Happy New Year and welcome back for what we here hope will be an exciting new decade of growth and innovation at Precious Yield. If you were holding a gold investment or silver investment since my last market update, you received quite a nice present at year-end. After all, gold prices were just about the most exciting thing happening across markets. Initially, gold price resilience in the face of a squarely risk-on backdrop triggered deep thought amongst many participants as to what was really driving markets. More on that in a bit. And then, geopolitical tensions resurfaced in a major way, driving spot gold prices to new cycle highs. As I’ve said consistently over the last few months, much of this can be explained by central bank activity. So, I’ll start there first before moving on to geopolitical. I’ll finish with a brief update on economic data, of which there was little, before exploring each of the individual markets. 2020 – here we go!
As my regular readers know, I’ve spent a lot of time recently talking about the Fed balance sheet and the QE/not QE T-bill purchase program that is currently underway. Unfortunately, this alone probably does not explain the resilience we saw in gold prices during this year’s Santa Claus rally. One topic that caught my eye recently which I have failed to adequately explore is central bank purchases of gold. I believe this provides a significant piece of the supply/demand puzzle for gold – particularly as of late. Through mid year 2019, central banks made record gold purchases in an attempt to diversify away from the dollar as trade tensions simmered. This trend has continued throughout the rest of the year with both China and Russia leading the way as shown in the chart below.
When you overlay this steady demand with an accommodative Fed, you create a powerful combination of forces that can be hard to overwhelm. Since we last spoke, the Fed balance sheet has increased another $75+BN as shown in the chart below. I would note that much is being made of the rate of Fed balance sheet increase when compared to the rate of the decrease we saw during the Fed’s quantitative tightening phase (i.e. much faster versus much slower).
On the geopolitical front, the biggest news was clearly the rapid escalation of tensions between the US and Iran. It started with an alleged Iranian-backed militia rocket attack in Iraq which killed an American contractor. Shortly thereafter, American airstrikes killed 24 members of the same Iranian-backed militia. This led to pro-Iranian demonstrators breaking into the US Embassy compound and a subsequent order from President Trump for 750 additional troops to be deployed in the region. Through all of this, markets continued their upward march undisturbed until President Trump ordered a successful US airstrike that killed Iran’s top security and intelligence commander, Maj. Gen. Qassim Suleimani. This was a dramatic escalation and Iran’s leaders quickly promised retaliation for the general’s killing. Shortly thereafter, the State Department urged American citizens to leave Iraq immediately. It was this final action that broke the market’s momentum and investors decided that it was finally time to take some risk off.
Remember the US-China Phase One trade deal? With everything going on in Iraq/Iran, news flow on this front got a little lost in the shuffle. That said, Phase One appears to continue to be on track with President Trump saying that he will sign the trade agreement on January 15th. I still believe that given there was no significant follow through rally in the yuan upon the deal announcement, it’s easy to conclude that the Phase One details were underwhelming and only somewhat better than kicking the can down the road further.
Turning quickly to economic data – it has been relatively light over the last few weeks. Of note, durable goods orders were a major disappointment falling 2% MoM in November vs. a consensus estimate of 1.5% MoM growth. Excluding transportation, the result was still a bit disappointing but much less so. On the positive side, US personal income grew more than expected, increasing 0.5% MoM vs a 0.3% growth expectation. As far as the Atlanta Fed GDPNow is concerned, economic data continues to indicate Q4 GDP growth at the top end of consensus as shown in the chart below.
Around the world, UK growth and inflation came in a touch higher than expected yet the BOE left rates unchanged. Also, Japan’s inflation rate saw a big uptick. And while US Treasury – German Bund spreads plumb recent lows, they haven’t been able to break through the lows of early December.
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 that will drive gold investment returns. In support of developing that view, let’s review the major markets that precious metals take their cue from.
When we last checked in, the S&P 500 index had just closed at a new all-time high of 3,168. Since then, the index has attained several new highs, peaking at a closing level of 3,257 this past Thursday. This momentum, however, could not be sustained in the face of Friday’s geopolitical turmoil. As a result, the index took a slight step backward, finishing the first week of the new year at 3,234. Looking at the entire 3-week period, the index has risen nearly 2.1%. From a 60,000 foot point of view, most would call this a quite successful Santa Claus rally.
From a technical perspective, almost immediately after my last writing in mid-December, the rally pushed the S&P into “overbought” territory where it has stayed for most of the last three weeks. Friday’s sell-off relieved some of this perceived technical pressure. In this environment, however, I think being “overbought” is less relevant to near-term market direction because I consider us to be in a trending (as opposed to non-trending) market. What do I mean by this? Traditional non-trending indicators like the relative strength index which currently indicate we are “overbought” are overridden by trending indicators which suggest the market will continue its current trend (which is higher). Note that the market started to “trend” shortly after my last writing. To reiterate, my confidence in this outlook stems largely from the belief that the Fed’s QE/not QE launch is the main culprit behind this rally. Abent further updates, these Fed purchases are expected to last at least into the second quarter of 2020 and should provide a safety net underneath the market until then. That all said, the situation with Iran remains tense and further escalation and/or retaliation will likely cause additional market damage. If that were to occur, I would be focused on the 50-day moving average of 3,130 followed by the early December intraday low of 3,070. At the end of the day, please keep in mind that fundamental factors (corporate earnings, economic data, supply/demand and geopolitical events that affect them) will always dominate technical analysis. Think of the technical analysis as a supplementary tool.
