Whereas last week’s theme was gold, gold, gold, this week’s theme was clearly shifting expectations surrounding the amount and timing of policy easing built into expectations. I must admit that the US jobs number released on Friday was quite good and should be used as an opportunity to reevaluate one’s outlook. Certainly, 3-month T-bill yields and Fed Funds Futures took the opportunity to do so. When juxtaposed against the ADP Employment change release on Wednesday (which showed a sequential rebound but clearly missed expectations), the significance of the Non Farm Payrolls release is a bit tempered. While my base case expectation remains unchanged and I feel that new market highs provide a good opportunity to rotate more defensively, the solid jobs report may have pushed back the timing of the next market sell-off. However, if you saw my recent tweet @CIORobPerry regarding the upcoming earnings season, I personally would not wait for higher stock market levels. Let’s stick with our format from last week and review the key drivers for the gold money relationship.
Driver #1: Further Weakening in US Economic Data
The latest Atlanta Fed GDPNow Q2 estimate dropped a bit further this past week to 1.3%. Again, expectations still indicate economic growth, albeit slower. Broadly speaking, economic data was mixed. For example, Markit Services PMI was better than expected while ISM Non-Manufacturing PMI was worse. Both are still above a reading of 50, indicating expansion. As mentioned earlier, ADP was a disappointment while Non Farm Payrolls beat. Finally, both Markit and ISM manufacturing PMIs were better than expected.
Weaker data earlier in the week drove 10-year Treasury yields below 2.00% and 10-year German bunds breached -0.4%, an all-time low. While Friday’s Non Farm Payrolls report reversed this dynamic, the absolute level of global yields suggest that yield alternatives will continue to be a focus. Upcoming testimony from Chariman Powell and corporate earnings will determine if the recent upward market trend persists. Although my conviction level is low/moderate, my best guess is that forward guidance given in conjunction with corporate earnings will be a tailwind for gold.
Driver #2: Progress (or Lack Thereof) on a Trade Deal with China
How much of this week’s strength in the dollar vs the yuan was driven by better US economic data as opposed to softening of expectations for a near-term trade deal? While we can never know the answer exactly, it seems to me that both were a factor as the dollar started to strengthen earlier in the week when economic data was much more mixed and bond yields were falling. This would indicate that some reassessment surrounding the likelihood of a trade deal was driving the fx pair at the beginning of the week and would be in line with my thought from last week that the US-China trade war would resurface as a market concern.
Driver #3: Geopolitical Tensions
As I will discuss in more detail in our Gold section below, additional tensions out of Iran in the early part of the week did not boost gold prices further. Only after global bond yields slipped did gold see its best day of the week. This lack of momentum was despite a slight re-rating of the market’s view of the likelihood of a US-China trade war truce. This affirmed my view that geopolitical tensions (or the lessening thereof) would likely be a headwind for gold. Said another way, near-term, most geopolitical discomfort has been built into the price of gold. Longer-term and at higher levels of discomfort, this would be a potential catalyst for precious metals prices.
All in all, this week pulled us a bit back from the ledge but I don’t think we are out of danger and I maintain my base case view. I still advocate for investor alert in this environment and have personally taken measures to rotate more defensively as it applies to my own circumstances.
The S&P rallied 1.6% during this holiday-shortened week, setting new record highs along the way. Friday’s close was slightly off of Wednesday’s highs after the better than expected Non Farm Payrolls number was released. The VIX collapsed from 15.08 to 13.28, declining nearly 12% in the face of the stock market rally. With Friday’s ultimately muted sell-off, the VIX did pick up a bit off of Wednesday’s closing low of 12.57. Using log normal VIX data, these lows approach one standard deviation below long-term averages. It’s no secret that a major component of the collapse in volatility is EXPECTED global central bank dovishness. However, as we saw with Friday’s market action, good data may start to be bad for the market if participants feel that it will drive the Fed to cut rates less than expected. That having been said, US equities recouped most of their early morning losses before the end of the day so we will need more evidence first before coming to a more definitive conclusion on that particular market sentiment.
