Author: Colin Twiggs

Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters. Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis. Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events. He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
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Gold: Reasons for the up-trend

Gold is in a medium- to long-term up-trend. Apart from record central bank purchases of bullion and a weakening Chinese Yuan, real long-term interest rates are declining.

The chart below highlights the inverse relationship between gold and real long-term interest rates (10-year Treasury yield minus CPI YoY%). When LT interest rates fall, gold prices surge.

Spot Gold in USD compared to Real 10-Year Treasury Yields

Treasury yields are falling because the Fed is cutting short-term interest rates but, more importantly, because QE has resumed. With the ECB driving bond yields into the negative, demand for Treasuries is surging.

The Fed has also reversed course, expanding their balance sheet after the recent liquidity squeeze forced them to resume overnight repos.

Fed Total Assets and Excess Reserves on Deposit

Our target for Gold is the 2012 high of $1800/ounce.

A weak rally strengthens the bearish argument for China’s Yuan, suggesting continuation of the primary down-trend.

CNYUSD

The Yuan is in a long-term down-trend against the Dollar that shows no signs of easing. Resolution of trade tensions is unlikely. Trade is merely the tip of the iceberg in a far wider clash between two global powers with conflicting ideologies which is likely to continue for decades.

Gold is testing support at $1495/ounce. Breach would warn of a correction.

Spot Gold in USD

Silver is similarly testing support. Breach of $17.50/ounce is likely and would warn of a correction, with Gold expected to follow.

Spot Silver in USD

The All Ordinaries Gold Index is trending lower. Breach of 7200 would warn of another decline, with a short-term target of 6500.

All Ordinaries Gold Index

Patience is required. Gold remains in a long-term up-trend and a correction may offer a sound entry point.

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Gold finds support

China’s Yuan found short-term support at 0.1395/0.1400 against the US Dollar but the ensuing rally is weak, suggesting continuation of the primary down-trend.

Our view is that the Yuan is in a long-term down-trend against the Dollar that shows no signs of easing. Resolution of trade tensions is unlikely, with trade merely the tip of the iceberg in a far wider clash, between two global powers with conflicting ideologies, that is likely to continue for decades.

CNYUSD

The soft Yuan rally strengthened demand for Gold. A correction would present a good entry point in an expected long-term up-trend but patience is required.

Spot Gold in USD

Problems with continued use of the Dollar as a global reserve currency are driving central bank demand for Gold. According to Peter Schiff:

“Central bank gold purchases in April continue a trend we saw through 2018. In total, the world’s central banks accumulated 651.5 tons of gold last year. The World Gold Council noted that 2018 marked the highest level of annual net central bank gold purchases since the suspension of dollar convertibility into gold in 1971, and the second highest annual total on record.

A move to minimize dependence on the US dollar, especially by countries like Russia and China, is driving this central bank gold-buying spree.”

Our target for Gold is the 2012 high at $1800/ounce.

Silver found support at $17.50 after a stronger retracement. Breach of support on Silver would be a bearish medium-term signal for Gold.

Spot Silver in USD

The All Ordinaries Gold Index is trending lower. Breach of 7200 would warn of another decline, with a target of 6000/6500. The primary trend is expected to remain upward, so this could present a good entry point.

All Ordinaries Gold Index

A long-term chart of the All Ordinaries Gold Index plotted against Gold (in AUD) shows valuations are relatively low compared to the boom of 2007 and 2011. A weaker Aussie Dollar and stronger gold price could both lift prices for local gold miners.

All Ordinaries Gold Index Relative to Gold Price

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The canary in the coal mine

Bellwether transport stock Fedex (FDX) is testing long-term support at 150. Peaks close to zero on the Trend Index warn of selling pressure. Breach of support would warn of a decline with a long-term target of 100.

Fedex

Breach of LT support would also be a bearish sign for the US economy, warning that economic activity is weakening.

The S&P 500 is testing resistance at 3000. Expect stubborn resistance followed by a test of support at 2800. Breach of 2800 would flag a reversal with a target of 2400.

S&P 500

Dow Jones – UBS Commodity Index rallied strongly with the Saudi oil price shock but finished the week with a strong bearish reversal signal. Expect another test of support at 76. Breach would signal a (primary) decline. We maintain our bearish long-term outlook for commodities.

DJ-UBS Commodities Index

We have reduced our equity exposure to 36% of (International Growth) portfolio value because of our bearish outlook on the global economy.

