This week was a rollercoaster of news regarding US-China trade talks, most of which was negative. Added to that, on Tuesday, a formal impeachment inquiry against President Trump was initiated by the House of Representatives after a whistleblower suit provided new revelations about his dealings with Ukraine. Combined, these newsworthy items drove the vast majority of market gyrations. Not to be lost in the shuffle, however, was the Fed’s need to continue to inject liquidity into the market via various repurchase agreement (“repo”) auctions. Last week, I stated that “anytime there is a problem in the most mundane parts of America’s financial plumbing, you have to take notice.” On this front, given this week’s auction demand, I’d have to say my fears have been heightened as opposed to quelled. So, let’s start with where the repo issue stands first before we get into this week’s US-China trade related news. After that, we’ll cover off some economic data and start to think about earnings season before diving into the individual markets.
Last week, I informed readers that after Friday’s repo auction, the Fed announced that the $75BN overnight repurchase operation would be conducted every day from Monday through Thursday until October 10th AND that it would also introduce two week (14 day) term repos with a total size of at least $30BN. My assessment was that based on the announcement, the Fed didn’t see the liquidity crunch going away immediately. Here’s what happened this week. With respect to the overnight repo auctions, the Fed determined that the $75BN facility size was insufficient and upped the amount to $100BN for Thursday’s auction See the Max Facility line in the chart below.
If you contemplated this chart in a vacuum, you might reach the conclusion that market stress had lessened by week’s end since the amount of collateral submitted dipped well below the max facility size. But this is only part of the picture. There were also two 14-day term repo auctions held this week. The first was for $30BN and was more than 2x oversubscribed. Given this oversubscription, the Fed upped the max facility size on the second auction to $60BN and it was still oversubscribed. When looking at both the overnight repo auction and the two 14-day term repo auctions on a combined basis, you get a much different picture.
As you can see from the above chart, the total liquidity injected into the market continued to increase throughout the week. Thus, you can probably better understand my heightened anxiety level. As a result, I continue to argue for investor alert and believe that market data and news flow has provided a mandate to rotate more defensively.
Moving on to US-China trade relations, there was lots of news this week. On Tuesday, in President Trump’s address to the United Nations, he listed all of the United States’ grievances with China without any hint of an olive branch. In an apparent reversal, he followed his speech up with a comment to reporters on Wednesday that with respect to a US-China trade deal “it could happen sooner than you think”. Wednesday’s bounce was short-lived, however, when Bloomberg reported on Thursday that the US was unlikely to renew the current waiver (which expires November 19th) for American Huawei suppliers. This was followed by Friday’s report that the White House was deliberating whether or not to place a block on all US investments in China. On balance, the trade news was decidedly negative despite the brief mid-week respite. That said, senior level negotiations are still expected to take place in early October.
In economic news, Q3 GDP estimates moved slightly higher as some disappointing consumer confidence numbers and decreases in real consumer spending growth estimates (August personal spending +0.1% vs. consensus of +0.3%) were more than offset by positive revisions to real gross private domestic investment growth. As you know, the state of the consumer has been front and center for me as the engine that keeps the economy from falling into a recession. So while I am glad that there were some positive offsets to the disappointment on this front, I think investors should continue to remain vigilant.
As a quick sidebar, German manufacturing continues to be abysmal, with many investors looking for fiscal stimulus out of the German government to help right the ship. As you can see below, German PMI data is at the lowest levels since the financial crisis and any reading below 50 signals an ongoing contraction.
To conclude, this coming Monday marks the end of the third quarter and companies will begin to report earnings in a few short weeks. Per FactSet Insight, 113 S&P 500 companies have issued EPS guidance for Q3 of which 82 have issued negative EPS guidance and 31 have issued positive EPS guidance. FactSet Insight reports that the number of companies issuing negative EPS guidance is well above the 5-year average of 74 and is particularly acute in the Technology and Health Care sectors. To be clear, most prognosticators believe Q3 earnings will barely break even again on a year over year basis.
With that, 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. Many times over, I have discussed that there are several 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 index fell a little over 1% this week to finish at 2,962. After opening above the psychologically important 3,000 level on Tuesday, the S&P suffered for balance of the day on the back of Trump’s UN speech and the launch of the impeachment inquiry against him by the House of Representatives. Markets rebounded somewhat on Wednesday on renewed US-China trade optimism, only to decline for the remainder of the week as the drumbeat of negative US-China trade news flow resumed. In terms of key levels, the 50 day moving average currently sits at 2,948 – we will see if the S&P 500 can continue to hold this level on a closing basis this week. Holding the 2,948 level is key to maintaining the “period of sideways trading absent additional catalysts” that I discussed last week. I would note also that the market never made it back to its all-time highs in this most recent run-up, a potential foreshadowing of resolving the sideways trading to the downside when it happens.
The VIX followed a similar pattern to the S&P 500 index this week, first spiking on Tuesday in conjunction with the aforementioned news. Wednesday saw less volatility on the back of Trump’s comments but then the VIX climbed for the remainder of the week to finish at 17.22. On an intraday basis, both Tuesday and Friday saw VIX levels break through the long-run average of 17.99 (since January 1990) using log normal data. Vix futures remain in contango (i.e. upward sloping) through the November contract, despite renewed geopolitical concerns. The balance of the curve is less predictable, although in my mind, I would still consider its shape to be normal. For now, I still believe that the curve’s shape indicates that the market does not believe there will be meaningful near-term volatility. That doesn’t mean, however, that the market will be correct in its assessment.
