Happy Early Thanksgiving! We here at Kilo Capital, Precious Yield and Kilo Futures, are very thankful for our readers and our clients. We are also thankful for all of your referrals as you help us redefine what it means to hold precious metals as part of a broader investment portfolio. Simply said, without you, bringing a yield on gold (and other precious metals) to market would not be possible. Given this week’s holiday, the next Precious Metal Market Update will be published on December 8th.
This week was clearly dominated by headlines related to US-China trade negotiations and most of those headlines were negative. Market reaction? Almost sanguine if you ask me. Yes, domestic economic data was positive on many fronts and we should give it proper recognition. I will do this in more detail below. But also, my conviction surrounding a Fed induced tranquility (by the way, China cut rates this week as well) continues to grow the more trading days we see like the ones we saw this past week. December will present its challenges, however, with an FOMC meeting, the UK elections, an ECB meeting, and the December 15th tariff implementation deadline fast approaching. Can the markets remain calm in the face of these events? Will the asymmetric upside environment continue to dominate? One way or the other, it will be a good test of my Fed theory and should be of great interest to anyone holding a gold investment or silver investment.
On the geopolitical front, several negative headlines broke this week. Starting with Monday, news that the mood in Beijing is pessimistic about a trade deal filtered into the markets with muted impact. On Wednesday, there were signs that the trade talks might slip into next year. Complicating matters further, a Senate bill in support of the Hong Kong protestors muddied the picture more. How do I sum this all up? I believe that the markets are pricing in a 65% chance that the trade deal fails – you can read more about this in the US Dollar section below.
Shifting to economic data – it was a bright spot. Unfortunately, none of the releases were considered major. This explains why the Atlanta Fed’s GDPNow Q4 estimate only inched a bit higher to 0.4%. It’s still early days, but note that Q4 consensus is in the range of 1.2% – 2.1% so there is room for disappointment. Let’s now look at some of the individual data that came out.
Starting with housing, there were several reports released throughout the week. Those data points either met or exceeded expectations. This includes building permits (1.461MM vs. 1.385MM consensus), housing starts (1.314MM vs. 1.32MM consensus) and existing home sales (5.46MM vs. 5.47MM consensus). More important than the housing data in my opinion, indications on the health of the consumer stayed strong while manufacturing PMI results improved. The US Michigan Consumer Sentiment index final reading for November came in at 96.8, an upward revision from its initial reading of 95.7. The IHS Markit US Manufacturing PMI also beat expectations, coming in at 52.2 vs. the estimate of 51.3. As you know, manufacturing has been the real weak spot in the US economy as the trade war has played out but does not comprise a big enough percentage of GDP to cause a recession in and of itself. The below chart shows the rebound that we’ve experienced over the last few months in this index. Clearly, economic data was a nice counterweight to the negative trade war headlines this week.
Before I wrap up with the overview, as I’ve been saying recently, none of my other indicators are flashing incremental warning signs at this point. Without going through them all, I’d like to point out that the US Treasury – German Bund spreads appear to be stuck in the +210bps – +220bps range. That said, in my opinion, there’s nothing in the below chart that indicates the overall trend of tightening spreads (since the all-time wide last November) has changed.
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 was modestly negative this week, declining 0.3% to finish at 3,110. The index traded in an extremely narrow band all week and never closed below the 3,100 level. This is quite impressive/resilient given the negative headlines that persisted with respect to the US-China trade talks.
From a technical perspective, I’ve been concerned that the market is overdue for a pullback (albeit a modest one). While this week was pretty boring in terms of price action, it did have the positive impact of letting some steam out of the market. Another week or so like this would go a long way towards removing this technical (as opposed to fundamental) risk. However, if we don’t escape the pullback, I still believe that the previous ceiling of 3,025 now provides a floor to the market with the 50-day moving average of 3,017 not far behind it. This would represent a nearly 3% decline from current levels. I also continue to believe that the Fed’s QE/not QE launch that I discussed in my Precious Metal Market Update – 20 October 19 is the main culprit behind this rally and the overall decline in market volatility. Remember, Fed purchases will last at least into the second quarter of 2020 so the safety net underneath the market has some time to run.
As one would expect, the VIX showed a modest uptick this week with the decline in the S&P. The index closed at a level of 12.34 and as the narrow trading band on the S&P would suggest, continues to be more than one standard deviation from its long-run average (since January 1990) using log normal data. At this time, I’d like to reiterate a few points from last week. First, at these low spot readings on the VIX, “it becomes incrementally harder for the index to move lower”. Next, I’d like to remind readers that we have seen several mini reversals this year when the VIX drops below 12. Why do I call them “mini”? Because on a longer-term basis, major reversals occur as the VIX approaches two standard deviations below the long-run average using log normal data. Two standard deviations to the downside represents a VIX index level around 9 currently. See last week’s Precious Metal Market Update for the long-term chart on VIX standard deviations. I will continue to monitor this data as an additional tool to try and decipher the next major market top.
