Welcome back from Thanksgiving break! We hope you enjoyed your time off and hopefully you spent it with friends and/or family. While most of us were away from our desk enjoying a well-needed respite, the overall theme of the market was “risk -on” with the S&P 500 reaching a new all-time closing high on the Wednesday before Thanksgiving and closing within 8 points of that high this past Friday. In the in-between, the markets got the overdue pullback I was looking for during the three day period beginning the Friday after Thanksgiving through Tuesday of this past week. Not surprisingly, the pullback was driven by fears over US-China trade relations. In my opinion, however, trade relations have taken a back seat to the Fed and economic data in terms of being the main drivers of the markets. I’ll start with those topics first since it’s my estimation that they are the topics most relevant to anyone holding a gold investment or silver investment.
In order of importance, I believe the single biggest driver of market sentiment and price right now is the Fed. This first chart shows the Fed’s balance sheet back over $4TN with their ongoing support of the repo market and purchases of T-bills.
If you’ve been following me on twitter, I’ve made the point over the last few weeks that T-bill purchases have really been the incremental driver of Fed balance sheet growth. As you can see from the chart below, repo outstandings have been steady at +/- $200BN since the end of September.
This Fed support combined with the current trajectory of economic data (improving) is a powerful combination. Look at how the Atlanta Fed GDPNow estimate has trended. Before we left for Thanksgiving break, it looked as though GDP growth was stalling out in Q4. With economic data releases over the last two weeks, GDP growth looks poised to achieve the high end of consensus estimates. And while 2% GDP growth isn’t awe-inspiring, it is solid late economic cycle performance in my opinion.
While not every piece of economic data was strong (domestic manufacturing indices are still below 50 and construction spending remains weak), most releases solidly beat. The biggest jump in the Q4 GDPNow estimate was driven by US durable goods orders. These orders increased 0.6% MoM in October vs. a consensus estimate of a 0.8% decline. This more than offset the slight downward revision to the prior month. Second in order of importance was the US Non Farm payrolls report which showed gains of 266K in employment vs.consensus of 180K for November. In addition, payrolls for the prior month were revised upward. When combined with a beat in the University of Michigan Consumer Sentiment index, the health of the consumer continues to be on solid ground. The following chart shows how a rebound in payrolls and consumer confidence appear to go hand in hand.
Other major releases (personal spending, personal income, ISM non-manufacturing & balance of trade) over this two week period were either in line or slightly weaker than expected. I won’t go into them in detail as their cumulative impact vis-a-vis the data that I detailed above appears insignificant in relation to the GDPNow estimate.
On the geopolitical front, news flow regarding US-China trade relations continued to yo-yo back and forth despite the rapidly approaching December 15th deadline for implementing additional tariffs. It all started with President Trump, on the eve of Thanksgiving, signing legislation that authorized sanctions on Chinese and Hong Kong officials responsible for human rights abuses in Hong Kong. Then, this past Tuesday, President Trump “raised the prospect of postponing a trade deal with China until after the 2020 election”. This immediately followed news on Monday that he would impose tariffs on steel and aluminum from Brazil and Argentina which many saw as a way of punishing them for supplying China with goods previously purchased from the US. The stated reason, however, was that the tariff implementation was a response to the South American countries’ currency manipulation that has been hurting American farmers. After all of that consecutive bad news, the picture looked pretty bleak and odds of a trade deal failure rose to their most recent highs. Riding to the rescue, however, was Larry Kudlow, director for the White House Economic Council, who not more than a few days later said that a trade deal was “close” and “probably even closer than in mid-November”. So while the market still moves on these sorts of headlines, their overall impact continues to decline as investors have become accustomed to the constant posturing inherent in these negotiations. What can we really expect from the December 15th deadline?
In my opinion, if negotiators continue to kick the can down the road, we will have more of the same market action over the next few quarters. This means risk-on oriented markets backstopped by the Fed. A completed trade deal will only exacerbate the upside as I believe that the market is pricing in a higher probability of failure than success. If tariffs get implemented as planned, I think we will see a mild flight to safety effect while a more aggressive tariff implementation would open up unanticipated downside. As I laid out in my last report, December presents several other challenges besides the tariff deadline: an FOMC meeting (12/11), the UK elections (12/12) and an ECB meeting (12/12). I personally don’t see any major surprises coming from the central banks and my base case expectation is for the asymmetric upside environment to continue.
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.
Here we sit, just a shade off of the all-time closing highs set on the eve of Thanksgiving for the S&P 500. As mentioned in the overview, negative trade related headlines produced the modest pullback I was looking for from the Friday after Thanksgiving through Tuesday of this past week. All told, the S&P declined 84 points from its intraday high on the eve of Thanksgiving to its intraday low of 3,070 this past Tuesday. In percentage terms, this represents a decline of just over 2.6%. Positive economic data and Larry Kudlow’s Friday China trade comments helped the index rebound, finishing the week at 3,145, just 8 points off the closing high.
From a technical perspective, the pullback that ended on Tuesday was very healthy for the market. It let out just enough steam so that the market should be able to grind higher absent a UK election and/or tariff deadline surprise. My confidence in this outlook stems from the belief that the Fed’s QE/not QE launch that I discussed in my Precious Metal Market Update – 20 October 19 is the main culprit behind this rally and the overall decline in market volatility. Remember, Fed purchases will last at least into the second quarter of 2020 so the safety net underneath the market has some time to run. Going forward, this past week’s pullback shifted technical ranges a bit. I now believe that Tuesday’s intraday low of 3,070 provides an interim floor to the market with the 50-day moving average of 3,042 not far behind it.
