There was big excitement this week on a number of fronts with respect to news flow, but oddly, most of it (with a few exceptions) did little to move markets broadly. Think about it – we got newfound clarity on central bank policy, US-China trade and UK elections/Brexit all within the span of three short days. And while that sounds like quite a pile to get through, I think the fact that markets behaved the way they did tells us something important about how we should interpret each of these outcomes and how much time and space we should dedicate to analyzing them. So with that, let’s finish this year’s last Precious Metal Market Update on a high note! We’ll be back with our next report for the week ended January 5th, 2020!
Since it’s my number one key driver of the current risk-on market environment and most relevant to anyone holding a gold investment or silver investment, let’s start with the Fed. Wednesday saw the end of the Fed’s last scheduled meeting for 2019 and the outcome of its rate decision was much as expected. This included a dovish revision to the individual members’ future projections which significantly narrowed the gap with current Fed Funds future expectations. This caused longer-dated Treasury yields to fall initially and the dollar to weaken which I will discuss in more detail below. On Thursday, the Fed followed its rate decision with an announcement that it is ramping up its repo operations to head off year-end funding issues. It will be interesting to see if the amounts outstanding under these facilities ramp up significantly as we approach year-end. As I’ve said for several weeks now, the main driver of the Fed’s balance sheet growth recently has been the T-bill purchase program. Repo outstandings have remained relatively stable at +/- $200BN since the end of September and have not been the driver of incremental growth (see below).
Not to be lost in the central bank shuffle, on Thursday, the ECB also kept its rates unchanged during new President Christine Lagarde’s first monetary policy meeting. The central bank stated that until it has seen the inflation outlook “robustly converge” to a level close to but below 0.2%, rates will stay at the current level. In addition, and similar to the Fed’s balance sheet expansion, the ECB confirmed that its net asset purchase program had started in November at a monthly rate of EUR 20BN and would continue “as long as necessary”. This was all as expected and did not carry the same temporary impact on markets that was seen from the Fed’s revised future rate path expectations. Why temporary? Because progress in the US-China trade stand-off unwound some these market movements. So let’s cover all things geopolitical next.
On Thursday, just as US markets were opening, President Trump tweeted that the US was “very close to a BIG DEAL with China”. This more than reversed the impact of a more dovish Fed on 10-Year Treasury Note yields and stocks recovered from their modest losses earlier in the week. In addition, the yuan strengthened significantly against the dollar, falling back below the psychologically important 7:1 barrier and copper prices have broken out to new cycle highs.
Adding to Thursday’s risk-on sentiment, news of the Conservatives victory in the UK elections brought greater clarity to Brexit and the likely go-forward pro-business posture of the British government. Some market participants saw this strongly pro-business result as even more important to global growth than a Brexit resolution.
On Friday, the US-China phase one trade agreement was officially announced but details were relatively hard to come by. Per Reuters reporting, the agreement includes a commitment from China to purchase $16BN more per annum of agricultural products over the next two years and to buy, in aggregate, $200BN more in US goods and services focused on manufacturing, energy, agriculture and services over the same time frame. No further specifics were given so as not to distort markets in advance of Chinese purchases. In return, the US is cutting tariffs in half (to 7.5% from 15%) on $120BN worth of Chinese goods and will not charge Beijing with any of the new tariffs that were set to begin on December 15th. However, the US will be maintaining its 25% tariff on approximately $250BN worth of Chinese imports. Whether or not the remaining tariffs will be on the table as part of the “phase two” talks is unclear, but those talks with China will begin immediately. The following graph shows the US phase one concessions in summary form.
