#yield matters! This is my new mantra as we continue to see global interest rates plummet. After all, 10-year German Bunds are at new all-time low yields as shown in the below chart.
Even the 30-Year German Bund briefly traded with a NEGATIVE yield on Friday.
Before we dive in further, I’d like to remind our readers that 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 and consider their expected holding period. There are many and varied drivers of the gold money relationship. I will attempt to provide as much detail as possible on those drivers in order to help potential investors make an informed decision.
With the continued decline in global interest rates and the litany of other events that transpired this week (that are in theory supportive of gold), I would have thought that precious metal prices would have increased even more. In the gold section below, I will highlight what I believe to be the singular factor that held gold back from even bigger gains this week. In the meantime, the fact that gold wasn’t even higher supports my view that for US dollar investors, gold is in a consolidation phase and currently looks a bit tired. Over the intermediate term, however, if global economic weakness spills over into the US in a more meaningful way, the yellow metal should continue its upward bias.
Here’s a quick list of some of the major events that moved markets this week (of which there were many).
- Geopolitical Tensions
- Fed Policy Announcement
- July jobs report
- Corporate Earnings
First, numerous geopolitical headlines hit the tape this week. On Wednesday, North Korea conducted its second weapons test in less than a week. Despite the recent provocations, President Trump continues to paint a positive picture of his relationship with Kim Jong Un. On Thursday, President Trump announced 10% tariffs on another $300BN of Chinese goods starting September 1st. The announcement came as a surprise given that the US and China just restarted trade talks at the beginning of the week. Also, much speculation abounded given that the announcement was made the day after the Fed cut interest rates and Powell disappointed markets in the ensuing press conference (more on this in the next paragraph). Some saw the announcement as a means to pressuring the Fed to do more. From a market perspective, the announcement certainly reversed the Fed Fund Futures market. Others saw the timing of the announcement as pre-planned, hoping that the negative headline would be absorbed with general optimism post Fed. Finally, on Friday, the US abandoned the 1987 nuclear arms deal with Russia after having given Russia a full 6 months to get back into compliance. While anticipated, the official demise of this historic deal added to market angst.
Second, the Fed policy announcement was pretty much all fine and dandy as far as the market was concerned until Powell remarks in the post announcement press conference rattled investors looking for continued dovishness. From my commentary last week, I said that “a 25bp cut with no future commitment to lower rates further would likely have the opposite effect”. The opposite effect referred to triggering a market decline (as opposed to rally) in both equities and gold. Note that gold did not rally until the end of the week on geopolitical headlines. Let’s analyze this a bit deeper and start with the announcement itself. With some market participants looking for a 50bp cut, the Fed ameliorated their disappointment with a 25bp cut by deciding to end the program of quantitative tightening months earlier than expected. This was probably the best solution in an attempt to suppress market volatility. However, Mr. Powell’s post announcement press conference remark indicating that the cut was just a “mid-cycle adjustment” was interpreted as no guarantee with respect to future rate cuts. Remember, going into the announcement, Fed Funds futures were anticipating an 87% chance of an additional 25bp cut this year and a 50% chance of an additional 50bp cut this year. Who knows where those probabilities would have ended the week had President Trump not ratcheted up the pressure on China with his additional planned tariffs. In the end, further rate cut expectations became an even higher probability event despite the reaction to Powell’s comments. The below chart shows a 100% chance of an additional 25bp cut and a nearly 75% chance of a 50bps cut by year end.
Third, the July jobs report was a bit of a mixed bag as current month employment was in line with forecasts but previous months were revised downward. June’s blockbuster number of 224K jobs was revised down to 193K while May’s dismal reading of 72K jobs was revised further downward to 62K. That’s an aggregate loss of 41K jobs just due to revisions. On the plus side, average hourly earnings both MoM and YoY as well as the labor force participation rate came in better than expected. Separately, on the economic data front, I’d like investors to note that early estimates for Q3 GDP growth are currently in the 1.5% to 2.5% range – consistent with Q2.
Finally, corporate earnings continue to come in better than expected. With 77% of S&P 500 companies now having reported, I think we can start to draw some meaningful conclusions. Earnings surprises (both in number and magnitude) continue to be above the 5-year average per FactSet. Revenue beats, however, are below the 5-year average in number but above the 5-year average in magnitude. While forward guidance continues to shrink analysts go-forward estimates, the downward revisions (specifically for Q3) are within a normal range. 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.
Clearly, revenues continue to grow and market participants seem to be willing to look through margin pressures. Whether that revenue growth is sustainable in the face of a global slowdown and those margin pressures are temporary in the face of US-China trade relations remain key unanswered questions. 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, I remain convinced that 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.
