Welcome back readers! After a brief one-week hiatus, I return to the markets feeling, in many ways, much the way I did when I last wrote two weeks ago. Corporate earnings continue to be “good enough” and admittedly, recent domestic economic data has shown a bit more pep. Would we be hitting new all-time highs on the S&P without Fed QE/not QE? I’m not sure given that 1) stocks are already expensive (17.4x forward 12-month PE ratio), 2) corporate earnings are likely to finish with a decline for a third consecutive quarter and 3) analysts are now expecting a decline in earnings for Q4 as well. Either the market is looking ahead to at least Q1 2020 or there is extra cash sloshing around in the system due to the Fed or both. As for precious metals, unfortunately, anyone holding a gold investment or silver investment this week finally had market headwinds catch up with them. I’ll cover this in more detail in the Gold section below. Because the biggest upside risk to equities / downside risk to precious metals lies in improving economic data and its ties to US-China trade talks as well as the potential for a Fed-engineered soft landing, I’ll cover those two topics first. Then, I’ll touch on corporate earnings (which are largely complete at this point) before tying up remaining loose ends.
The most impactful domestic data release by far over the last two weeks was the US Non Farm Payrolls report. Job growth easily cleared low expectations (128K actual vs. 89K consensus) despite the since-resolved GM strike. Equally important, prior month jobs were revised substantially higher to 180K from the previous report of 136K. Current month job growth of 128K is a hair above the long-term average as reported by Trading Economics. In other economic data, the Q3 GDP advance estimate also came in better than consensus at a 1.9% annualized rate. To be clear, the trend in GDP has been one of slowing and initial estimates for Q4 GDP could see that trend continue.
ISM Manufacturing as well as Non-Manufacturing PMIs were both released over the last two weeks. The manufacturing index posted its third straight month below 50 but saw a sequential improvement from September. Rose-colored glasses will ignore the fact that the release was slightly below consensus and instead focus on that sequential increase. On the non-manufacturing side, the ISM PMI was decidedly upbeat showing both sequential improvement and beating consensus. We will see if this is the start of a new trend or an anomaly in an otherwise ongoing downtrend since the middle of 2018 as shown by the chart below.
Finally, on the domestic front, the University of Michigan preliminary November consumer sentiment release showed a slight sequential uptick despite being a shade below consensus. To remind readers, confidence has rebounded steadily since August and the overall level remains well above the average of 86.6 Index Points from 1952 until 2019 per Trading Economics. Long story short, the consumer continues to hold the economy together giving the manufacturing side of the equation both time and space to rebound in the face of the US-China trade war.
Before we move off of economic data, a couple of international data releases caught my eye. First, it appears as though both of our North American trading partners are suffering with Mexico officially entering a recession after unexpectedly reporting a second straight quarter of GDP declines. To the north, Canada reported 1) an unexpected outright decline in employment for October as well as 2) a PMI result below 50 which was well below the consensus estimate of 54.4 per Trading Economics. In somewhat more encouraging international news, Chinese imports/exports were both better than expected despite still showing year over year declines.
The Fed. First, the Fed cut rates as expected at its most recent meeting to a range of 1.50% – 1.75% and delivered the following message: current monetary policy stance “likely to remain appropriate”. There is no longer a disconnect between Fed fund futures and messaging from the Fed as discussed in more detail in the Government Bond section below. In the background, however, the Fed’s balance sheet continues to grow, recently reclaiming the $4TN mark as shown in the chart below. Total outstandings under the repo program are a bit off of their highs but still above $200BN. This combined with the $60BN of T-bill purchases per month will likely cause the Fed’s balance sheet to approach previous highs. Given that these purchases are expected to run into the second quarter of 2020, this monetary policy accommodation will continue to help underpin the market in the context of current weak corporate earnings expectations (see next paragraph).
So how weak are corporate earnings expectations? As of the end of this week, 89% of all S&P 500 companies have reported earnings. Per FactSet Insight, substituting actual earnings for earnings estimates, in aggregate, Q3 earnings are anticipated to decline 2.4% (vs. an estimated decline of 3.7% last time we checked) on 3.2% revenue growth (vs. an estimated increase of 2.8% last time we checked ). Upward revisions through the earnings season like this are typical. Consistent with earlier in the earnings season, more companies in number are beating earnings estimates than the 5-year average but the magnitude of the positive beat of those same companies remains less than the 5-year average. Revenues continue to be above average on both metrics. In my opinion, revenue growth remains key for the projected rebound in 2020 earnings that the market and analysts currently anticipate. I would note though that Q4 guidance has caused analyst estimates to now show a decline in Q4 earnings. As far as I can tell, my prior assessment that “the market will be able to digest both results and guidance…in the context of a currently accommodative Fed” has held true.
As a final thought, none of my other indicators are flashing incremental warning signs at this point. US Treasury – German Bund spreads are firm. Copper prices briefly broke above $2.70 for the first time in several months. In general, recent data and price action indicates a decline in near-term risk.
