While much of this week’s market action was driven by anticipation of and reaction to geopolitical turmoil, it is remarkable how little volatility we have experienced (particularly in stocks) given the severity of the escalation in tensions between the US and Iran. As I’ve said consistently over the last few months and generally to the benefit of those holding a gold investment or silver investment (gold set new cycle highs this past week), much of this can be explained by central bank activity. That said, I won’t spend as much time going over the Fed this week because as the famous Led Zeppelin song title goes, “The Song Remains the Same”. As a result, I’ll first review geopolitical before briefly touching on the Fed, this week’s jobs report as well as other economic data and the upcoming corporate earnings season. Let’s get started.
As you know from last week’s update, last Friday, President Trump ordered a successful US airstrike that killed Iran’s top security and intelligence commander, Maj. Gen. Qassim Suleimani. When markets opened for trading this week, fears of retaliation and further escalation hung over the mood of investors as Ayatollah Ali Khamenei continued his vow of “harsh revenge”. Fast forwarding to Tuesday evening, Iran made good on their promise by launching missiles at US military facilities in Iraq. Markets knee-jerked lower with Asian stocks tumbling, US stock futures trading sharply to the downside and the LBMA AM gold price fix (5:30AM EST) hitting its high for the week. However, as the assessment of casualties (of which there were none) and damage progressed, it became increasingly probable that President Trump might opt to not further escalate and the markets began to recover. This was confirmed shortly before the markets opened on Wednesday as President Trump said that Iran appears to be “standing down” and that he would respond to the attack with new sanctions on Iran (as opposed to additional use of force). While this response appears to have stabilized the situation, I think it’s too early to fully understand the unintended consequences of these actions. For example, we already know that Iraq’s parliament as well as its outgoing prime minister have requested that the US pull all troops out of the country. More time is needed to see how this recent set of actions reshapes US influence in the broader Middle East landscape. In the face of it all, US stock indices achieved new all-time highs and as I’ve said in the past, I think this finger can be pointed squarely at the Fed.
So what is new with the Fed? Not much as policy makers continue the status quo. To be clear, that status quo equates to approximately $60BN of T-bill purchases a month and a growing balance sheet while pledging to hold rates steady. I did some math to check and make sure that the Fed is on target with their T-bill purchase commitments (at least through Q2 2020). The result of that analysis is shown in the chart below.
Economic data this past week did little to cause investors to question the Fed’s current stance. On Tuesday, US ISM Non-Manufacturing PMI beat consensus estimates and remains comfortably above 50. Employment reports were mixed vs. consensus but both were still indicative of economic expansion. On Wednesday, ADP reported a 202K gain in employment vs. consensus of 160K. This was followed on Friday by the US Non-Farm Payrolls which showed a 145K gain vs. expectations of a 164K gain. As you can see from the chart below, the economy has consistently produced employment gains since 2011 using either metric.
And despite Friday’s slight disappointment, the Atlanta Fed GDPNow estimate continues to hold up. In fact, consensus has now begun to catch up as shown by the grey shaded band in the chart below.
Finally, corporate earnings season is right around the corner. Trading at a forward 12-month multiple of 18.4x per FactSet Insight, stock valuations continue to climb higher and higher above both the 5-year and 10-year averages. This is in the face of a 4.7% decline in Q4 earnings estimates which is greater than the 5-year (-3.3% reduction), 10-year (-3.1% reduction) and 15-year (-4.4% reduction) averages. As a result, Q4 earnings are expected to decline 2.0%, and this would be the first time the index reported four straight quarters of earnings declines since 2H 2015/ 1H 2016. Dare I invoke Fed policy again as the cause? Seems reasonable to me.
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 finished the week just a touch off of its all-time closing high set on Thursday at 3,265. The index was able to book a gain of nearly 1% despite Iran’s retaliation against the US and its resilience continues to be a hot topic for debate (Fed-induced rally vs. genuine acceleration in the economy vs. some combination of both).
From a technical perspective, the S&P is reapproaching “overbought” territory according to traditional non-trending indicators. However, trending indicators continue to argue that we should ignore these signals. Positive trending signals, however, do not last forever. With the number of stocks leading the market higher narrowing significantly, we may see a turn in the trending indicators sooner rather than later and corporate earnings season will likely be a catalyst one way or the other. If we get a dip, expect it to be shallow with the Fed currently in QE/not QE mode. Note that the 50-day moving average currently sits at 3,153 (a 3.4% decline from current levels). This is the first level I would look to for support if we see the market turn.
In terms of the VIX, fears receded throughout the course of the week. The index climbed as high as 16.39 on an intraday basis Monday before starting its descent, finishing the week at 12.56. On an intraday basis Friday, the VIX nearly broke my key level of 12 which has indicated the potential for mini reversals in the market over the past year. This also lends credence to the view that trending indicators may be starting to look tired. Note that at 12.56, the VIX is just over one standard deviation from the mean since January 1990 using log normal data.
The US government bond yield curve experienced a small parallel shift higher this week as the need for flight to safety investments declined in conjunction with US-Iran tensions. Case in point, Treasury yields peaked on Wednesday after President Trump’s announcement. However, government bond prices recovered somewhat towards the end of the week on the weaker than expected non-farm payrolls report. Specifically, 10-year Treasury yields increased from 1.80% to end the week at 1.83%. 10-Year Treasury yields continue to hold the late October lows of just under 1.7% and I am still focused on a yield level of 2.15% for the upper end of the trading range. 2.0% also provides an important psychological level.
