Let me start by saying that it is good to be back talking about the markets. As I’m sure you are all aware, as always, there were many noteworthy events over the last two weeks. But, in my opinion, the most important market action as it relates to movements in the gold money relationship happened during the last two trading days of this past week. Up until this last Thursday, US equities continued to trade in a range, US Treasury yields continued to fall (particularly in the longer end of the curve), the dollar continued to strengthen and the gold price per ounce advanced practically unimpeded. So what happened?
On Thursday, prior to the US markets open, it was announced that the United States and China would hold trade talks in Washington in early October. In support of this early October ministerial-level meeting, it was also announced that deputy-level meetings would take place ahead of the talks. Further bolstering investor’s risk on sensibilities, Chinese media seemed to indicate more optimism surrounding the newest round of scheduled talks. First, Hu Xijin, editor-in chief of Chinese state media Global Times said Thursday on twitter that “there’s more possibility of a breakthrough.” Per CNBC, Hu has been “spot on with the recent developments in the escalated trade war.” In addition, a closely-followed blog called Taoran notes said it’s “very likely” there will be “new developments” in the upcoming trade talks. This news broke many of the trends that had dominated the markets over the last several weeks. I’ll cover those in more detail in the individual markets sections below but I think it’s worthwhile to spend a moment on gold upfront.
In my last report two weeks ago, I took the opportunity to remind our readers that “I continue to maintain that if any actual progress gets made in the trade talks, it should be a very solid positive for risk-on markets and conversely, the gold price per ounce would likely suffer.” As the US-China trade news broke, this is exactly what happened. As measured by the LBMA afternoon fix, the gold per ounce price declined $22.40/oz. or 1.4% to $1,523.70/oz. But, do you remember the “odd little wrinkle” that I spoke of two weeks ago? The LBMA afternoon fix settles at 3:00PM GMT (11:00 AM EST) but the spot price of gold in ounces continues to trade up until 4:00PM EST. And in that final trading push, gold declined a further $17.20/oz to $1,506.50/oz. All told, the gold price per ounce fell over 2.5% from Wednesday’s LBMA afternoon fix – a significant reaction to Thursday’s US-China trade war news.
Now that we’ve discussed what I believe to be the biggest game changer over the last two weeks, let’s talk a little about other important events that happened. Starting with economic data, well, it hasn’t been so hot. The Atlanta Fed GDPNow estimate has declined from the top of the consensus ranged to the bottom as shown by the chart below.
In total, the estimate for Atlanta Fed GDPNow Q3 real GDP growth has fallen from its recent peak of 2.3% to 1.5% after disappointing US personal income, pending home sales, ISM manufacturing PMI, construction spending and balance of trade reports.
Of note, the US yield curve began to re-steepen last Wednesday and in my opinion, it was a delayed reaction to Tuesday’s US ISM Manufacturing PMI. This corrected the inversion in the 10s-2s part of the Treasury curve as the government bond market became more certain of near-term Fed action. What was so special about that singular piece of economic data as opposed to the others that caused downward revisions in the GDPNow forecast? It came in below 50 which indicates a contraction in the domestic manufacturing sector. It would appear that the trade war flu that has been infecting most other manufacturing economies has finally caught up with us domestically too. That said, a trade deal would go a long way towards reversing this trend globally.
All was not lost, however, on the economic data front. Last Thursday, the ISM Non-Manufacturing PMI was much better than expected and represents a much larger share of the domestic economy vis-a-vis manufacturing. And while the US Markit Services PMI continues to tread barely above 50 (in line with the flash PMI results I spoke about a few weeks ago), the ISM Non-Manufacturing PMI result provided some much needed breathing room. As discussed in my last report, the US is not a manufacturing dependent economy so we should view the ISM manufacturing data as concerning but not predictive of an imminent recession. However, the United States IS a services (and consumer) dependent economy. This is why I intend to watch the services numbers carefully.
Finally, the US Non Farm payrolls report released on Friday was viewed as a miss versus consensus despite benefiting from government hiring of employees for the 2020 census. While the 130K jobs that were created were below consensus and July job growth was downwardly revised, I did not view the result as bad given the blowout job growth reported in the household survey portion of the release. The household survey showed a 590K gain in employment after last month’s 283K gain. Nonetheless, we must keep an eye on job growth moving forward as the risk of a downshift appears to be underway in the more closely followed payroll survey portion of the release.
