Please note that I will be off Labor Day weekend and our next weekly market report will be for the week ending September 8th.
Let’s start this week’s discussion with an odd little wrinkle. Did you know that you would have had to look beyond the LBMA afternoon fix of the gold price per ounce to really understand what happened with the gold money relationship this week. Why? Well, the LBMA afternoon fix is set at 3:00PM GMT for gold which is 11:00AM EST. If I were to do this week’s analysis on the LBMA afternoon price fix movements alone, I would miss how the price of gold accounts for news after the daily fixing time. In a typical week, there isn’t much that happens in that window after the fix and before the US market closes so I don’t bother discussing it. But this week, there was significant news flow and market reaction to the escalating US-China trade war that happened in that window. Adjusting the analysis to include what happened during that window, the gold per ounce price was up once again. Let’s cover geopolitical first, since it was the main event of the week.
On Friday, China announced retaliatory tariiffs on $75BN of US goods starting September 1st. This was in response to the August 1st US announcement of a 10% tariff on the remaining $300BN of Chinese imports set to begin September 1st. As you know from last week’s report, the US subsequently announced a delay in some of these tariffs until December 15th as well as fully excluded some items. However, some products still are scheduled to be tariffed on September 1st. But that wasn’t all. Shortly after the LBMA set the afternoon fix for gold, President Trump “ordered” American companies to immediately start looking for an alternative to China and promised to further respond later in the day to China’s newest round of tariffs. Sure enough, at 2:00PM EST, President Trump announced (via tweet) that the existing $250BN of imports that are taxed at 25% would be taxed at 30% starting October 1st. Furthermore, he announced that the remaining $300BN of imports (some of which will start being taxed September 1st) would be taxed at 15% instead of the original 10% level. Starting with President Trump’s “order”, the rest of the trading day was dominated by a massive flight to quality as equities declined sharply, government bonds rallied and the price of gold increased. You won’t be surprised to see where the USD/CNY exchange rate sits as a result.
Risking boring you with my repetitiveness, I believe that continued trade tensions increase the likelihood that US corporate revenue and a return to earnings growth will be challenged in the face of a global slowdown and a drawn out US-China trade war. I also still believe that it is unlikely that the full impact from the additional 15% (originally 10%) tariff that was delayed from September 1st to December 15th or a further escalation from here is fully accounted for and therefore, puts the expected earnings rebound projected to start in Q4 2019 and further accelerate in 1H 2020 in jeopardy. Given this backdrop and despite the seemingly continued resilience of the consumer (more on this later), I continue to advocate for investor alert and a rotation towards a more defensive portfolio.
Despite the week being defined by trade war news, there were other interesting events that happened, but none moved the markets in a similarly violent manner. For example, on Thursday, Fed Chair Powell’s much anticipated annual remarks from Jackson Hole were viewed by Fed Fund futures as a bit more hawkish than the market was expecting. Why do I conclude that? Because even though he stated that the Fed would “act as appropriate to sustain the expansion,” he also said that there is no “rulebook” on trade wars and that the Fed may have to “look through” short-range developments. Fed Funds futures must have focused more heavily on that second remark, because the contracts started to price in a small probability that the Fed wouldn’t cut rates AT ALL in September. This was noteworthy versus the end of last week where the same futures contracts were pricing in a 100% chance of a 25bp cut and a 22% chance of a 50bp cut. Friday’s trade war news, however, reversed a bit of the move.
US economic data also provided some interesting clues this week as the releases were, on balance, below expectations. In particular, Thursday’s PMI data continued to set the bar lower. I’ve talked for awhile about the global weakness in manufacturing but the US has managed to continue to expand albeit at lower rates. That is until now. The below chart shows how US manufacturing PMI finally dipped below 50 in August. Note that the left hand axis is US manufacturing PMI while the right hand axis is Euro Area manufacturing PMI for comparison purposes.
As discussed last week, the US is not a manufacturing dependent economy so we should view this data as concerning but not predictive of an imminent recession. However, the United States IS a services (and consumer) dependent economy. With that in mind, the US services PMI dipped to 50.9. This was well below consensus expectations of 52.8 and the previous month of 50.9 per Trading Economics. As shown by the chart below, the trend since March looks less than appealing. This, I intend to watch carefully.
Finally, I’ve spent a fair bit of time talking about the “flies in the ointment” for the bears: the consumer and copper prices. While the weakening services PMI may contain information as to the direction of the consumer, I also found David Rosenberg’s take on the recent retail sales numbers as instructive. He’s considered a permabear so keep his comments in perspective. As for copper, the front month futures contract has moved back down towards $2.50 and is once again approaching critical technical levels that help maintain the bulls narrative. We’ll see if it can continue to hold this level of support.
Before I look at each individual market, I’d like to remind readers that anyone who is thinking about buying gold 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. There are many and varied drivers of the gold money relationship. In support of developing that view, let’s review the major markets that precious metals take their cue from.
