If you were following my @CIORobPerry or the @PreciousYield twitter accounts this week, you would have seen a few different market heavyweights come out with bullish views on gold. Both hedge fund billionaire Paul Tudor Jones and bond king, Jeffrey Gundlach, expressed macro views consistent with my own (see Precious Metal Market Update – 2 June 2019). The precious metal, however, has already booked some significant gains. Since May 17th when President Trump moved forward with new tariffs on China, gold is up over $70/oz or 5.5%. If you are thinking about buying gold as an investment, you should carefully consider what’s going to drive the gold money relationship from this point forward.
In my opinion, the key drivers for a continued rally in gold are 1) further weakening in US economic data, 2) lack of progress on a trade deal with China and 3) geopolitical tensions. Of these three drivers, weakening US economic data is by far the most important. I would note, however, that a trade deal (or lack thereof) with China is a key ingredient and very intertwined with how weak or strong that future data will be. Simply said, the market must believe that we are tipping further toward recession in order to drive gold prices higher still. With that, let’s take a look at some of the economic data/indicators from this past week.
To start, the Atlanta Fed GDPNow model estimate for real Q2 2019 GDP growth increased to 2.1% from 1.4% the prior week. Better than expected retail sales (+0.5% ex autos MoM vs +0.3% consensus expectation) and industrial production (+0.4% MoM vs. +0.2% consensus expectations) triggered an increase in the nowcast of second-quarter real personal consumption expenditures growth from 3.2% to 3.9%. This better than expected data combined with a decline in consensus expectations for Q2 GDP (see chart below) has significantly reduced the likelihood of a miss. I would emphasize that expectations still indicate economic growth albeit slower.
Not all economic data was rosy however. Inflation readings were in line to slightly weaker (core PPI, core inflation, import/export prices). Additionally, there were a few outright bearish notes with crude oil stocks unexpectedly rising and the consumer expectations component of the University of Michigan’s consumer sentiment index deteriorating sharply over tariff concerns and slowing employment gains. In another sign of weak sentiment, the Morgan Stanley Business Conditions Index posted the largest one-month decline on record due to a sharp, broad-based deterioration in sentiment across all sectors.
Let’s move on to our second key driver of gold, the trade war. In any given week, news flow related to US-China trade seems to bounce back and forth between hope and despair. To cut through the noise, I’ve taken to following the USD-CNY fx pair to assess the likelihood of a resolution. On that basis, it appears that we are moving farther away from an agreement – meaning the dollar continues to strengthen further even after the shock of Trumps’ May 17th tariffs. So while economic data was not supportive of gold prices this week, trade war concerns were.
Our third and final driver, geopolitical tensions, was clearly a positive for gold this week. We will get into more detail on US-Iran relations in the gold section below. Before we start, here’s a few other miscellaneous thoughts before jumping into the markets. Global bond yields remain on the floor but did not decline further. Expectations for future Fed rate cuts remained steady around aggressive easing. Interest in yield alternatives continues to pick up steam. Copper prices attempted to rebound earlier in the week but the gains didn’t hold.
And off we go…
The S&P was modestly higher this week, gaining 0.5% and trading in a relatively narrow range. Despite the modest gain, the index did close above the 2876 level that we outlined in last week’s report and increases our confidence in the market’s ability to return to the highs. Remember, this level represented the closing S&P level on the day prior to the new Chinese tariffs going into effect (May 16). Given the relatively narrow trading range of the week, the VIX declined, falling from 16.30 to 15.28. Interestingly, almost all of the VIX decline was realized on Friday despite increasing geopolitical tensions with Iran. I attribute the lack of market volatility to the better than expected economic data combined with the market’s faith in a newly accommodative Fed. Whether or not that faith is misplaced (60% chance of THREE rate cuts by the December Fed meeting) remains to be seen.
US 10-year treasury yields were flat for the week at 2.09% and remain at recent lows. Rates attempted to back up early in the week only to fall again as geopolitical tensions flared. Of note, the yield on the 3-month T-bill dropped from 2.28% to 2.20%. This is yet another sign of the market’s faith that the Fed is about to ride to the rescue. In fact, the market thinks there is a 28% chance of a rate cut NEXT WEEK. In addition to being a barometer for future Fed action, the falling 3-month yield also changed the shape of the yield curve. While still inverted, the inversion became less prominent falling to 11bps from 19bps the prior week.
Given the lack of movement in longer-dated government bonds, the US Treasury – Precious Yield spread remained stable. 2-Year Treasury notes finished the week at 1.84% while Precious Yield continues to offer 2-year term deposits of 2%. 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 – see our white paper entitled “The Alternatives Available for Precious Metals Investors” from March 24, 2018. Earning a yield on gold with Precious Yield, while always attractive for long-term holders, continues to be an attractive yield alternative in this environment.
The dollar index strengthened 1.1% this week, appreciating uniformly against the Euro and the pound with smaller gains against the yen. With global bond yields, Fed expectations and the US Treasury – German Bund spread relatively stable on the week, better than expected economic data allowed the dollar to log gains. We stand by our view from last week that additional weakness in the dollar will be more difficult to come by given the amount and timing of monetary policy easing built into expectations. Continued dollar weakness will be dependent on a further deterioration in domestic economic data and a further compression in the US Treasury – German bund spread.
As measured by the LBMA afternoon fix, gold finished the week up 0.8% at $1,351.25/oz. The precious metal was surprisingly resilient in the face of a decline in stock market volatility, a stronger dollar and steady longer-dated bond yields. Why was the gold price movement at odds with its typical drivers? Since most of the strength in gold prices came towards the end of the week, we believe this resilience was driven by geopolitical concerns. First, the suspected attacks on two oil tankers in the Gulf of Oman Thursday sent oil prices sharply higher. Then, Friday’s news escalated tensions further as President Trump directly blamed Iran for the attack pointing to video the Pentagon released as evidence. Consequently, if geopolitical tensions soften, we wouldn’t be surprised to see gold cool off a bit in the near-term. If some weakness in price transpires and given our base case view with respect to recession odds, that could provide an interesting entry point for those considering gold as an investment.
While an investment in gold has historically been associated with negative carry, Precious Yield offers investors the opportunity to earn a yield on gold. If you are a long-term holder, turning gold as an asset for diversification purposes into an alternative investment with Precious Yield allows for some cushion against gold price movements via the gold yield. To learn more, please browse our website or contact us for more information. Due to an upcoming vacation, our next market report will be published the week ending June 30th. In the meantime, please follow me (@CIORobPerry) or Precious Yield (@PreciousYield) on twitter for up to the minute insights.
Gold 1-Month Price Chart
Silver 1-Month Price Chart
Platinum 1-Month Price Chart
Palladium 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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