The US Treasury yield curve logged its second straight week of flattening, threatening the re-steepening trend that began at the beginning of September as shown in the chart below.
Let’s break down the components of this flattening. On the longer end of the curve, 10-year Treasury Notes rallied with yields falling 7 bps from 1.84% to finish the week at 1.77%. Admittedly, I’ve been surprised that 10-year Treasury Note yields dropped below 1.90% so quickly after breaking through their September 13th cycle high. While I still feel as though a yield level of 2.15% is the new upper end of the trading range, a break below the late October lows of 1.70% would likely cause me to reconsider.
Conversely, 3-month T-bill yields (the best barometer of future Fed action) increased slightly closing at a yield of 1.58% vs. 1.57% last week. With the Fed’s most recent target Fed Funds range of 1.50% – 1.75%, a yield of 1.58% indicates uncertainty over additional moves by the Fed. Consistent with last week, Fed Fund futures are still pricing in a wide variety of outcomes by the end of 2020. The highest probability outcome continues to be a 25bp cut and chances of cumulative easing have risen to 66.4% from 61.3% last week. The futures market also continues to price in a slim chance of an interest rate increase. On balance, the market seems to believe that the Fed will turn out to be more dovish. Likewise, the wide dispersion of probabilities indicates a lack of conviction in that view.
This week, 2-Year Treasury Notes decided to act like the shorter end instead of the longer end of the treasury curve with yields unchanged at 1.61%. 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. The spread between these two instruments remained constant at -.39% on a week over week basis. 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.
As measured by the US Dollar index (Ticker: DXY ), the dollar recouped much of the prior week’s losses to finish up just under 0.3% at 98.27. Dollar strength showed itself against the Euro (up 0.3%; 57.6% index weight) and the Pound (up 0.5%; 11.9% index weight). To remind readers, I expect that volatility in the Pound/Dollar currency pair will likely pick back up between now and the end of January. Finishing with the Yen, the dollar was 0.1% weaker (13.6% index weight). In times of global stress, the Yen becomes a flight to safety option for investors given that the Japanese people own most of the country’s debt and therefore there is little pressure from foreign holders. Perhaps the Yen benefitted slightly this week from the negative US-China trade headlines.
Breaking with recent assumed correlations but consistent with the trade dispute headlines this week, the dollar strengthened 0.5% against the Chinese Yuan. Usually, whatever direction the dollar heads as measured by the dollar index means the complete opposite for the dollar trading against the Chinese Yuan – just not this week. Remember, my thinking is that as the trade war gets worse, other developed market currencies become more attractive versus the dollar but by the same token, it’s also pretty clear that the trade war has a greater negative impact on China than it does on the US.
Diving a bit deeper, early in the week, I tweeted a simple analysis which suggested that the USD/CNY currency pair was indicating a 65% chance of a Phase One trade deal failure. You can see my comment and the analysis behind that tweet here. I’m including the chart that was attached to that tweet below so that you can see the recent trading range for this fx pair.
Also, this same chart continues to support my belief that 6.75:1 (levels last seen in early May) is a good target if the Phase One trade deal is successfully completed.
Much like 10-Year Treasury Note yields, gold prices appear as though they need to find a direction. This week, the impact of a stronger dollar seemed to offset the perceived benefits of falling equity prices, higher volatility and lower Treasury yields on the price of gold. As measured by the LBMA afternoon fix (11:00AM EST), the gold per ounce price decreased from $1,466/oz to settle $2 lower at $1,464/oz. Spot gold prices declined a bit further going into the NY close (4:00PM EST) with a last trade of $1,461/oz. At these prices, we are 5.3% below the recent cycle high of $1,546/oz., and I am still focused on the $1,400-$1,425/oz downside trading range price target. I would note that the 200-day moving average sits just below this trading range at $1,396/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 next downside targets in play. From last week, you know that these targets look reasonable in my opinion when looking at gold prices concurrently with the last time 10 Year Treasury Note yields were above 2% in the late June/early July time frame. The bigger question is if 10-Year Treasury Note yields will reach those levels anytime soon with the Fed currently buying T-bills. I wish I had that answer.
Checking in on gold volatility, the “Gold VIX” was a touch higher this week with a reading of 11.32. Looking at both the AM & PM LBMA fixes, the gold price per ounce trading band stayed largely consistent, fluctuating $17/oz. between the high and the low (vs. $15/oz. last week). I use these price bands to better understand the movements in the “Gold VIX” (Ticker – GVZ ) levels from above. A slight widening of the price band (1.1% between the high and low LBMA fix) is consistent with a slight increase in volatility. 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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