With that, I’d like to remind readers that anyone who is thinking about buying gold as an investment or silver as an investment and who is worried about initiating a new position at current prices should carefully develop their own view and consider their expected holding period. A gold long term investment or a silver long term investment is very different from investing in precious metals on a short term basis. Depending on one’s objective, when investing in gold and silver, there are several drivers of precious metal price that investors need to be mindful of that will drive gold investment returns. In support of developing that view, let’s review the major markets that precious metals take their cue from.
The S&P 500 has gone practically straight up since I last wrote with 7 out of the last 10 trading days showing gains. In the process, the market achieved new all-time highs and the S&P now sits at 3,093. Of note, the three down days experienced over the last two weeks were muted with the worst being a decline of 9 S&P points or less than 0.3%. Breaking down the performance a bit further, the majority of the index’s gains were logged during the prior week. In fact, the two biggest daily gains occurred on November 1st in conjunction with the better than expected jobs report followed by Monday October 28th when the White House hinted that Phase One of the trade deal could be signed next month.
Clearly the technical picture has now changed with stocks hitting new all-time highs. The paradigm shift in trading range which I alluded to has arrived. The previous ceiling of 3,025 now provides a floor and 3,100 seems to be the next logical target. On a near-term basis, the market looks a bit stretched. Why? The rally that started towards the beginning of October has driven the relative strength index (RSI) into overbought territory. I would note that while not a 100% fit, the timing of the early October rally aligns with the Fed’s QE/not QE launch that I discussed in my Precious Metal Market Update – 20 October 19. Remember, on October 11th, the Fed announced it would purchase $60BN of T-bills per month after holding and unscheduled meeting the week prior. If we do get a near-term pull back and China trade negotiations remain on track, the dip will likely be bought with the Fed back to increasing its balance sheet. Fed purchases will last at least into the second quarter of 2020 so the safety net underneath the market has some time to run.
The VIX. At these levels, it becomes incrementally harder for the index to move lower yet that is what it has done over the last two weeks. Currently, the VIX sits at 12.07 and continues to be more than one standard deviation from its long-run average (since January 1990) using log normal data. In fact, the index nearly dipped below 12 on an intraday basis Friday. From my last report, I pointed out how any dip below 12 on the VIX this year has been quickly met with a reversal. This gives additional credence to the theory that we are currently overbought and due for a pull back.
Unsurprisingly, VIX futures remain in contango (i.e. upward sloping). When the curve is in contango, it indicates that the market does not believe there will be meaningful near-term volatility. Depending on the absolute level of the VIX, this can sometimes be a contrarian indicator. Given the current technical picture, this may be one of those times. In my opinion, fundamentals will likely have a harder time driving further price gains until we have a healthy (but likely modest) pull back.
Volatility came back to the government bond market over the last couple of weeks as yields initially fell around the Fed’s decision to cut rates only to reverse higher on stronger economic data and continued momentum in the US-China trade talks. 10-year Treasury Note yields fell to a closing low of 1.69% on the day after the Fed announcement but finished this week at 1.94%, eclipsing the September 13th closing level of 1.90% and setting a new cycle high. The below chart shows this breakout in yield and likely resets the trading range to 1.90% on the low-end and 2.15% on the high-end.
Conversely, 3-month T-bill yields (the best barometer of future Fed action) dropped and stayed down. 3-month T-bills closed at a yield of 1.54% on the day after the Fed announcement and finished this week at 1.55%. With the Fed’s most recent target Fed Funds range of 1.50% – 1.75%, a yield of 1.55% indicates uncertainty over additional moves by the Fed. Fed Fund futures confirm this uncertainty all the way through 2020, as futures trading levels indicate that there is a greater than 50% chance that the Fed does nothing. The combined moves in the 10-year Treasury and the 3-month T-bill since the end of August/beginning of September have been nothing short of astounding – see next chart. The Fed’s T-bill purchase program is likely exacerbating this curve re-steepening trend.
2-Year Treasury Note yields essentially walked a middle ground when compared to the 10-Year Treasury and the 3-Month T-bill. 2-Year Treasury Note yields dropped as low as 1.52% the day after the Fed announcement but rebounded somewhat to finish this week at 1.68%. The spread between 10s and 2s now stands at 26bps and the entire yield curve is now back to looking normal again.
With Precious Yield continuing to offer 2-year physical gold term deposit rates of 2%, the US Treasury – Precious Yield spread* remains in Precious Yield’s favor. That said, the spread decreased from -.37% last time we checked to -.32% given the increase in 2-Year Treasury note yields. Note that a negative spread favors Precious Yield while a positive spread favors US Treasuries. Since Precious Yield offers investors in gold the opportunity to earn interest, the US Treasury – Precious Yield spread is tighter than the US Treasury – gold yield spread. To remind our audience, the gold yield is negative in most other holding forms outside of Precious Yield. This includes paying for storage of physical metal whether investor-owned or via a physically -backed storage program and paying management fees for GLD or similar ETFs. See our how to gold investment white paper for a more thorough discussion. Precious Yield (whether hedged* or unhedged) provides a much needed yield alternative in this environment of ultra-low / negative global bond yields. I believe yield alternatives continue to be a major investor focus.