The early part of the week’s stock market rally was driven by a continued drop in government bond yields. In fact, 10-year Treasury bonds closed below 2.00% on two consecutive days. However, the strong US labor market data released on Friday caused yields to increase from Wednesday’s closing low of 1.96% to 2.04%. The Friday sell-off was really felt in the short-end of the curve as 3-month T-bills ended the week at 2.23% (the best barometer for future Fed action). This speaks to worries over the Fed’s next move in light of the strong data and worsened the yield curve inversion from 12bps to 19bps. So much for the re-steepening that tends to be the “final recessionary shoe” as we are now re-approaching the recent lows in the 10-Year, 3-Month spread.
If you are wondering about that US Treasury – German Bund spread we’ve talked so much about, the spread increased from +235bps to +240bps which is consistent with better than expected US economic data. 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. As highlighted in several of my recent reports, I have been worried about the amount of Fed easing built into market expectations. While the market still fully expects a 25bp cut at the July meeting, the probability of a 50bp cut has dropped from a high of 42.6% on June 24th to only 5.4% as of Friday. On a longer dated basis, the probability of three rate cuts by the December Fed meeting as fallen from just under 60% last week to just over 40%. I view this pull back in expectations as healthy and we were able to achieve it with limited stock market damage.
Given the continued decline in longer-dated government bonds yields, the US Treasury – Precious Yield spread increased for the first time in a few weeks but still remains NEGATIVE. 2-Year Treasury notes finished the week at 1.87% from last week’s low of 1.75% while 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.
With higher rates here in the US and a widening US Treasury – German Bund spread, the dollar index (Ticker: DXY ) strengthened 1.2% to 97.29. The Euro and the pound weakened against the dollar pretty much in line with the index while the yen was relatively unchanged. Of note, the Canadian dollar held on to its recent gains and even strengthened a bit further, rising 0.4% on the week. On balance, the remaining components of the index (Swedish krona, Swiss franc) were weaker than the index itself. I believe that despite the better than expected jobs number, the Fed will still be inclined to cut 25bps at the July meeting and that the actual cut of rates will likely cause the next bout of dollar weakness. Given the change in market expectations with respect to the Fed, the hurdle on dollar weakness going forward has been lowered somewhat.
Dropping global bond yields temporarily drove gold prices modestly higher in the middle of the week, only to end up finishing back below $1,400/oz at $1,388/oz on Friday (as measured by the LBMA afternoon fix). Rising US yields and a strengthening dollar on the back of the US jobs report were too much for the precious metal to overcome. I find the price action in the early part of last week particularly interesting for a few reasons. First, the Trump-Xi trade war pause was almost immediately met with renewed geopolitical tensions out of Iran. On Monday, international inspectors and Tehran both agreed that Iran had broken the limit set on its stockpile of low-enriched uranium by its 2015 nuclear deal. Despite this news and a Tuesday drop in 10-Year treasury bond yields below 2.0%, gold prices FELL. Only Wednesday, when bond yields dropped even further did gold nose a bit above last Friday’s close. It would seem to me, that at least for the moment, the gold rally has become particularly stretched. While the better entry point for those looking to get long gold as an investment came later than expected, I would expect this window to persist as long as economic data doesn’t falter again before corporate earnings announcements.
One interesting dynamic that we are watching closely is investor interest in gold ETFs (as measured by inflows) compared to investor lack of interest in physical coins (as measured by coin premiums). Coin premiums have again gone negative on the bid side for some popular products not of the current 2019 year. This includes Eagles and Maples. It is unclear why investors are favoring one form of obtaining gold exposure to the other but we speculate that it might have something to do with lower overall cost of ownership. Precious Yield compares favorably on that basis.
With the milder swings in gold prices this week, gold volatility (as measured by the “Gold VIX”, Ticker – GVZ) dropped a bit further to 15.07 from 15.99. While the current reading is below the average since June 2008, it is well within 1 standard deviation and does not portend mean reversion for those who like to marry fundamental analysis with technicals. As discussed last week, 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.
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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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