Precious Metal Market Update – 30 June 2019


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Gold.  Gold. Gold.  That’s been the story over the last few weeks.  It’s always nice to plug back into the markets after a respite to see if overall investment themes have remained intact.  By and large, those themes appear to be undisturbed. If you are thinking about buying gold as an investment, you should carefully consider what’s going to drive the gold money relationship from this point forward. Let’s review the key drivers for a continued rally (or not) in gold.

 

Driver #1:  Further Weakening in US Economic Data

 

After a brief rebound in economic data earlier in June, recent releases have started to drag on estimates again.  Here’s the latest Atlanta Fed GDPNow estimate.

 

The most recent revision to this estimate was on June 28th post the personal income and outlays release.  While the release was better than expected on a headline basis, the details caused a reduction in the forecast growth for real personal consumption expenditures. Also, Q1 final GDP and the release of the underlying detail tables of the national income and product accounts dropped estimates for Q2 real gross private domestic investment.  On a combined basis, these estimate reductions lowered the Q2 real GDP growth estimate from 1.9% to 1.5%. I reiterate, however, that expectations still indicate economic growth, albeit slower. A continued weakening in data should lead to lower bond yields, a more aggressive Fed and a weaker dollar. This week’s job report will be key and if these data trends persist, this would be supportive of gold.

 

Driver #2:  Progress (or Lack Thereof) on a Trade Deal with China

 

The timing of this writing benefits from knowing the outcome of President Trump and President Xi’s meeting at the G-20.  Clearly, hopes for this meeting played into the softening of gold prices during the latter part of last week. Will a simple pledge to restart discussions and a delay in further tariffs be enough to shelve this fear for a bit?  It might as far as the market is concerned, but I personally don’t see much (if any) hard-won progress towards a resolution as part of the outcome here.  My best bet is that this resurfaces as a market concern and a potential catalyst for precious metals prices. Let’s take a look at the USD/CNY pair to see how far the market is tilted toward deal or no deal. 

If you use an fx rate of 6.74 as a level reflective of high hopes for a deal and 6.92 as a level reflective of despair with respect to a potential deal, then at 6.86 the market is assigning only a 33% chance of a deal (at least near-term).  On that basis, I’d have to agree. Near-term, this will be a headwind for gold. Longer-term, more tensions and more tariffs would be supportive of gold.

 

Driver #3:  Geopolitical Tensions

 

The US-China trade war is part of this category.  For the moment, the market should be appeased. Outside of China, there have been no new headlines out of Iran for a little over a week (see our Gold section below).  And of course, the tariff threat against Mexico resolved almost as quickly as it surfaced. In aggregate, these should be a near-term headwind for gold.

Overall, and as I’ve said in the past, the market must believe that we are tipping further toward recession in order to drive gold prices higher still.  While the 10 year – 3 month part of the treasury curve remains inverted, I quite liked this piece as it relates to leading indicators of recession.  It argues that a re-steepening of the treasury curve, once it has inverted, is the “final recessionary shoe”.  While not every piece of data out there lines up with this thesis (think rebounding copper prices), there are enough floating around to suggest that something may be up.

My review of the following markets will encompass the last two weeks…

 

US Equities: 

The S&P gained 1.9% over the last two weeks although all of the gains came in the week prior.  In-line economic data and a dovish Fed were primarily responsible. This past week, economic data was less robust but with bond yields still basking in the glow of the Fed and hopes surrounding the Trump-Xi G-20 meeting, the market held onto most of its gains.  Of note, the market did make a new high the day after the Fed meeting with the S&P closing at 2,954. This is in line with our base case view laid out in the Precious Metal Market Update – 2 June 2019. With a rising market, the VIX was slightly lower over the two-week period ending at a level of 15.08.  As discussed previously, I attribute the lack of volatility to the market’s faith in a newly accommodative Fed.  Whether or not that faith is misplaced (still a 60% chance of THREE rate cuts by the December Fed meeting) remains to be seen.