Given that there was no follow through rally in the equity markets or the yuan upon the deal announcement, it’s easy to conclude that the phase one details were underwhelming and only somewhat better than kicking the can down the road further. Admittedly, this was muddied a bit by domestic economic data, but I feel comfortable in that assessment given that I share the reported views of Goldman Sachs’ Chief Economist. Speaking of economic data, it was a relatively light week in terms of major releases and from a 60,000 foot point of view, the Atlanta Fed GDPNow estimate for Q4 remains at 2.0%, consistent with last week. That said, Friday’s retail sales were a disappointment coming in at 0.2% growth MoM vs. a 0.5% consensus estimate. Prior month growth was revised upward by 0.1% but still not enough to offset the current month miss. While disappointing versus the consensus estimate, I don’t view these results as alarming and the timing of Cyber Monday could have played a role in the miss. As we have discussed over the last several months, the consumer has been the linchpin to sustaining the economic expansion in the face of the trade war and therefore, we must watch consumer-related data closely.
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 gained a little over 0.7% this week to close at a new all-time high of 3,168. The bulk of the week’s gains occurred on Thursday, driven by President’s Trump’s tweet that the US was “very close to a BIG DEAL with China” as mentioned in the overview. These gains were aided by the UK elections in which the Conservatives were given “an overwhelming mandate” to get Brexit done. This positive momentum continued into Friday’s trade as confirmation of the phase one deal saw the market hit an intraday high of 3,182. However, concerns regarding the deal’s details surfaced and the market closed essentially unchanged on the day.
Technically speaking, while marching slowly back towards overbought territory, the market likely has more room to run before one might become concerned about a near-term pull back. Clearly, the UK elections and the US-China trade agreement benefited this march. To reiterate, my confidence in this outlook stems largely from the belief that the Fed’s QE/not QE launch is the main culprit behind this rally and the overall decline in market volatility. Abent further updates, these Fed purchases are expected to last at least into the second quarter of 2020. This provides a safety net underneath the market. Consistent with last week, I believe that the early December intraday low of 3,070 provides an interim floor to the market with the 50-day moving average now having moved up to 3,063.
In sync with the S&P 500 moving higher, the VIX finished the week lower at 12.63. The early part of the week saw VIX levels rise as high as 16.9 on an intraday basis. Even with this temporary spike, the VIX spent the entire week below its long-run average since January 1990. As of Friday’s close, the VIX is almost exactly one standard deviation below the same long-run average using log normal data. As I have discussed previously, sub 12 readings on the VIX have usually signaled the potential for a technical pullback in the market this year. As such, the current VIX level indicates movement back toward overbought territory but isn’t flashing an immediate warning signal yet. As a reminder, in my opinion, major (as opposed to mini) reversals tend to occur as the VIX approaches two standard deviations. If you are interested, I showed a graph of this in the Precious Metal Market Update – 17 November 2019. I continue to monitor this data as an additional tool to try and decipher the next major market top.
With so much news flow in the last half of this past week, 10-Year Treasury Note yields gyrated. First, yields dropped after the Fed left rates unchanged on Wednesday and the future rate path projections were reduced (more on that in the US Dollar section). This drop was immediately reversed and then some on Thursday as President Trump’s aforementioned tweet led many market participants to believe a US-China trade deal was imminent (which it was). As details of the deal were released on Friday, however, yields fell once again. All told, 10-Year Treasury Note yields fell 2bp to end the week at 1.82%. Of note, the 10-Year continues to hold the late October lows of 1.7% and to the upside, I still feel as though a yield level of 2.15% is the upper end of the trading range.
In contrast, 3-month T-bills (the best barometer of future Fed action) saw yields increase to 1.57% vs. 1.53% last week. With the Fed leaving rates unchanged on Wednesday, an increased yield of 1.57% indicates more uncertainty over additional moves on a week over week basis as the Fed Funds target range remains 1.50% – 1.75%. On a combined basis with the 10-Year, the treasury curve is now 6bps flatter and continues to struggle to steepen beyond what it was able to achieve in early November.
