The highlight of this week came in the form of the Q2 2019 advance estimate of GDP released by the Bureau of Economic Analysis. In my opinion, the release reinforces a tale of two distinct and divergent drivers of the economy: the manufacturing (and housing) sector and the consumer. I believe understanding the interplay between those two drivers is one of the keys to divining the gold money relationship from this point forward. Anyone who is thinking about buying gold as an investment or buying gold’s more volatile sibling silver as an investment and who is worried about initiating a new position at current prices should carefully develop their own view. Here’s the way I see it.
At 2.1%, Q2 GDP was a beat given the Atlanta Fed GDPNow estimate going into the number as well as vs. the Blue Chip consensus average as shown in the chart below.
While a clear slow-down from Q1’s growth rate of 3.1%, the economy continued to perform well mainly driven by the CONSUMER. Per Trading Economics, personal consumption expenditures (PCE) jumped 4.3% in Q2, the most since Q4 2017. Goods consumption increased 8.3% (vs. 1.5% in Q1) while services consumption increased 2.5% (vs. 1% in Q1). So, in short, even though the manufacturing and housing sectors continue to suffer, they only account for 11.4% (as of 2018) and 3.7% (as of Q2 2019) of US GDP respectively. Given that personal consumption expenditures account for 68% of GDP, the consumer is currently smoothing over those rough patches. With no end to the trade war(s) in sight and renewed market cautiousness over how aggressive the Fed might be in easing, the consumer will need to continue to perform well in order to hold things together. Given the lack of significant deterioration in corporate earnings/guidance, it would appear that corporate profits are depending on that as well.
As many of you already know, earnings season is in full swing now and the percentage of S&P companies having reported has grown from 16% last week to 44% or nearly half of the index. Earnings surprises (both in number and magnitude) continue to be above the 5-year average per FactSet. To remind folks, these beats are against low expectations for this quarter. However, the market has been further supported given that forward guidance is still hanging in there.
Let’s talk about forward guidance some more because in my opinion, it is the thing that matters most. Per FactSet, on balance, guidance has deteriorated a touch since last week with 28 (vs. 11 last week) companies issuing negative EPS guidance and 10 (vs. 5 last week) issuing positive EPS guidance in conjunction with their earnings. According to Factset historical data, and using a 5 year average, this now swings the percentage of companies issuing negative EPS guidance to above normal. All in all, here is where we stand. Note: A red shaded cell indicates a negative week on week change while a green shaded cell indicates a positive revision. Yellow indicates unchanged.
*The blended earnings decline of -3.4% for last week is different than the -1.9% in our previous report due to FactSet’s incorporation of changes made to the estimates for Boeing for Q2 after publication. According to FactSet, the mean EPS estimate for Boeing for Q2 excluded the charges the company announced in relation to the 737 MAX grounding. After publication of the report, the basis of the mean EPS estimate for Boeing was changed to include the charges. Please see their most recent publication for additional details.
Can the bulls claim victory at this point? Well, this coming week sports an additional 168 companies reporting earnings which will take the total number of companies having reported to over 75%. If the trends in earnings and guidance are not impacted with these releases, I think we can sound the all clear on Q2. I maintain that the biggest positive in all of this is that revenues continue to grow and that participants seem to be willing to look through margin pressures. Whether those margin pressures are temporary remains a key unanswered question in the face of US-China trade relations. Remember, in order for a recession to be in play, guidance would have to indicate the potential for a decline in revenues. Given all of the data above, we just aren’t seeing that and therefore, in my opinion, a methodical, opportunistic rotation towards a more defensive portfolio can take place over a period of time.
With that, let’s look at how each of the major markets performed this past week.
