Gold, crude and copper is where the action is, while stocks and Treasuries take a back seat for the present.
Markets are signalling a reluctance to take on risk, while long-term Treasury yields threaten to trend higher.
We also revisit rising Treasury debt — the elephant in the room — and examine the CBO’s budget projections in more detail.
Crude Oil
Brent crude respected resistance at $84 per barrel, signaling a decline to below $80.
Nymex light crude breach of support at $78 per barrel would confirm the reversal. A decline in crude oil is likely and would ease inflationary pressures, with the expected fall in long-term yields bullish for stocks, bonds and precious metals.
Crude oil production remains steady at a massive 13.1 million barrels per day according to the EIA report for the week to May 3.
Inventories (including SPR) recovered to above 1.6 trillion barrels, while market concerns eased over Iran-Israel tensions.
Copper
Copper is testing short-term resistance at $10K per metric ton. Breakout is likely and would test major resistance (green) at $10.5K.
The rise, however, is caused by a production halt at Cobre Panama. Production could be resumed if the mine-owner First Quantum can reach agreement with the new president-elect Jose Raul Mulino. From Reuters:
Mulino, a 64-year-old former security minister, won Panama’s election on Sunday [May 5] with 34% of the vote and said his government would be pro-investment and pro-business, adding that the Central American country would honor its debts, while he vowed to not forget the poor. He won with the help of popular former President Ricardo Martinelli who was barred from running due to a money laundering conviction. Mulino, who served as security minister during Martinelli’s administration from 2009 to 2014, had been Martinelli’s vice presidential candidate and took his place.
Gold & the Dollar
The Dollar Index continues to test support at 105. Respect remains likely, with Trend Index troughs above zero signaling buying pressure, unless Janet Yellen at Treasury intervenes to weaken the Dollar in support of the UST market.
Gold broke resistance at $2350 per ounce, signaling another advance. But first expect retracement to test the new support level. Respect would confirm a target of $2500 per ounce.
Shanghai Gold Exchange domestic contract Au99.99 is trading at 553 RMB/gram, equivalent to a USD price of $2380 per ounce at the current USDCNY exchange rate of 7.2268.
Stocks
The S&P closed above 5200 on Friday but a doji candlestick and lower Trend Index peaks indicate a lack of enthusiasm from buyers.
The Russell 2000 small caps ETF (IWM) reflects the lack of broad market support for the rally, with Trend Index peaks below zero warning of selling pressure. Another test of support at 200 is likely.
Financial Markets
Ten-year Treasury yields continue to test the band of support between 4.4% and 4.5%. Recovery above 4.5% would signal another test of 4.7%.
Bitcoin is testing support at $61K. Follow-trough below say $60K would confirm the decline — initially signaled by breach of support at $64K — and warn that financial markets are moving to a risk-off position.
Commercial bank reserve balances at the Fed, however, grew by $78 billion in the week to May 8, indicating that financial market liquidity is improving.
Consumers
Consumer sentiment retreated to 67.4 in the University of Michigan survey for May 2024, but the up-trend continues.
Five-year inflation expectations jumped to 3.1% but the three-month moving average, ranging between 2.9% and 3.0%, signals little change in the long-term outlook.
The Elephant in the Room
Last week we published a note suggesting that investors were distracted by short-term noise and ignoring the elephant in the room — the precarious level of US federal debt. The bipartisan Congressional Budget Office (CBO) projects that Treasury debt will grow to a clearly unsustainable 172% of GDP by 2034.
The US fiscal deficit is projected to grow from $1.6 trillion in 2024 to $2.6 trillion by 2034. Remember: all projections are wrong, but some are useful.
Often the most useful part of a projection is the underlying assumptions.
Real GDP growth below is a modest 1.5% in 2024, reaching 2.2% by 2026 — nothing controversial there. But the inflation projection is Pollyannaish, assuming a steady CPI decline from 3.2% in 2023 to 2.2% by 2034 — totally unrealistic if the budget deficit is to remain at close to 6.0% of GDP.
Assumed inflation (above) also impacts on projected nominal interest rates, with the projected fed funds rate declining to 2.9% by 2027 and 10-year Treasury yields to a low 3.8%. Every 1.0% overshoot in inflation would be likely to cause a similar increase in both long- and short-term interest rates.
The budget projection below is equally unrealistic. Defense spending, the CBO would have us believe, declines to 2.5% of GDP by 2034. Given rising geopolitical tensions with Russia-China-Iran, defense spending is likely to exceed the long-term average of 4.2%.
Net interest is budgeted to grow from 2.4% of GDP to 3.9% of GDP by 2034 but is based on unrealistic interest rate projections.
Treasury debt is likely to grow a lot faster than projections — because of the likely understatement of both defense spending and interest costs. That means that debt held by the “public” will have to grow a lot higher than the $48.3 trillion projected by 2034. If real interest rates are too low, any shortfall in take up by the public will have to be absorbed directly or indirectly by the Fed.
Conclusion
Rising inventory and easing Middle East tensions have weakened crude oil prices. A long-term decline in crude would be likely to relieve inflationary pressures and allow the Fed to cut interest rates.
Copper is rising steeply due to supply shortages, but prices could fall just as rapidly if the Cobre Panama mine is reopened by the new president-elect.
Gold broke resistance at $2350 per ounce, signaling another advance. Retracement that confirms the new support level at $2350 would offer a target of $2500.
Long-term Treasury yields are testing support. Respect of support is likely and would confirm the recent up-trend.
Perceptions of market risk are rising, with Bitcoin testing support at $61K and the Russell 2000 small caps ETF (IWM) warning of selling pressure.
Financial market liquidity, however, recovered slightly in the last week.
Consumer sentiment continues to trend higher, while long-term inflation expectations remain steady at close to 3.0%.
The elephant in the room remains Treasury debt, with CBO projections understating likely deficits due to unrealistic assumptions for inflation, interest rates and defense spending. Debt issuance by Treasury is expected to exceed demand from foreign investors and the general public, leaving the shortfall to be absorbed by the Fed or commercial banks.
The result is likely to be higher long-term inflation, boosting real asset prices while eroding the value of financial assets.
We are long-term bullish on Gold, Defensive stocks, the Heavy Electrical sector, and Critical Materials (Lithium and Copper). The last two stand to benefit from the energy transition. We are also overweight short-term financial assets with duration of 2 years or less: Mortgages, Term Deposits and Money Market Funds.
We remain underweight Growth stocks — which we consider overpriced — and long-duration financial assets.
Acknowledgements
- EIA: Petroleum & Crude Inventory
- EIA: Weekly U.S. Field Production of Crude Oil
- University of Michigan: Surveys of Consumers
- CBO: The Budget and Economic Outlook, 2024 to 2034
- Shanghai Gold Exchange: Delayed Quotes
- CoinDesk: Bitcoin Prices
- Reuters: Exclusive-Panama’s president-elect vows to help fix canal water problems, build major train line
- Adam Taggart’s Thoughtful Money: Interview with Michael Pento