If you look at a longer-term version of this same chart, it would seem that this spread should make its way back to somewhere between 300bps and 400bps at some point. The question is, how will it do that? Will it steepen as the result of the Fed cutting short-term rates in response to a weakening economy? Or will it steepen as a result of an accelerating economy, higher inflation and consequently, higher 10-year Treasury Note yields. To me, I think it will have to be a combination of both. After all, even if the Fed cut rates to zero again, the 10-year Treasury yield would have to move at least 125bps to get the spread back into that range.
Switching to 2-Year Treasury Notes, yields remain unchanged at 1.61% for the second consecutive week. 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 -.39%. 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.
The US Dollar, as measured by the US Dollar index (Ticker: DXY ), was weaker by a little over 0.5%. The bulk of this weakness came surrounding the two-day Fed meeting in the early to mid part of the week. If you remember from last week, I showed a CME chart that indicated that the highest probability outcome had shifted to 50bps of cumulative easing from a single 25bp cut for all of 2020 by the Fed. Unfortunately, the CME-provided chart that I used in support of that assessment appears as though it was incorrect. Based on the data that shows on their website today, the chance of a 25bp cut by the end of 2020 was just under 63% as of last Friday and fluctuated in a range of mid 50s% – mid 60s% over the course of this week (both pre and post Fed meeting).
Of note, the release of individual members’ future projections (i.e. the “dot plot”) showed a dovish downward shift vis-a-vis the September meeting albeit still not quite as easy as Fed Funds futures imply. On balance, the dot plot indicated that no hike was expected in 2020.
Breaking the dollar performance down by its major constituents, the USD fell nearly 0.6% against the Euro (57.6% index weight) but gained a little over 0.7% against the Yen (13.6% index weight). Gains against the Yen were logged as news of the US-China trade deal lessened the need for flight to safety assets. Finally, and once again claiming the top spot for fx volatility this week, was the Pound. News of the Conservatives victory in the UK elections brought greater clarity to Brexit and the likely go-forward pro-business posture of the government. When all was said and done, the dollar weakened an additional 1.4% against the Pound (11.9% index weight).
Before moving on to the Chinese yuan, I’d like investors to keep in mind the drag on corporate earnings that has been caused by dollar strength over the last two years. The below chart shows you that but also shows you how currency headwinds are beginning to abate on a year over year basis. While not quite a tailwind for earnings yet, it’s something to watch. It might just become another reason why stocks can remain resilient and head even higher.
As discussed in the overview, President Trump’s Thursday tweet drove meaningful appreciation of the yuan, causing it to fall back below the psychologically important 7:1 level against the dollar. Given the extremely limited roll back of existing tariffs, it does not surprise me that the exchange rate post deal falls well short of the exchange rate just prior to the early May implementation of tariffs. If we see further roll-back of existing tariffs during phase two, I would look for the exchange rate to fall back to it’s early May level of approximately 6.75:1.
Extending the recent trend, the price of gold in ounces produced very little excitement this week. On the positive side, falling Treasury yields and a weaker USD were able to offset the negative impacts from rising equity prices and decreased volatility. Add it all up and the gold per ounce price increased from $1,459/oz to settle $7 higher at $1,466/oz as measured by the LBMA afternoon fix (11:00AM EST). Of note, spot gold prices continued to climb going into the NY close (4:00PM EST), finishing at $1,475/oz. In terms of technicals, I am still focused on the $1,400-$1,425/oz trading range to the downside and note that the 200-day moving average sits squarely within this range at $1,407/oz. To reiterate, 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.
Let’s move on to the the “Gold VIX”. It produced even less excitement than the gold price itself this week with the index falling further to 10.39 from 10.73 last week. This low level of gold volatility indicates to me that there is pent-up energy building given that Friday’s closing level is in excess of 1.5 standard deviations below the average (since June 2008) using log normal data. Consequently, I would expect a sharp move one way or the other in the not too distant future. Looking at both the AM & PM LBMA fixes, the gold price per ounce trading band narrowed, fluctuating $13/oz. between the high and the low (vs. $18/oz. last week). 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 ). 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 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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