Dear readers – please note that I will be traveling and unable to publish a report for the coming week. The next Precious Metal Market Update will be published for the week ending November 10th.
Despite a mixed bag of economic data, markets generally operated in risk on mode this week as corporate earnings reports continued to be “good enough”. If the Fed wasn’t back to its easing ways, I’m not sure the markets would be having the same reaction. Why? Even with corporate earnings beats, we might experience a third consecutive quarter of earnings declines during Q3. As for precious metals, anyone holding a gold investment or silver investment this week was probably thankful that prices increased modestly given most of the typical drivers were a headwind. I’ll cover this in more detail in the Gold section below. With that, let’s examine this past week in order of importance. I’ll cover the Fed and corporate earnings first, followed by a review of this week’s economic data.
This week, the Fed surprised market yet again, announcing a sharp increase in the amount of help it is providing to the financial system. As you know, the Fed has been supporting the overnight repo market to varying degrees over the last 5 ½ weeks. On Wednesday, the Fed increased its overnight repo facility limit from $75BN to $120BN and its 14-day term repo limit from $35BN to $45BN. As you can see from the chart below, the announcement on the overnight repo side is curious given that collateral submissions exceeded the limit only on one day in October. My conclusion? The Fed must think that the liquidity needs of the market are going to increase. In my opinion, at best, this signaling from the Fed is a neutral and possibly a negative for future risk on sentiment.
On a combined basis with the 14-day term repo, facility outstandings hit a new high on Thursday as shown in the next chart.
Last week, I talked about how the Fed’s balance sheet expanded 5x from just under $900BN before the financial crisis to just over $4.5TN at its peak as a result of quantitative easing (QE). I still believe it is shocking that we ran into market liquidity problems with a Fed balance sheet that had only shrunk to $3.75TN via quantitative tightening. Between the repo auctions and T-bill purchases, the Fed’s balance sheet is approaching $4TN again. Combined with a 90%+ expectation that the Fed will cut its benchmark overnight rate at this coming week’s meeting (the third such 25bp cut this year), you can see how this monetary policy accommodation is helping to underpin the market in the context of weak corporate earnings expectations (see next paragraph). There is a debate, however, whether the lowering of the Fed Funds rate portion of this accommodation extends beyond one near-term rate cut. Some market participants believe that this may be the end of the Fed’s “mid-cycle adjustment” to rates and Fed Funds futures indicate only a 50/50 chance of an additional rate cut through the first half of 2020.
So how weak are corporate earnings expectations? This week, the number of S&P 500 companies reporting increased to 40% from 15%. Substituting actual earnings for earnings estimates for those companies that have already reported, in aggregate, Q3 earnings are anticipated to decline 3.7% (vs. last week’s estimate of a 4.8% decline) on 2.8% revenue growth (vs. last week’s estimate of 2.6% growth) per Factset Insight. This week’s batch of reports did little to change recent trends with more companies beating earnings estimates than the 5-year average but the magnitude of the positive beat less than the 5-year average. Revenues, however, continue to be above average on both metrics. Revenue growth remains key for the projected rebound in 2020 earnings that the market and analysts currently anticipate. As a result, I maintain my assessment from last week that “the early returns suggest that the market will be able to digest both results and guidance”. To that, I would add “in the context of a currently accommodative Fed.”
Shifting gears to this week’s economic data, reports were mixed. Early in the week, September US existing home sales fell to a seasonally adjusted annual rate (SAAR) of 5.38MM vs consensus expectations of 5.45MM and August’s rate of 5.5MM. Current sales rates are reminiscent of the late 1990s and still well below the peak which preceded the financial crisis.
In my opinion, from an overall economic impact perspective, probably the most important release for the week came on Thursday with US durable goods orders for September declining 1.1% on a month over month basis vs. a consensus forecast of a 0.8% decline. While a miss, it was somewhat counterbalanced by a slight upward revision to August’s numbers. Last, as far as precious metal investing is concerned, the final October reading for the University of Michigan consumer sentiment released Friday was the most important driver. The index showed a slight downward revision to 95.5 from its preliminary estimate of 96. This triggered a brief rally in government bonds and precious metals in the morning but reversed when the Office of the US Trade Representative (USTR) said that there was more progress in China trade talks after a call between Chinese Vice Premier Liu He, USTR Robert Lighthizer and Treasury Secretary Steven Mnuchin. Despite the disappointment over the sentiment reading, confidence has rebounded steadily since August as shown in the chart below and the overall level remains well above the average of 86.6 Index Points from 1952 until 2019 per Trading Economics. My quick read here is that the consumer continues to keep a lid on recession probabilities.
With the meat of this week’s news out of the way, I’ll mention a couple of other quick things that caught my eye. First, the ECB left rates unchanged in President Mario Draghi’s last monetary policy meeting at the institution despite continued dismal manufacturing PMI numbers coming out of Germany. Second, the Brexit impact on gold price was minimal this week despite a rapidly approaching October 31st deadline and news that Boris Johnson will ask for an early election on December 12 in return for giving UK lawmakers more time to review his Brexit deal. Finally, I’ve spent the last several weeks talking about how the US Treasury-German Bund spread has remained stable at new tighter levels. In reaffirming that view this week, I started to wonder about US Treasury spreads to other sovereigns, particularly Japan. In my Precious Metal Market Update – 6 October 19, I mentioned that the Bank of Japan was considering slashing bond purchases in October and that the Government Pension Investment Fund is pivoting toward buying more foreign debt (as opposed to domestic Japanese government debt). Well, here is a graph of the Japanese Government Bond – US Treasury spread since late last year when the Fed stopped raising rates. The reduction in spread between the two has been even more dramatic than the reduction in spread between US and German government bond yields. Again, I monitor these changes in spread direction for clues about recession.