3-month T-bills (the best barometer of future Fed action) saw yields increase from 1.52% to 1.54%, still close to the bottom of the current Fed Funds target range. At these levels, I believe the market is still leaning towards additional future rate cuts but am respectful of the fact that this signal is somewhat distorted by the Fed’s current T-bill purchase program. Consequently, Fed Funds futures are probably the more reliable indicator in this environment. This week, the probability of a rate cut by year-end 2020 (as indicated by those futures) fell to 58.5% from 63.1% and was low as 55% in the middle of the week.
On a combined basis with the 10-Year, the current spread with 3-month T-bills is 29bps and remains below the spread from early November. Remember that if you look at this relationship on a longer-term basis, this spread should make its way back to somewhere in the range of 300-400bps over time.
Finally, 2-Year Treasury Note yields increased from 1.53% to 1.56% by week’s end. With Precious Yield continuing to offer 2-year physical gold term deposit rates of 2%, the US Treasury – Precious Yield spread* is in Precious Yield’s favor at -.44%. 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.
With rising equities and higher US Treasury yields, the US dollar strengthened against most major currencies as measured by the US Dollar index (Ticker: DXY ). The index increased 0.5% in total with most of the gains booked in the second half of the week after tensions with Iran decreased. Along the way, the index reclaimed the 97 level, ending the week at 97.36. Breaking the dollar performance down by its major constituents, the USD strengthened nearly 0.4% against the Euro (57.6% index weight) and a less impressive 0.2% against the Pound (11.9% index weight). The relative outperformance of the Pound was driven by continued steps towards Brexit becoming law in the UK, thus continuing to remove uncertainty from the situation. Finally, the dollar strengthened the most against the Yen (13.6% index weight), increasing almost 1.3% for the week. This outsized move was likely the result of fears being removed from the marketplace as the US-Iran situation played out.
As has been typical over the last several months, a strengthening of the US dollar vs. other major currencies coincided with a weakening of the US dollar vs. the Chinese yuan. As far as I can tell, the Phase One trade deal continues to be on track for a January 15th signing or shortly thereafter. In terms of yuan strength, the small bit of follow through from the Phase One trade deal announcement continues to be seen in the fx pair with the yuan strengthening nearly 0.7% this week to finish at 6.91:1 As mentioned last week, the yuan strengthening we have seen falls short of the exchange rate just prior to the early May implementation of tariffs and if we see further roll-back of existing tariffs during phase two, I would continue to look for the exchange rate to fall back toward its early May 2019 level of approximately 6.75:1.
As alluded to in the overview, the price of gold in ounces almost perfectly followed the increases and subsequent decreases in geopolitical tensions over the course of the week. When all was said and done, as measured by the LBMA afternoon fix (10:00AM EST), the price of gold per ounce increased 0.3% to finish at $1,553/oz. Mid-week, prior to Trump’s tension deescalating announcement, the LBMA morning fix hit a new cycle high of $1,582/oz. with spot gold prices having spiked over $1,600/oz. in the wake of Iran’s retaliation. Given that I believe these geopolitical events are the main reason for the breakout to new cycle highs, I hesitate to say that the old cycle high of $1,546/oz. set on September 4th will provide a new floor to the market. Instead, I am focused on the 50-day moving average of $1,487/oz and the 200-day moving average which has now moved up to $1,429/oz., a shade above my downside trading range of $1,400-$1,425/oz. As I’ve said in the past, the upside breakthrough of 1.9% on the 10 Year Treasury Note yield drove gold prices to my initial downside target and I would expect an increase in yields above 2% to put my these next downside targets in play. The questions are 1) whether or not active QE by the Fed will allow 10-year yields to rise above the 2% level and 2) whether geopolitical tensions are truly on the decline. As I said last week, I suspect that the answer to the first question is “no” until the Fed changes course (2H 2020?). For the moment, I do believe global tensions will temporarily recede but expect that they will resurface later down the road. So as long as there is no technical pull back in the stock market, I would expect spot gold prices to be under some pressure.
From a fundamental perspective, I talked a bit last week about the rapid pace of gold accumulation by global central banks, particularly Russia and China. I thought I’d add a few other recent trends for readers to keep in mind. First, 2019 US mint gold coin sales were the weakest on record. In addition to the reasons mentioned in the linked story, it’s likely that coin dealer inventories became bloated with retail sellers and thereby reduced coin dealer demand from the mint. I conclude this from data which shows that coin premiums dropped sharply from January through August of 2019, even becoming negative (i.e. a discount to spot) at their lows before recovering over the balance of the year. At the moment, it does not appear as though retail holders of physical metal are taking advantage of the recent new highs in gold prices because coin premiums are back to more normal levels. As long as this stays true, it indicates that any doward movement in spot prices should be orderly.
Turning our attention to the “Gold VIX” (Ticker – GVZ ), the index continued its upward movement in lockstep with gold through mid-week (peaking at 14.65 on an intraday basis Wednesday) before falling over the balance of the week to finish at 12.27. This move has brought gold volatility to just over 1 standard deviation below the average (since June 2008) using log normal data. Looking at both the AM & PM LBMA fixes, the gold price per ounce trading band checked in at $34/oz. or 2.2% between the high and the low. I use these price bands to better understand the movements in the “Gold VIX” (Ticker – GVZ ) levels from above. 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 ). 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 have 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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