While initially weaker around the Fed meeting, the US dollar strengthened in aggregate over the last two weeks as higher bond yields likely stoked the demand for dollars. As measured by the dollar index ( Ticker – DXY ), the greenback gained a little over 0.5% during the two week period. Looking at the major index components, there was very little divergence. The dollar strengthened 0.7% against the Euro (57.6% index weight), 0.5% against the Yen (13.6% index weight) and 0.4% against the Pound (11.9% index weight). With the EU agreeing to a further extension to January 31st, 2020 on Brexit, volatility in the Pound has temporarily ebbed.
The dollar, however, did not gain against the Chinese yuan as momentum continues to build towards Phase 1 of a trade deal. We are now back below the psychological 7:1 barrier which was a very big deal when we broke through it to the upside. As shown in the chart below, the USD/CNY pair traded below 6.75:1 before the trade war really ratcheted up in early May.
It’s possible that a successful completion of Phase One could have the dollar weaken further to levels last seen in early May. Here’s what a longer view of the USD/CNY pair looks like.
I doubt any comprehensive agreement (beyond phase one) will have us revisit the 6.25:1 level, but I believe it’s useful to know when figuring out the range of possibilities for this currency pair.
Last time, I wrote that “If we see 10-Year Treasury yields revisit the September 13th high of 1.90%, that would be a potential catalyst for gold to visit my downside price targets.” This is exactly what happened as 10-year Treasury Note yields burst through 1.90% to finish at 1.94% this week. As measured by the LBMA afternoon fix (11:00AM EST), the gold per ounce price sank below its most recent intraday low of $1,466/oz (first downside price target) to settle at $1,464/oz. Spot gold prices continued to drop further going into the NY close (4:00PM EST) and now sit at $1,458/oz. going into next week’s open. At these prices, we are 5.7% below the recent cycle high of $1,546/oz. and my $1,400-$1,425/oz second downside trading range price target remains firmly in play. I would note that the 200-day moving average sits just below this trading range at $1,388/oz. With the ascent of the S&P, decreased volatility, higher Treasury yields and a stronger dollar (ex against the yuan), it should be no surprise that the US dollar price of gold in ounces reacted in this manner.
Checking in on gold volatility, the “Gold VIX” decreased to 12.27 from 13.48 two weeks ago. Looking at both the AM & PM LBMA fixes over the course of just this past week, the gold price per ounce trading band continued to widen, fluctuating $45/oz. between the high and the low (vs. $28/oz. last time we checked). I use these price bands to better understand the movements in the “Gold VIX” (Ticker – GVZ ) levels from above. Clearly, a widening price band is inconsistent with a decrease in volatility. Perhaps there has been a decline in speculative options bets as the gold per ounce price has lost momentum. To remind our readers, the Gold VIX measures the market’s expectation of 30-day volatility of gold prices by applying the VIX methodology to options on SPDR Gold Shares (Ticker – GLD ). As I have stated previously, looking at the price band of spot gold prices alone will not capture the supply/demand dynamics that take place in GLD options but at least it is an additional tool. GLD is an exchange-traded fund that represents a fractional, undivided interest in the SPDR Gold Trust, which primarily holds gold bullion. As such, the performance of GLD is intended to reflect the spot price of gold, less fund expenses.
While gold and silver investing has historically been associated with negative carry, a Precious Yield precious metal account offers investors the opportunity to earn a yield on gold and silver instead. If you are a long-term holder, turning gold and silver as an asset for diversification purposes into an alternative investment and yield alternative with Precious Yield allows for some cushion against price movements via the gold and silver yield. To learn more, please browse our website. Alternatively, contact us directly for more information or to answer your precious metal investment questions. For up to the minute thoughts, please follow me (@CIORobPerry) or Precious Yield (@PreciousYield) on twitter.
* Note that while I use the US Treasury – Precious Yield spread as a relative value metric, a better apples to apples comparison of similar instruments would be US Treasuries vs. a fully hedged gold position. For more information on a fully hedged gold position as a yield alternative, please visit our www.kilofutures.com website and read about The Cash and Carry Trade.
Gold price per ounce 1-Month Chart
Silver price by ounce 1-Month Price Chart
Platinum price per ounce 1-Month Price Chart
Palladium price per ounce 1-Month Price Chart
About the Author
Rob Perry is an avid student of the markets and an aspiring tennis player. He is currently Chief Strategist for Precious Yield as well as Chief Investment Officer of Pecan, a single-family office based in San Diego, CA. Most recently, he was located in New York City working as Chief Strategist of and a Portfolio Manager for Kingsland Capital, a multi-billion dollar boutique asset management firm focused on below-investment grade corporate credit. Twitter: @CIORobPerry
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