Volatility, as measured by the VIX, also indicates that the market can grind higher from a technical perspective. The sub 12 readings (indicative of a potential mini reversal) that we saw leading up to Thanksgiving disappeared with the modest pull back. The snap back rally that ensued from Wednesday through Friday this week left the VIX at a level of 13.62. This level is now less than one standard deviation below its long-run average (since January 1990) using log normal data and supports the theory that the market is no longer overbought from a technical perspective.
Since we last checked, the US Treasury curve has re-steepened a bit but has yet to reclaim the steep shape that it had a few weeks back. On the short-end of the curve, we see 3-month T-Bill yields have fallen, closing at 1.53% as of Friday. This contrasts with 10-Year Treasury note yields which have increased, closing at 1.84% also as of Friday. Despite the passage of additional time since my last report, nothing has changed with respect to my anticipated trading ranges. While I still feel as though a yield level of 2.15% on the 10-Year Treasury Note is the new upper end of the trading range, a break below the late October lows of 1.70% would likely cause me to reconsider.
Digging into the short end of the curve a bit deeper, with the Fed’s most recent target Fed Funds range of 1.50% – 1.75%, a 3-month T-bill yield of 1.53% (the best barometer of future Fed action) implies an increasing investor bias towards additional easing by the Fed. Fed Funds futures confirm this sentiment shift. When we spoke two weeks ago, Fed Fund futures were pricing in a wider variety of outcomes by the end of 2020. While the variety of outcomes remains a bit higher than usual in my opinion, the possibilities have narrowed somewhat. Currently, the highest probability outcome has shifted to 50bps of cumulative easing from a single 25bp cut previously. Please see the following chart for the latest probabilities as implied by Friday’s ending Fed Funds futures trading levels.
Switching to 2-Year Treasury Notes, those yields remain unchanged at 1.61%. 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 -.39%. 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.
Over the last two weeks, the dollar, as measured by the US Dollar index (Ticker: DXY ), was fairly stable – until the negative US-China trade headlines hit. As equities sold off and Fed probabilities shifted more definitively toward an easing bias, the dollar weakened in sympathy. In aggregate, the dollar weakened 0.6% all within the last week as it fell nearly 0.4% against the Euro (57.6% index weight) and 0.8% against the Yen (13.6% index weight). The dollar also weakened against the Pound, falling a whopping 1.6% (11.9% index weight). Of note, the Pound regained the 1:1.30 level against the dollar after a more than 6 month hiatus. Breaking through this barrier came largely on the back of increased odds that a Conservative majority will be achieved at this coming week’s election. To remind readers, I expect that volatility in the Pound/Dollar currency pair will continue over the next week.
Consistent with recent assumed correlations, the dollar strengthened a touch against the Chinese Yuan this week. Usually, whatever direction the dollar heads as measured by the dollar index means the complete opposite for the dollar trading against the Chinese Yuan. During the early part of the week, in the heat of the negative trade related headlines, the dollar was at its strongest levels against the Chinese Yuan. In my simple analysis, the fx rate earlier in the week indicated a 75% chance of the trade deal failing. You can see the associated chart in this related tweet. By week’s end, the market implied probability had fallen back to approximately 65% which is where we left off last time we checked. Remember, my thinking is that as the trade war gets worse, other developed market currencies become more attractive versus the dollar but by the same token the trade war has a greater negative economic impact on China than it does on the US.
As much as I hate being on the fence, gold prices still appear as though they need to find a direction. On the one hand, you’ve got the Fed easing via QE – a clear positive for gold. On the other, you’ve got stable to improving economic data that is driving equity prices higher and volatility lower – a clear negative. Maybe that’s why gold was essentially unchanged this past week. As measured by the LBMA afternoon fix (11:00AM EST), the gold per ounce price decreased from $1,460/oz to settle $1 lower at $1,459/oz. Two weeks ago, the price was $1,464/oz. As an aside, spot gold prices were unchanged going into the NY close (4:00PM EST). At these prices, we are 5.6% below the recent cycle high of $1,546/oz., and I am still focused on the $1,400-$1,425/oz downside trading range price target. I would note that the 200-day moving now sits squarely within this trading range at $1,404/oz. To reiterate, 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 next downside targets in play. I still believe these targets look reasonable in my opinion when looking at gold prices concurrently with the last time 10 Year Treasury Note yields were above 2% in the late June/early July time frame. The bigger question is if 10-Year Treasury Note yields will reach those levels anytime soon with the Fed currently buying T-bills. Fence!
Checking in on gold volatility, the “Gold VIX” was barely changed this week but lower on a two week basis with a reading of 10.73. This low level of gold volatility is nearly 1.5 standard deviations below the average (since June 2008) using log normal data. Looking at both the AM & PM LBMA fixes, the gold price per ounce trading band stayed largely consistent, fluctuating $18/oz. between the high and the low (vs. $17/oz. last time we checked). I use these price bands to better understand the movements in the “Gold VIX” (Ticker – GVZ ) levels from above. 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 ). As I have stated previously, looking at the price band of spot gold prices alone will not capture the supply/demand dynamics that take place in GLD options but at least it is an additional tool. 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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