The S&P 500 declined 1.4% this past week to finish at 2,847. All of the damage was done on Friday after President Trump’s “order” . Of note, the index did not retest the 2,825 level on an intraday basis, as the market bottomed at 2,834 Friday afternoon. The index has tested the 2,825 three times recently and I wouldn’t be surprised to see it take another run at that level during the early part of this coming week. As discussed previously, the S&P has been recently confined to a price band delineated by the 50-day moving average (now 2,946 vs. 2,944 last week) to the upside and the 200-day moving average (now 2,802 vs. 2,797 last week) to the downside. Assuming no further catalysts, I would expect this range-bound market, when it decides to break one way or the other, to resolve itself to the downside given Friday’s news. This would be supportive of the price of gold.
Volatility, as measured by the VIX, increased from 18.57 to 19.87 this week. In unison with the S&P sell off, the VIX hit its highs on Friday. The VIX futures curve (September through December monthly contracts) remained in backwardation this week, indicating continued levels of stress in the market. Normally, VIX futures are in contango where the front month futures price is higher than spot and each successive monthly contract is higher than the previous.
#yield matters! Up until Friday, it looked as though US 10-year Treasury yields were going to increase for the first time in several weeks. The sell-off in US government bonds reached its zenith on Thursday in conjunction with Fed Chair Powell’s Jackson Hole remarks. But with Friday’s news, the 10-year Treasury yield ended up falling once again from 1.55% last week and 1.62% the prior day to 1.52%. However, Friday’s news was not enough to overpower the moves in the shorter end of the US Treasury curve. 3 month T-bill yields actually increased from 1.87% to 1.97% week over week, reaching as high as 2.00% on a closing basis on Thursday. Looking at the moves in the 10-year and 3-month in conjunction with one another, this caused the inversion to jump from -32bps to -45bps. Remember, with the Fed Funds rate currently in the range of 2% – 2.25%, a 3-month T-bill yield of 1.97% predicts one very near-term rate cut. As we’ve discussed for a couple of weeks now, Fed Funds futures are expecting more than just one cut by the end of the year.
Given last week’s intraday inversion between the 10-Year Treasury and the 2- Year Treasury, let’s take a moment to reflect on this part of the curve as well. First, we had more intraday inversions this week but again, never had a daily close that way. 2-Year Treasury notes, like 3-month T-Bills, were higher in yield, rising from 1.48% to 1.51%, after touching 1.61% on Thursday. Only 1bp separates 10-Year yields from 2-Year yields at this point.
Because Precious Yield continues to offer 2-year physical gold term deposit rates of 2%, the US Treasury – Precious Yield spread* once again favored Precious Yield at week’s end. The spread itself narrowed slightly to -.52% from -.49% last week with the aforementioned move in 2-Year Treasury notes. 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.
Finishing with overseas action, US Treasury – German Bund spreads continued to maintain their tightest levels since last November’s all-time wide of +280bps. In terms of levels, the spread ended the week at +221bps, slightly tighter from the prior week. The German bund component of this spread, at a yield of NEGATIVE -0.677%, continues to hover around its all-time closing low of -0.711%. A continued tightening of this spread is a key component to my recession watch list.
The US Dollar weakened 0.5% this week as measured by the US Dollar index (Ticker: DXY). Consistent with other markets, all of this move transpired on Friday. Of note, all major components of the index were stronger vs. the dollar. The Euro (+0.5%), the yen (+0.9%) and the Pound (+1.1%) all logged gains. As discussed in previous weeks, the Pound continues to experience additional volatility around Brexit news flow. Comparing Yen vs. Euro performance, it makes sense that the Yen outperformed given its safe haven status.
As it relates to the Chinese yuan, since you’ve already seen the chart, I’ll only take this opportunity to remind everybody that I continue to maintain that if any actual progress gets made in the trade talks, it should be a very solid positive for risk-on markets and conversely, the gold price per ounce would likely suffer. I maintain this view as the US Dollar – Chinese yuan exchange rate hits its highest level in a decade.
As measured by the LBMA afternoon fix, the gold price per ounce decreased 0.75% this week to $1,503.80/oz. As mentioned in the intro, I’m not going to leave the comparison at that. As of 4:00PM EST Friday, the price of gold had increased to $1,529.40/oz, a new cycle high and a 0.9% increase from the previous Friday LBMA afternoon fix. The escalating US-China trade war provided all of the elements for a gold rally ON FRIDAY with equity markets declining, volatility increasing, global bond yields sinking and the US dollar weakening. Including Friday’s post-LBMA afternoon fix gains, the gold per ounce price is up 19.6% since May 3rd, the last market trading day prior to President Trumps’ surprise announcement of Chinese tariffs on Sunday, May 5th. For future reference, the price of gold in ounces on that date was $1,278.55.
Switching gears, gold volatility increased handily to 18.36 from 16.86 the prior week. Intraday Friday, this volatility spiked as high as 20.46, above the average since June 2008 using log normal data. Remember, I use the “Gold VIX” (Ticker – GVZ ) to get a sense for this metric. 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 (ETF) 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 an investment in gold and silver has historically been associated with negative carry, Precious Yield 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 with Precious Yield allows for some cushion against price movements via the gold and silver yield. To learn more, please browse our website or contact us for more information. 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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