 

Government Bonds: 

US 10-year treasury yields fell again from 2.09% at the time of my last writing to 2.00% and remain at the lows.  In fact, the entire treasury yield curve between 3 months and 10 years fell between 8 and 9bps over the time frame, indicating a parallel shift.  As a result, the yield curve remains inverted. US Treasury – German Bund spreads continue to hover just above recent lows but have yet to see consistent closes below +230bps.  We would expect this spread to compress further if the Fed does embark upon a rate cutting path as the fed funds futures market indicates. At a yield of 2.12% for 3-month T-bills (the best barometer for future Fed action), the market is assuming a cut imminently.

Given the continued decline in longer-dated government bonds yields, the US Treasury – Precious Yield spread shrank further and remains NEGATIVE.  2-Year Treasury notes finished the week at 1.75% while Precious Yield continues to offer 2-year 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 – see our white paper entitled “The Alternatives Available for Precious Metals Investors” from March 24, 2018. Earning a yield on gold with Precious Yield, while always attractive for long-term holders, continues to be an attractive yield alternative in this environment.

 

US Dollar: 

The dollar index weakened almost 1.5% over the last two weeks.  The lows in the index were seen in the early part of last week as the reaction to the Fed announcement fed through to the currency markets in the form of a weaker dollar against most currencies.  This was a surprise to me given the amount of easing already built into the Fed Funds futures market and no actual cut. The Euro (57.6% index weighting) appreciated against the dollar largely in line with the index while the yen (13.6% index weighting) appreciated only 0.62% and the pound (11.9% index weighting) only appreciated 0.82%.  That doesn’t seem to add up, now does it? Well, the Canadian dollar (9.1% index weighting) strengthened 2.39% against the dollar from 1.3413 to 1.3092. Why? Canadian monthly GDP was higher than forecasted and the Bank of Canada business outlook survey showed companies were optimistic about sales growth in the second half of the year. I still believe that additional weakness in the dollar will be more difficult to come by given the amount and timing of monetary policy easing built into expectations.  Continued dollar weakness will be dependent on a further deterioration in domestic economic data and a further compression in the US Treasury – German bund spread. An actual cut of rates by the Fed (perhaps July), will likely be the next chance for the dollar to take another leg lower.

 

Gold: 

As measured by the LBMA afternoon fix, gold finished up another $58/oz. over the last two weeks to end at $1,409, a cumulative 4.2% gain.  Falling yields, a weaker dollar and geopolitical tensions were all supportive of the precious metal. Despite my hope that a softening in geopolitical tensions could provide a better entry point for those looking to be long gold as an investment at the time of my last writing, the price of the precious metal provided no such opportunity.  Some of this had to do with the continued drop in bond yields and weaker dollar post Fed meeting. However, just as gold got bolstered with falling yields, additional geopolitical tensions drove the price higher still. First, Iran shot down an American drone.  Then, President Trump approved a military strike against Iran only to abort the decision at the last second.  With geopolitical headlines fading over last weekend, gold was poised for a pause only to be revived by a return of yields to their recent lows.  It was only after last Tuesday’s high of $1,431.40/oz. that gold took a breather, declining 1.6% for the balance of the week, as the Trump-Xi meeting at the G-20 approached and rates remained stable. 

With the 9.5% rapid rise in gold since new tarifs came into effect on May 10th, our readers may be wondering if levels of gold volatility are beginning to look stretched.   No doubt, gold volatility (as measured by the “Gold VIX”, Ticker – GVZ) exploded from 11.9 two weeks ago to 15.99. 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. Last Tuesday, the index reached as high as 17.08 when gold hit $1,431.40/oz.  Sadly, and with data only going back as far as June 2008, even the mid-week high remains below the long-term average.  Keep in mind, however, that this data set includes gold’s meteoric rise to almost $1,900/oz. back in September of 2011.

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.

 

Gold 1-Month Price Chart

 

Silver 1-Month Price Chart

 

Platinum 1-Month Price Chart

 

Palladium 1-Month Price Chart

 

Correction:  My previous writing had indicated that President Trump raised tariffs against Chinese imports on May 17th.  In fact, those tariffs were levied on May 10th and President Trump first spoke of a potential increase on May 5th as talks were “too slow”.

 

About the Author

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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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