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ASX 200 tests resistance, Iron ore tests support

Iron ore found resistance at $95/ton and is likely to again test short-term support at $90. Support is unlikely to hold and breach would offer a medium-term target of $80 per ton.

Iron Ore

The ASX 300 Metals & Mining index found support at 4100 but the rally is weak. Breach of 4100 would complete a head and shoulders reversal, giving a target of 3400.

ASX 300 Metals & Mining

A fall in iron ore prices would increase downward pressure on the Aussie Dollar.

The Financial sector continues to look bullish, testing resistance at 6500, with Trend Index troughs above zero indicating buying pressure. Housing woes are far from over, despite improved auction clearance rates, and we expect the sector to remain a drag on growth for the next three to five years — unless the RBA & APRA go “all-in” on a housing bubble to “rescue” the economy.

ASX 200 Financials

The ASX 200 is edging upwards, towards a test of resistance at the 2007 high of 6800. Expect stubborn resistance. Reversal below 6400 would warn of a decline to test primary support at 5400.

ASX 200

We maintain exposure to Australian equities at 25% of portfolio value, with a focus on defensive and contra-cyclical stocks, because of our bearish long-term outlook.

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Australia: Leading Index of Employment in 16th month of decline

The Department of Employment, Skills, Small and Family Business released their Monthly Leading Indicator of Employment for September 2019, recording its 16th straight month of decline.

Hat tip to Macrobusiness, this is a peach of an indicator, predicting Australia’s economic performance.

I have added % retracement in the ASX 200 to the graph below. Each of the significant past troughs in the Leading Index coincides with a drawdown of more than 20% in the ASX 200.

Leading Index of Employment

Is the current fall in the Leading Index a false alarm, as in the 2005/2006 raging commodities bull market, or are we in for another retracement?

Leading Index of Employment - Components

My money is on the retracement.

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Robert Shiller’s warning

Nobel prize-winning economist Robert Shiller warns that cracks are once again surfacing in the US housing market.

“We have had a strong housing market for pretty much all the time since 2012. Just after the financial crisis, the housing market didn’t recover, maybe because banking was in disarray and people were still expecting declines after the event. After 2012, it started going up at more than 10 per cent a year nationwide in the US, and has been slowing down since.”

Shiller says that a worrying pattern emerging in house prices is reminiscent of the property market in the run-up to the Great Recession.

The bursting of the US housing bubble in 2006-07 was a key trigger of the financial crisis…… “I have seen this happen before, we’re like back in 2005 again when the rate of increase in home prices was slowing down a lot but still going up.

Case Shiller Index

Growth in the Case Shiller National Home Price Index is clearly weakening but we need to be careful of confirmation bias where we “cherry-pick” negative news to reinforce a bearish outlook. I would take the present situation as an “amber” warning and only a drop below zero (when house prices fall) as a red flag.

Shiller has an enviable reputation for predicting recessions, having warned of the Dotcom bubble in tech stocks and the housing bubble ahead of the 2008 global financial crisis. He is correct that narratives (beliefs) can become self-fulfilling prophecies. If the dominant view is that the economy will contract, then it probably will — as corporations stop investing in new capacity and banks restrict lending. Geo-political tensions — US/China, UK/EU Brexit, and Iran/Saudi Arabia — combined with massive uncertainty in global trade and oil markets, could quickly snowball into a full-blown recession.

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Witching hour on Friday

“Witching hour” refers to the last hour of trading on days, normally the third Friday of the month, when there is a simultaneous expiry of options and futures in derivatives markets. Traders who don’t roll-over into a new contract are forced to cover their positions, which can lead to massive intra-day volatility in underlying markets.

“Quadruple witching” happens four times each year — on the third Friday of March, June, September, and December — when index futures, index options, stock futures, and stock options expire simultaneously. With that level of futures and options expiring, trading volume in equities usually spikes in the last hour.

Spot the June and September witching hours on the chart below.

Witching Hour June & September 2018

Note that June had witching hours on Friday 15th and 22nd. Also note that there was not a lot of price movement despite the heavy trading volumes. That’s not to say that witching hour is incapable of disrupting an already unstable market but it’s unlikely to have a long-term impact if conditions are settled.

After the liquidity squeeze earlier this week, it’s important to keep an eye on this.