Government bonds continued the rally that started on September 13th when 10-year yields peaked at 1.9%. This continuing rally was felt throughout the curve including the short (< 2 years), intermediate (2 year through 10 year) and long (>10 year) end. Specifically for 10-year Treasury yields, they fell from 1.74% to 1.69%. Tuesday saw the greatest flight to safety with the 10-year yield closing as low as 1.64%
With the exception of Monday, 3-month T-bill yields fell pretty much throughout the week to finish at 1.80% from 1.91% at the end of last week. Of note, the short-end of the curve fell the most, posting an 11bp decline vs a 5bp decline in 10-Year Treasuries. This traditional curve steepening had the outcome of lessening the yield curve inversion. Looking at the moves in the 10-year and 3-month in conjunction with one another, the inversion improved to -11bps versus -17bps last week and is still well inside the deepest inverted levels (~ -45bps). While still in the range of the Fed’s most recent target of 1.75% – 2.00%, a yield of 1.80% indicates that T-bills are predicting a higher likelihood of an additional future rate cut. But what about Fed Funds futures? Immediately following the Fed’s most recent rate announcement on September 18th, the market was assigning a 42% chance of an additional rate cut prior to year-end. This week that probability rose to over 80% before settling back to a 70% probability.
Quickly, for those who are keeping score like myself, US Treasury – German Bund spreads remain range bound between +215bps on the tight end to +235bps on the wide end. I laid these out for readers last week and there has been no change. Remember, a continued tightening of this spread is a key component to my recession watch list.
Finally, the 10s-2s portion of the yield curve remained upward sloping this week and the steepness between the two maturities was relatively unchanged. 2-Year Treasury yields declined 6bps from 1.69% to 1.63% and only 6bps (vs. 5bps last week) separates 10 year yields from 2 year yields. Precious Yield, on the other hand, continues to offer 2-year physical gold term deposit rates of 2%. As a result, the US Treasury – Precious Yield spread* continued to favor Precious Yield at week’s end. The spread increased from -.31% last week to -.37% given the fall 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.
The persistently strong dollar trend continued its march higher this week. The dollar index (Ticker: DXY) gained 0.6%, reaching new cycle highs since the early 2018 lows (see chart below). Remember, the last peak in the dollar index was 103.3 in December 2016.
As for the major index components, the Euro was 0.7% weaker against the dollar, the Yen was 0.3% weaker and the Pound was a full 1.5% weaker. The bulk of the Pound’s decline came on Wednesday when the return of British Parliament highlighted the continued stalemate with respect to Brexit.
Shifting gears to the yuan, the Chinese currency posted its second consecutive week of declines vs. the dollar. As you know from last week, I believe this reversal started with the release of weaker than expected Chinese industrial production and retail sales data. In my view, the deterioration in this week’s US-China trade relations news flow will likely promote further weakening in the yuan this coming week. I would note, however, that the currency exchange rate remains comfortably inside the highs set just prior to the September 5th announcement that the US and China were renewing attempts at trade talks.
I have cautioned our readers over the last couple of weeks that a pledge for renewed talks is not the same as achieving an actual trade deal. This week’s news flow continues to highlight that point. If any progress gets made in the trade talks towards an actual trade deal, it should be a positive for risk-on markets and conversely, the gold price per ounce would likely suffer.
With falling equity prices, increased volatility, lower Treasury yields and heightened geopolitical tensions, gold should have performed well this week. In fact, the only thing working against the yellow metal was the strength of the US dollar. As expected, the yellow metal performed well through the middle part of the week, only to see the gold per ounce price decline 0.8% to finish at $1,489/oz as measured by the LBMA afternoon fix (11:00AM EST). Of note, the gold price per ounce strengthened a bit off of the afternoon fix levels going into the NY close (4:00 PM EST), reclaiming spot gold’s 50-day moving average along the way. Of note, the price per ounce silver also got whipped around this week, seeing exaggerated moves vis a vis gold both to the upside in the early part of the week and to the downside at week’s end.
To repeat from last week, the following levels appear to provide technical support for gold prices. Note that $1,500/oz has already been breached to the downside. This is followed by the 50-day moving average which currently sits at $1,492/oz and then the $1,400-$1,425/oz. trading range. No surprise, these downside targets remain in tact. Equally important, I will also watch to see if gold can breakout to new highs above $1,552/oz. Because it is curious that the gold price per ounce behaved the way it did this week given the movements in its typical drivers, it makes me wonder if we will break out of our trading range to the downside – at least on a near term basis.
Moving to gold price volatility, the upside volatility early in the week surprisingly drove the “Gold VIX” higher to 17.22. Equally curious, the downside volatility towards the end of the week caused the “Gold VIX” to decline to 14.96. Perhaps this is simply a supply/demand issue for GLD options, the underlying security used to calculate the “Gold VIX” (Ticker – GVZ) levels. 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. At a level of 14.96, this is still below the long term average using log normal data since June 2008.
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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