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. 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 1.2% this week, reclaiming the 3,000 level along the way. Market tone was good with the index registering gains on 4 out of the 5 trading days. Tuesday (earnings related) and Friday (positive China trade news) saw the strongest performance. The index finished the week at 3,022, just a shade below its all-time high of 3,028, and on Friday, the index made three runs at that all-time high on an intraday basis.
From a technical perspective, the market is threatening to break out of its range going all the way back to early June. While my best guess was that this sideways trading was more likely to resolve itself to the downside, a new all-time high close would invalidate that view and create a new technical framework for the market. Remember, the current framework has stocks trading in a range of 2,825 to 3,025. I believe the near-term areas of downside support for stocks are the 50 day moving average (2,957) and the 200 day moving average (now 2,877). The next few trading days will be critical in determining if there is a paradigm shift. At these levels, I don’t believe stocks are technically overbought yet.
As for the VIX, it continued its decline, closing almost on the lows for the week at 12.65. The last time we saw these levels was towards the end of July. As you can see from the YTD chart below, any dip below 12 on the VIX this year has been quickly met with a reversal. Of note, at a level of 12.65, we are now more than one standard deviation from its long-run average (since January 1990) using log normal data.
Finally, VIX futures remain in contango (i.e. upward sloping). When the curve is in contango, it indicates that the market does not believe there will be meaningful near-term volatility. While these VIX readings are becoming more extreme to the downside, they can probably fall a bit further before threatening a technical reversal. Combined with the lack of an overbought condition in stocks, this makes it harder to call the near-term direction of the market from a technical perspective. Fundamentals should continue to be the sole driver of price in the coming week.
For the second consecutive week, US government bonds were practically asleep. Only on Friday with the news of progress in US-China trade talks was there some modest movement in the intermediate (2 year through 10 year) part of the yield curve. 10-Year Treasury Notes increased 4bps in yield to 1.80% from 1.76% while 3-Month T-bills (the best barometer of future Fed action) remained unchanged at 1.66%. With the Fed’s most recent target Fed Funds range of 1.75% – 2.00%, a yield of 1.66% indicates one future rate cut with increasing odds of a second rate cut. As mentioned earlier, Fed Funds futures continue to indicate a 90+% chance of a rate cut next week.
The combined moves in the 10-year Treasury and the 3-month T-bill continued the re-steepening of this part of the curve (now 14bps, up from 10bps last week). The Fed’s T-bill purchase program is likely exacerbating this trend.
2-Year Treasury Note yields rose 5bps to finish the week at 1.63%. The spread between 10s and 2s was largely unchanged (1bp tighter). With Precious Yield continuing to offer 2-year physical gold term deposit rates of 2%, the US Treasury – Precious Yield spread* remains in Precious Yield’s favor. That said, the spread decreased from -.42% last week to -.37% given the increase in 2-Year Treasury note yields. 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 dollar index ( Ticker – DXY ), was modestly stronger on the week, gaining a shade over 0.5% to finish at 97.84. The dollar strengthened 0.8% against the Euro (57.6% index weight), 0.2% against the Yen (13.6% index weight) and close to 1.2% against the Pound (11.9% index weight). The Pound continues to be the most volatile of the group as Brexit headlines persist.
The dollar, however, did not gain against the Chinese yuan as momentum continues to build towards Phase 1 of a trade deal. As previously discussed, news relaying this progress contributed to much of Friday’s stock market gains. Interestingly, the Chinese currency broke through the double bottom that had formed just under 7.07:1 by the end of the week as shown in the chart below.
With rising equity prices, decreased volatility, higher Treasury yields and a stronger dollar, the US dollar price of gold in ounces had headwinds on pretty much every front. Despite that, the gold per ounce price was able to hold steady for most of the week but largely remained below $1,500/oz. This early week performance in the face of fundamental headwinds seemed to point toward a solid level of buying support for gold. On Friday, with the release of the consumer sentiment numbers, gold prices surged into the LBMA afternoon fix (11:00AM EST). This surge drove gold solidly above $1,500/oz to finish the week at $1,513/oz., an almost 1.6% increase. In my opinion, gold continues to be bounded by both the $1,466/oz recent intraday low and the $1,400-$1,425/oz trading range to the downside and the recent cycle highs ($1,546/oz.) to the upside. If we see 10-Year Treasury yields revisit the September 13th high of 1.90%, that would be a potential catalyst for gold to visit my downside price targets.
Checking in on gold volatility, the “Gold VIX” decreased to 13.45 from 14.85 the prior week. Looking at both the AM & PM LBMA fixes over the course of the week, the gold price per ounce trading band widened to levels last seen two weeks ago, fluctuating $28/oz. between the high and the low (vs. $12/oz. last week). This represents 1.9% overall (vs. 0.8% last week) as measured against this week’s low of $1,485/oz. 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 ). Obviously, 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.
Silver, at times considered an alternative to gold investment, saw a much more pronounced increase in price this week. Like gold, almost the entirety of silver’s gains were logged on Friday. All told, the price of silver by the ounce increased almost 4.0% to finish at $18.13/oz as measured by the LBMA daily fix.
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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