditionally benefits from a rise in geopolitical tensions in the Gulf, US-China trade conflicts and no deal Brexit angst. It is significant that silver soared to above $50 in an epic rally in 1979, the year of the Iranian revolution and the Soviet invasion of Afghanistan. The world silver market was even “cornered” by Texan oil billionaires Nelson Bunker and Lamar Hunt, a strategy that ended in tears in 1980 when the Volcker Fed hiked interest rates to choke a 15% inflation rate.

Six, the key to silver’s (and gold’s) bullish momentum is that the Federal Reserve monetary policy enacts the three rate cuts till January 2020 priced into the Chicago Fed Fund/Eurodollar futures markets. This will not happen if US payrolls/retail sales and industrial production data strengthens in the months ahead. If the US Dollar Index rises to 99 – 100, expect a swift, brutal fall in the prices of both silver and gold. I had forecasted a $1500 gold price target when prices were in the $1240 – 1260 an ounce range. Gold will only overshoot my $1500 target if the US, Europe and China engage in a “currency war”.

While silver has not confirmed gold’s breakout, I know from painful experience that every silver bull market scales a wall of false dawns, retracements and back testing. In the absence of inflation, a financial market meltdown on the Lehman/AIG scale or a major geopolitical shock, gold and silver prices will be in a trading range, where it is still possible to make money via COMEX option spread strategies. The current precious metal market seems in a classic “stealth bull” phase, where only the cognoscenti/hedge funds/investors benefit from the price action and wider public participation has still not led to the sort of parabolic moves the speculative mania in bitcoin exhibited since March 2019. So despite its July breakout, silver does not meet my definition of a bubble and so will accumulate more on any post FOMC dip.

More by this author: Macroeconomic storm clouds and geopolitics will weaken the Turkish lira!

My goldbug friends in town will have to concede that the last $150 per ounce rise in the price of gold was based on speculative inflows into the gold ETF/Russian and Chinese central bank buying, not on intrinsic fundamentals. After all, King Dollar is 98 on its trade weighted index and inflation is non-existent in the US and Europe.

Gold trades at a $80-100 an ounce premium to real US yields and investor positioning so if the Powell Fed disappoints on its interest rate guidance, a $80 – 100 an ounce pullback in gold is inevitable. A surge in the US dollar is normally Count Dracula’s cross in sunlight for the yellow metal, so this gold rally is skating on thin macro fundamental ice and such moves always self abort as this one can, down to 1340 – 1360 an ounce.

Boris Johnson’s Cabinet purge and no deal Brexit rhetoric have triggered a fall in sterling to 1.2145 as I write. There is no reason the EU will remove the Irish backstop before negotiations begin, as Theresa May found out twice to her regret. Britain will pay a steep price for Johnson’s “do or die” pledge on a October 31 Brexit. Note that sterling has also fallen to 0.9150 against the Euro. 

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