With upside surprises in both US GDP and domestic corporate earnings, the S&P 500 gained almost 1.7%, finishing the week at 3,025.86, a new all time high. As a reminder, at current S&P 500 index levels, the forward 12-month P/E ratio is 17.1x which is above both the 5-year (16.5x) and 10-year (14.8x) averages per FactSet. This ratio continues to be the beneficiary of low and declining global interest rates. As the market climbed this week, volatility, as measured by the VIX, declined from 14.45 to end the week at 12.16. With global central banks determined to throw a wet blanket on global trade risk, VIX levels (using log normal data) are back to being greater than one standard deviation away from long-term averages. Since January of 1990, only 12.2% of all VIX closing levels have registered lower than Friday’s close
US Treasury yields were slightly higher on the week with the 10-year Treasury increasing from 2.05% to 2.08%. 3-month T-bill yields (the best barometer for future Fed action) also increased, experiencing a 6bp bump to 2.12%. On a net basis, a bit more inversion was brought back to the curve as a result of this week’s market action.
Fed Funds futures were also tame and only re-rated slightly this week, consistently indicating a 75-80% chance of a 25bp cut and a 20-25% chance of a 50bp cut at this week’s upcoming meeting. In a 25bp cut scenario, I expect little market reaction with a slightly positive bias as long as the Fed leaves the door open to additional rate cuts this year. A 50bp cut would likely trigger a market rally in both equities and gold while a 25bp cut with no future commitment to lower rates further would likely have the opposite effect. And while rate cut probabilities did drop a bit this past week, I am surprised that there was not more of a reaction given the positive aforementioned data that we saw out of the US. It would seem to me that the cumulative probability of easing as implied by those futures should have dropped further.
So what happened this week with US Treasury – German Bund spreads in the wake of the ECB meeting and positive US economic data? First, the ECB did not cut rates but strongly hinted that rate cuts are coming in its statement with the language “key ECB interest rates to remain at their present or lower levels at least through the first half of 2020,” (emphasis added). Second, most saw signs of additional QE coming based on the statement language that Eurosystem Committees had been tasked with examining “options for the size and composition of potential new net asset purchases.” Given that, you will not be surprised to learn that the sovereign bond yield spread between the US and Germany widened a bit further. The alarming downtrend that I focused on earlier this year continues to abate as shown in the chart below.
Finally, the US Treasury – Precious Yield spread* reversed a bit this week with the increase in US yields. The spread narrowed to -.14% vs. -.20% last week as 2-Year Treasury notes finished the week at 1.86%. Precious Yield continues to offer 2-year physical gold 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. 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 white paper for a more thorough discussion. Precious Yield provides a much needed yield alternative in this environment of ultra-low / negative global bond yields.
The US Dollar strengthened 0.77% last week on the back of better than expected US data and the aforementioned dovish outlook from the ECB. The Euro dropped 0.84% while the Pound fell 0.95%. Additional weakness in the Pound was likely attributable to the election of Boris Johnson as the next prime minister and the spectre of a no-deal Brexit given his hard-line stance. The dollar similarly strengthened against the yen as this week’s risk-on environment deterred Yen buyers from seeking its safe-haven status.
As for the Chinese yuan, there has been little change in terms of the market’s view regarding the potential for a trade deal.
With all the data suggesting that gold would fall this week (rising equities, falling VIX, higher bond yields, and stronger dollar – particularly against the yen), it’s no surprise that it did. As measured by the LBMA afternoon fix, the price of gold decreased 1.3% finishing at $1,420.40/oz.
Silver, on the other hand, continued its speculative run, increasing nearly 0.8% for the week to end at $16.44/oz. With the gold-silver ratio still closer to the upper end of the range, I could see how one who is bullish on precious metals near-term might prefer silver to gold at this juncture. Just so it’s handy, the below chart is a 30-year chart of this ratio courtesy of macrotrends.net which I published last week. Many are using this ratio to support a bullish view on silver.
Finally, gold volatility declined from 15.83 to 12.31 this week using the “Gold VIX” (Ticker – GVZ). 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 ). GLD is an exchange-traded fund (ETF) that represents 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 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. 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 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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