On the corporate earnings front and out of curiosity, I checked in with Factset Insight to see if there has been any update to Q3 estimates. Last time we had an update, analysts were expecting a 3.1% decline in earnings paired with a 3.0% increase in revenues for Q3. While I don’t believe the impact of trade tensions has been fully baked in, I note that the latest estimate is for a 3.6% decline in earnings paired with a 2.9% increase in revenues. My opinion continues to be that trade tensions increase the likelihood that US corporate revenue and a return to earnings growth will be challenged in the face of a global slowdown. I also still believe that it is unlikely that the full impact from August/September additional tariffs or a further escalation from here is fully accounted for in current estimates and therefore, puts the expected earnings rebound projected to start in Q4 2019 and further accelerate in 1H 2020 in jeopardy. Given this backdrop and despite the seemingly continued resilience of the consumer (more on this later), I continue to advocate for investor alert and a rotation towards a more defensive portfolio.
Finally, let’s spend a moment on the “flies in the ointment” for the bears: the consumer and copper prices. As discussed above, the ISM Non-Manufacturing PMI alleviated some concern surrounding the weaker reading provided by the Markit Services PMI data. However, the final University of Michigan consumer sentiment reading was revised much lower than expected and registered a near 3-year low. The data from this survey indicate that the erosion of consumer confidence due to tariff policies is becoming more and more evident. This is cause for concern because prevailing economic theory believes that negative trends in consumer sentiment cannot be easily reversed. That said, despite the downshift shown shown in the chart below, the overall level of sentiment is still considered to be consistent with continued (albeit muted) gains in consumption.
As for copper, the combination of slightly better economic news out of China combined with renewed optimism surrounding US-China trade talks helped move the front month futures contract nearly 4% higher and further away from the dangerous $2.50/ high $2.40s technical level that I’ve previously mentioned. Also of note, copper futures pierced the most recent high from mid August (which is hard to see on the longer term chart I’ve included below). I believe that holding the $2.50/high $2.40s support level remains critical for the bull narrative. For the moment, that appears to be the case.
Before diving into each individual market, I’d like to remind readers that anyone who is thinking about buying gold 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. There are many and varied drivers of the gold money relationship. In support of developing that view, let’s review the major markets that precious metals take their cue from.
On a headline basis, the S&P 500 index increased a whopping 4.6% cumulatively over the last two weeks. This was achieved with a 2.8% gain the week before Labor Day followed by an additional 1.8% gain this past week to finish at 2,978. Surprisingly, the index never tried to retest the 2,825 level that it had bounced off of three times previously despite my view that I thought it might. Even more importantly, Thursday’s pledge for renewed trade talks broke the range-bound trading of the S&P that had been delineated by the 50-day moving average to the upside and the 200-day moving average to the downside since the beginning of August. This unanticipated catalyst caused an upside breakout as shown in the chart below.
Volatility, as measured by the VIX, decreased substantially over the last two weeks from 19.87 to 15.00. Most of the decrease in volatility, however, started this past Wednesday. The VIX then continued to fall sharply for the remainder of the week as markets reacted to the newly scheduled US-China trade talks. At a level of 15.00, we currently sit below the long-run average (since January 1990) using log normal data but well within one standard deviation. This is not a downside extreme in volatility by any means. Of note, the front month portion of the VIX futures curve reverted back to contango after having spent a significant period of time in backwardation. I can only conclude that for the time being, the market does not believe there will be meaningful near-term volatility given recent developments.
On a two week basis, US 10-year Treasury yields increased slightly from 1.52% to 1.55% With such a modest overall move, I think I can still safely claim that #yield matters! However, this modest overall increase in yields masks the fact that up until last Thursday (when the renewed trade talks were announced), bond yields continued to fall with the 10-year Treasury reaching a closing low yield of 1.47%. This was a new closing low yield for this cycle and frankly, the 10-year looked poised to make a run at its all-time lows set back in 2016 – see chart below. However, like stocks, Thursday’s news broke the trend in the government bond market. On Thursday alone, 10-year Treasury yields increased a full 10bps to 1.57% before settling back a bit on Friday in conjunction with the Non-Farm payroll release.
In contrast, 3-month T-bills were essentially unchanged over the two week period dropping 1bp to 1.96%. Of note, there was no noticeable reaction to Thursday’s news in this end of the curve. Looking at the moves in the 10-year and 3-month in conjunction with one another, the inversion now stands at -41bps versus the last time we checked in at -45bps. Much like the 10s-2s portion of the curve, which I will discuss shortly, the combined moves had the net impact of steepening the curve. Remember, with the Fed Funds rate currently in the range of 2% – 2.25%, a 3-month T-bill yield of 1.96% predicts one very near-term Fed rate cut. As we’ve discussed for a couple of weeks now, Fed Funds futures are still expecting an 80% chance of more than just one cut by the end of the year.