The S&P 500 logged one of its worst weeks in recent memory with the index declining 3.1% from its all time high to finish at 2,932. In the moments prior to the Fed announcement, the index was still trading firmly above 3,000. Consequently, almost all of the decline was generated by the combination of Powell’s post announcement press conference remarks and Trump’s additional planned tariffs. From a technical perspective, the index closed just above its 50 day moving average of 2,927. A close below that level may trigger further downside as the market is not yet technically oversold. From a fundamental perspective, at current S&P 500 index levels, the forward 12-month P/E ratio is 16.8x 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.
Volatility, as measured by the VIX, increased dramatically from 12.16 to end the week at 17.61. On an absolute basis, the low level of the VIX may have had some investors anticipating mean reversion coming into the week. While an understandable rationale in and of itself, all the tightly coiled VIX spring needed was a catalyst. As discussed, that catalyst was provided with the one-two punch of Powell and Trump.
US Treasury yields plummeted this week, particularly in the longer end of the curve. 10-year Treasuries fell a whopping 22bps to close below 2.0% and at their lowest levels for the year at 1.86%. 3-month T-bills, on the other hand, experienced a much more modest decline in yields from 2.12% to 2.06%, a decline of only 6bps. As a result, the yield curve inversion as it relates to these two maturities ended the week at -20bps, a significant increase from last week and re-approaching the largest inversion we have seen this cycle.
Spending an additional moment on 3-month T-bills (which I have argued previously is the best barometer for future Fed action), we can draw some additional inferences given that the Fed cut rates this past week. Given the modest decline in these T-bill yields, it would seem as though Jay Powell did a very good job of not guaranteeing any more rate cuts – whether or not you believe that is the right monetary policy stance at the moment. Why? With the Fed Funds rate now in the range of 2% – 2.25%, a T-bill yield of 2.06% signals lack of conviction that rates will go lower. As discussed in my overview, this is clearly not in sync with where Fed Funds futures ended the week. Only time will tell which of those two markets has it right.
So what happened this week with US Treasury – German Bund spreads? The chart below clearly shows a spread that was continuing to widen post the Fed announcement. This makes sense as a less than anticipated dovish message from the Fed should have had exactly that impact. But then bam! President Trump announced additional planned tariffs on China. As a result, investors started to deepen their worries over the US economy and ratcheted up their expectations of future rate cuts again. All of a sudden, Bunds didn’t look as bad on a relative basis. This spread reversal is obvious on the 5 day chart.
At +233bps, we are now back towards the lower end of this spread’s recent range and I will be closely watching to see if it makes new lows. A continued tightening of this spread is a key component to my recession watch list.
Finally, the US Treasury – Precious Yield spread* recovered a bit this week with the decline in US yields. The spread narrowed to -.28% vs. -.14% last week as 2-Year Treasury notes finished the week at 1.72%. 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. #yield matters!
The US Dollar was relatively unchanged (98.07 vs. 98.01) on the week as the strength ushered in by the Powell disappointment was quickly whisked away by Trump’s additional planned tariffs. There was, however, great divergence amongst the major components of the index. The British Pound continues to be a disaster in the wake of Boris Johnson’s election as the next prime minister with the currency weakening 1.8% vs. the dollar. The Yen, on the other hand, rallied sharply (1.9%) vs. the dollar, showing off its safe-haven status. The last major component of the index, the Euro was relatively unchanged (slightly weaker).
What happened with the Chinese yuan in the wake of Trump’s announcement? This happened – a breakthrough to new highs in terms of Chinese yuan weakness.
Said differently, if any actual progress gets made in the trade talks, it should be a very solid positive for risk-on markets at this point. Gold, however, would likely suffer.
As measured by the LBMA afternoon fix, gold recouped the prior week’s losses, increasing 1.5% to $1,441.75/oz. Many of the elements for a gold rally were present this week with equity markets declining, volatility increasing and global bond yields crashing – not to mention all of the geopolitical tension. So why wasn’t gold even higher? It was the resilience of the dollar which put the brakes on further increases.
In my introduction, I offered a scenario in which gold prices continue to increase in US dollar terms over the intermediate. Why am I emphasizing in US dollar terms? Because the general strength of the USD has masked the fact that gold prices are hitting all-time highs in other currencies. The newest currency to achieve this fame – the British pound (just by a hair).
These breakouts to new all-time highs for gold in other currencies are pointed to by those who are bullish as evidence in support of their thesis. If nothing else, the sharper upward movement in gold prices in these other currencies has likely attracted the attention of non-US investors considering the space. Of course, gold is nowhere near its all-time high in US Dollar terms. Look at the difference between gold in US Dollars and gold in British pounds.
Switching gears, gold volatility (along with most other measures of market volatility) increased to 15.00 from 12.31 the prior week. 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 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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