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Predicting recessions with payroll and unemployment data

Recessions are notoriously difficult to measure (even the NBER occasionally gets it wrong) and an official declaration of a recession may be lagged by more than 6 months. Economist Claudia Sahm devised the Sahm Rule, using changes in unemployment levels, as a more timely predictor of recessions.

Sahm rule: US Data

But the signal repeatedly lags the official start date of recessions by several months, limiting its usefulness for investment purposes.

In previous articles I observed that payroll growth is a good predictor of recessions. But payroll growth has been declining for decades; so it has been difficult to devise a one-size-fits-all-recessions rule. Until I turned to using momentum.

Twiggs Momentum is my own variation on the standard momentum formula and I applied this to monthly payroll data to arrive at a 3-month TMO.

Sweden: Sahm rule

The orange band on the above chart reflects the amber warning range, between 0.5% and 0.3%, where recession is likely. If TMO crosses below the red line at 0.3%, risk of recession increases to very high.

When the TMO falls below 0.5%, a recession is likely, but there is one false reading at 0.49% in 1986. So I treat 0.5% as an amber warning level.

There are no false signals below 0.3% in the last 50 years. So I treat the 0.3% level as a red warning — that recession risk is very high.

Some of the signals (e.g. 1975) are late but the TMO has a far better record, than the Sahm Rule, at giving timely warning of recessions.

The August 2019 TMO reading is an amber warning of 0.5%.

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Sahm Rule: Sweden tips into recession

Sweden: Sahm rule

What is the Sahm Recession Rule?

Recessions are notoriously difficult to measure (even the NBER occasionally gets it wrong) and an official declaration of a recession may be lagged by more than 6 months. Economist Claudia Sahm uses the following rule as a timely indicator of recessions:

Sahm RuleSahm RuleSahm Rule Graph

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NY Fed conducts first overnight repo in 10 years as rates surge

The last time that the New York Fed had to inject liquidity into financial markets via overnight repo operations was during the 2008 global financial crisis, when concerns over Bear Sterns and Lehman Bros were threatening to bring the financial system to its knees. From The Street:

The New York branch of the U.S. Federal Reserve said Tuesday that it was prepared to add as much as $75 billion in cash to broader markets in order to hold the Fed’s key rate inside its target range.

The so-called Repo operation, during which twenty four Primary Dealers in the Fed system can exchange eligible collateral, such as U.S. Treasury bonds or mortgage-backed securities, for cash. The move comes amid a massive surge in the price of what is known as ‘general collateral”, which is normally the cheapest batch of securities that banks use to pledge against cash, or other assets.

The costs for borrowing general collateral, often referred to as GC, spiked by 2.5% on Monday, and was followed by a 6% surge today, taking the price to as high as 8.75% at one point, some 6.5% higher than the upper-end of the Fed’s target rate range.

The Fed’s announced operation, however, pushed that overnight rate back down to 0% shortly after it was launched….

Steven Bartholomeusz at The Age suggests that the liquidity squeeze may be an anomaly:

There was an unusual confluence of events in the past few days that may have exacerbated underlying structural problems within the market.

US companies paid their quarterly taxes on September 15. They often prepare for the payment by parking the funds in short term money market fund accounts to generate a return.

The payments of those taxes, estimated at more than $US100 billion, meant a large amount of cash was withdrawn from those funds, which are a source of the cash for repo deals.

At almost the same time there was a settlement of auctions of about $US78 billion of Treasury bonds. With only about $US24 billion of bonds maturing at the same time that meant about $US54 billion of net cash was drained from the market to pay for those bonds.

The Financial Times’ Alphaville blog posited another strand to the explanation for the dollar shortage, albeit one it described as “highly speculative,’’ suggesting that the severe spike in oil prices after the drone attacks on Saudi Arabia’s most important oil processing complex might have triggered margin calls in oil futures markets, forcing a frantic scramble for US dollar-denominated cash.

Quarterly tax payments are a regular occurrence and the markets are accustomed to dealing with them as part of the quarterly cycle. Large fiscal deficits causing a net issue of $54 billion in Treasuries is a more likely culprit. The first rule of margin calls is never meet a margin call, so that seems an unlikely cause, but the spike in oil prices may have impacted elsewhere on financial markets.

We need to be on the lookout for a repeat. Demand for cash is surging. The graph of broad money (MZM plus time deposits) below shows a surge in broad money ahead of the last two recessions. And another worrying rise this year.

Broad Money: MZM plus Time Deposits

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