After spending much of the week before Labor Day inverted, the 10s-2s portion of the yield curve straightened out post Labor Day. 2-Year Treasury yields increased from 1.51% to 1.53% on a two week basis. Like 10-year Treasury yields, this two week move masks the fact that up until last Thursday (when the renewed trade talks were announced), 2-Year Treasury bond yields continued to fall as well. These yields reached a low of 1.43% before Thursday’s news broke.
Because Precious Yield continues to offer 2-year physical gold term deposit rates of 2%, the US Treasury – Precious Yield spread* once again favored Precious Yield at week’s end. The spread itself narrowed a bit further from -.49% last time we checked to -.47% given the aforementioned move in 2-Year Treasury notes. 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.
Finishing with overseas action, US Treasury – German Bund spreads continued to hover near their tightest levels since last November’s all-time wide of +280bps. The spread spent much of the last two weeks below +220bps, hitting a new cycle low of just under +215bps this past Wednesday before retreating back to +220bps. You can see this new cycle low in the chart below. Remember, a continued tightening of this spread is a key component to my recession watch list.
Unlike with stocks and the intermediate to longer dated portion of the Treasury curve, I don’t believe Thursday’s trade talk news broke the trend in the dollar index. What is the trend you might ask? A persistently strong dollar. On Tuesday, the dollar index (Ticker: DXY) hit a new cycle high of 99 which was the highest level since its most recent peak of 103.3 in December 2016. This new cycle high occurred after logging a 1.3% gain against the same basket of currencies the week before Labor Day. However, over the balance of this past week, the index retreated a bit from that cycle high to finish at 98.39. In my opinion, the recent weakness in the dollar was driven by the relative softness of economic data coming out of the US coupled with some second derivative changes in the economic data coming out from the rest of the word (i.e. the rest of world data was “less bad” than it had been).
Unlike the dollar index, the weakening of the dollar vs. the Chinese yuan was directly a result of Thursday’s news. You can add the movement in this fx pair to the list of markets that changed course. Here’s a chart of the fx pair from just before the news broke through the balance of the week.
I will note, however, that a pledge for renewed talks is not the same as achieving an actual trade deal. As a result, I’ll take this opportunity to remind everybody that I continue to maintain that if any progress gets made in the trade talks towards an actual trade deal, it should still be a very solid positive for risk-on markets and conversely, the gold price per ounce would likely suffer. I think the action that we saw across multiple markets at the end of this week supports that thesis.
So you already have an idea what happened to the gold price per ounce after Thursday’s new. I won’t rehash that here, but I will mention that gold had been extremely resilient leading up into that announcement. What do I mean by that? I mean that the price of gold continued to climb despite several headwinds. The headwinds included a major rally in stocks, a decline in volatility and a stronger dollar. In fact, the only thing that was supporting gold the week before Labor Day and the early part of last week was falling bond yields. So from that perspective, maybe we can conclude that falling bond yields are the number one driver of gold price right now. Including Friday’s post-LBMA afternoon fix losses, the gold per ounce price is still up 17.8% since May 3rd, the last market trading day prior to President Trumps’ surprise announcement of Chinese tariffs on Sunday, May 5th. Again, the price of gold in ounces on that date was $1,278.55.
During the week prior to Labor Day, upward volatility in the gold price did not translate to higher implied volatility in GLD options. Curiously, the end of week sell off in gold also did not translate. As a result, gold volatility decreased substantially to end the week at 14.75. This is below the long term average using log normal data since June 2008 but still within one standard deviation. 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.
As a final parting shot, I would be remiss if I didn’t mention that the price per ounce silver exhibited a very similar trend to gold albeit with much bigger price swings over the last few weeks. LBMA silver prices peaked on Wednesday at $19.305/oz. and similar to gold, limped into the 4:00PM EST NY close, finishing at $18.22/oz. In total, silver prices declined 5.6% over the two day period versus the 2.5% decline in gold prices over the same time frame. As of May 3rd, the silver price by ounce was $14.655. In total, the spot silver price is up 24.3% vs. the 17.8% increase in the spot gold price over the same period.
While an investment in gold and silver has historically been associated with negative carry, Precious Yield 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 with Precious Yield allows for some cushion against price movements via the gold and silver 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 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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