In terms of the VIX, we haven’t had a single close below 12 since my last writing and with Friday’s market sell-off, the VIX now sits at 14.02. Of note, we did see the VIX drop below 12 on an intraday basis on several trading days over the last few weeks. Why am I focused on this level? Because as I have discussed previously, sub 12 readings on the VIX have recently been a reliable signal for a technical pullback and therefore, at a level of 14.02, the current VIX does not indicate that the market is ahead of itself. As a reminder, in my opinion, major (as opposed to mini) reversals tend to occur as the VIX approaches two standard deviations. At -0.7 standard deviations from the mean since January 1990, we are still safely inside of this mark as shown by the updated chart below.
The US government bond yield curve has shifted a bit downward and become a bit steeper over the last few weeks. Starting with the 10-year Treasury, yields were actually higher going into Friday’s session before news of the US airstrike caused a flight to safety across markets. The 10-year yield finished the day 8 basis points lower at 1.80%. I note that the 10-Year continues to hold the late October lows of just under 1.7% and to the upside, I still feel as though a yield level of 2.15% is the upper end of the trading range. Yields did approach the recent cycle highs of early November over this time frame as as shown in the chart below.
Switching to 3-month T-bills (the best barometer of future Fed action), yields have fallen close to the bottom of the current Fed Funds target range, finishing Friday at a yield of 1.52%. At these levels, the market is clearly leaning towards additional future rate cuts. Don’t forget though that this signal is somewhat distorted by the Fed’s current T-bill purchase program. On a combined basis with the 10-Year, the current spread is 28bps and the curve continues to struggle to steepen beyond what it was able to achieve in early November. For context, remember that if you look at this relationship on a longer-term basis, it would seem that this spread should make its way back to somewhere between 300bps and 400bps at some point. Furthermore, I recently tweeted that the NY Fed probability of recession (based solely on the yield curve spread/inversion) has been falling as shown in the chart below.
Over the last few weeks, Fed Fund futures have also shifted slightly towards an easing bias but not in any meaningful way. The cumulative chance of easing by year-end 2020 stands at just a shade over 63%. After all, by and large, current economic data does not support the need for future Fed action. The next Fed meeting is slated for the end of January.
Finally, 2-Year Treasury Note yields have fallen to 1.53% from 1.61% last time we checked (mid December). With Precious Yield continuing to offer 2-year physical gold term deposit rates of 2%, the US Treasury – Precious Yield spread* is in Precious Yield’s favor at -.47%. 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 US Dollar index (Ticker: DXY ), has traded in a fairly narrow band over the last few weeks, but the overall trend continues to be towards a slightly weaker dollar. Of note, the index slipped below the 97 level for the first time since July, finishing the week at 96.84. Breaking the dollar performance down by its major constituents, the USD has weakened in sync with the dollar index versus the Euro (57.6% index weight). Likewise, the dollar weakened against the Yen (13.6%) but to a much greater extent than the index. On the flip side, the dollar has strengthened materially against the Pound (11.9% index weight). As the latest Brexit deadline of 1/31/20 approaches, expect continued excess volatility in this FX currency pair versus volatility in other major currency pairs. If you are interested in tracking this volatility, have a look at the following ticker: BPVIX.
As for the Chinese yuan, there has been a small bit of follow through from the Phase One trade deal over the last few weeks as shown in the chart below. Even so, the yuan strengthening we have seen falls well short of the exchange rate just prior to the early May implementation of tariffs. If we see further roll-back of existing tariffs during phase two, I would continue to look for the exchange rate to fall back to its early May level of approximately 6.75:1. At current levels, FX will still be a major headwind for US companies doing business in China through at least the first half of 2020.
As mentioned in the overview, gold has been a real star over the last few weeks, rising steadily since we last checked in. With Friday’s shocking turn in the geopolitical arena, the gold per ounce price reached a new cycle high in USD terms. Specifically, as measured by the LBMA afternoon fix (11:00AM EST), the price of gold in ounces hit $1,548/oz. with spot gold prices continuing to rise further going into the NY close (4:00PM EST). This is an $82/oz. increase representing a 5.6% advance in just the last few weeks. Given that this isn’t a major breakthrough of the most recent high hit on September 4th, I hesitate to say that Friday’s close is a new floor price on the market. Consequently, I am still focused on the $1,400-$1,425/oz trading range to the downside and continue to note that the 200-day moving average sits squarely within this range at $1,422/oz. As I’ve said in the past, the upside breakthrough of 1.9% on the 10 Year Treasury Note yield drove gold prices to my initial downside target and I would expect an increase in yields above 2% to put my these next downside targets in play. The questions are 1) whether or not active QE by the Fed will allow 10-year yields to rise above the 2% level and 2) whether geopolitical tensions spiral further from here. I suspect that the answer to the first question is no until the Fed changes course and the answer to the second question is anyone’s guess. Consequently, I don’t see the downside targets coming into play in the near-future.
Given the significant and rapid upward movement in the gold price per ounce, it should come as no surprise that the “Gold VIX” (Ticker – GVZ ) has made a significant upward move as well. The index level currently resides at 13.46 versus 10.39 the last time we checked. This move has brought gold volatility back under 1 standard deviation below the average (since June 2008) using log normal data. If you remember, the very low level of gold volatility as of my last writing led me to believe that “I would expect a sharp move one way or the other in the not too distant future”. I guess we got that sharp move and it turned out to be to the upside. 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 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 gold and silver investing have 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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