Category: China & HK

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Gradually Then Suddenly

Ernest Hemingway’s 1926 novel The Sun Also Rises contains this snippet, fondly referred to as the Hemingway Law of Motion:

“How did you go bankrupt?” Bill asked.
“Two ways,” Mike said. “Gradually and then suddenly.”

Niels Clemens Jensen at Absolute Return Partners has published an interesting piece on de-dollarisation. He believes that the US can get away with a lot more bad policy choices than the UK because the Dollar is the global reserve currency:

British investors learned (the hard way) what the consequences are when your Prime Minister mistakenly believes that large-scale tax cuts can be financed with borrowings. Liz Truss tried to do that in October 2022 and, within days, she was history.

You may wonder why the Americans can get away with such things when the British cannot, and the answer is simple. The Americans benefit from the US dollar’s reserve currency status, which means that foreign investors hold massive amounts of US debt but little UK debt.

However, poor policy choices have reduced the Dollar’s role as the global reserve currency. We are past the tipping point, and the shrinkage rate is accelerating.

I am not at all suggesting that the US is about to turn into the next Argentina. Nor am I saying that we are about to witness a repeat of the Liz Truss narrative. The US economy possesses so much talent and so many resources that an awful lot of bad decisions have to be made, before we are even close to an Argentina-like situation.

However, what I want to say with this is that the ongoing de-dollarisation will change the name of the game, and Americans had better realise that the rules are different, if you are no longer the hyperpower of the world.

Despite all Trump’s warnings, a change is underway…..

De-Dollarization

The watershed in de-dollarization may have been in 1971 when Richard Nixon removed the Dollar from the gold standard. However, the rot started earlier, with Lyndon Johnson’s guns-and-butter policies of the 1960s. Johnson prioritized expanding welfare with his Great Society programs but was caught up in the Cold War arms race and the Vietnam War. The conflicting demands strained the US budget, with rising deficits eroding confidence in the Dollar.

President Charles de Gaulle started a run on the Dollar in 1965 when he announced France’s intention to exchange US dollar reserves for gold at the official exchange rate. The French Navy sailed across the Atlantic to collect French gold, setting off demands by other states. This forced US President Nixon to end the convertibility of the Dollar to gold in August 1971 to prevent erosion of US gold reserves.

Removing the gold standard opened the Dollar to currency manipulation. Japan led the way, accumulating large reserves in US Dollars. The weak Yen gave Japanese manufacturers an enormous advantage over their US counterparts in export markets and the US domestic market.

US Current Account Deficit

Japan’s example was followed by South Korea, Germany, and China, forcing the US to run large fiscal and current account deficits to accommodate the excess savings of trading partners.

The supposed benefit of the strong Dollar—low interest rates—fed ballooning debt and rising instability as strains on the US economy increased.

The US net international investment position deteriorated from the world’s largest creditor to the world’s largest debtor.

US Net International Investment Position

The manufacturing sector was dealt a devastating blow, with industrial output plummeting as industry shed millions of jobs. The chart below reflects US manufacturing output relative to real GDP since the early 1970s.

US Industrial Output to Real GDP

The Tipping Point

Historian Niall Ferguson argues that a tipping point is reached when the cost of servicing government debt exceeds the defense budget. According to Ferguson, no hegemon in history has ever restored its previous supremacy after reaching that tipping point. When your economy can no longer support your military, however dominant it is, it becomes only a matter of time.

US Federal Spending on Defense & Interest
US Federal Spending on Defense & Interest - Sources

Conclusion

The typical complacent response is that the United States is far too powerful to be challenged, and there is no real substitute for the Dollar as global reserve currency or US Treasuries as global reserve asset. However, decades of economic mismanagement have eroded confidence in the Dollar as a store of value. Geopolitical blunders also squandered much of the advantage accumulated from the post-WWII Pax Americana.

The decline in American power over the past two decades is likely to seem gradual compared to its eventual collapse. Applying Hemingway’s Law of Motion, the change should come quickly once the tipping point is reached.

The Pax Romana lasted several centuries, but its decline was swift after Rome’s economic dominance crumbled. British dominance lasted from the end of the Napoleonic Wars in 1815 to the outbreak of the First World War in 1914. Britain’s navy still ruled the waves for another three decades, but its economic decline had already begun.

President-elect Trump has promised to reverse the US economic slide. Unfortunately, his chance of getting that right is closer to William Buckley1 than Lyndon Johnson or Richard Nixon.

Please note that this does not necessarily mean that the US central role in the global economy will be replaced by China, which faces its own set of challenges. What is more likely is a destabilizing vacuum, with rival states jostling for power and riding roughshod over their weaker neighbors. Ancient Greek historian Thucydides observed, in his History of the Peloponnesian War (c. 400 BC), on the conflict between Athens and Sparta:

The strong do what they will and the weak suffer what they must.

In times of uncertainty, demand for gold rises.

Acknowledgments

Notes

  1. In Australian vernacular, “Buckley’s chance” refers to William Buckley, who escaped from a convict ship in 1803 and was left presumed dead when the ship drew anchor and sailed onwards to Sydney. Thirty years later, Buckley turned up to greet the first ships arriving to settle the Port of Melbourne, having survived in the bush against improbable odds, supported by indigenous tribes.
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S&P 500 makes new high

Bond markets were closed Monday for Columbus Day, but financial market conditions show further signs of easing. Equities powered ahead, with the S&P 500 making a new high at 5859.

Stocks

The S&P 500 broke resistance at 5800, strengthening commitment to our target of 6000 by year-end. Rising Trend Index troughs signal long-term buying pressure.

S&P 500

The advance is broad, with the equal-weighted index ($IQX) breaking resistance at its previous high of 7300. This offers a target of 7500.

S&P 500 Equal-Weighted Index

Financial Markets

Moody’s Baa corporate bonds spread narrowed to 1.54%, signaling ready availability in credit markets.

Moody's Baa Corporate Bond Spreads
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Bitcoin also broke above its six-month trend channel, signaling strong liquidity in financial markets.

Bitcoin (BTC)

Dollar & Gold

The Dollar Index continues to strengthen as Treasury yields rise. This may seem counterintuitive, given the prospect of further rate cuts ahead, but the strong September jobs report has increased bond market concerns about an inflation recovery.

Dollar Index

Gold found support at $2,600 per ounce but has hesitated at $2,650. A lower Trend Index peak would warn of another test of support at $2,600. The Shanghai Gold Exchange no longer trades at a premium, with the iAu99.99 contract quoted at 605.04 RMB/gram, equivalent to $2,643 per ounce at the current exchange rate of 7.12 CNY to the Dollar.

Spot Gold

Silver is also hesitant, testing short-term support at $31 per ounce.

Spot Silver

Crude Oil

Brent crude is retracing to test support at $76 per barrel after Israel confirmed they would not strike Iranian oil targets and OPEC cut their oil demand forecast for 2024 and 2025.

Brent Crude

Brent [crude] fell 5%, or more than $4, in after-hours trading following a media report that Israeli Prime Minister Benjamin Netanyahu told the U.S. that Israel is willing to strike Iranian military targets and not nuclear or oil ones…..

OPEC on Monday cut its forecast for global oil demand growth in 2024 and also lowered its projection for next year, marking the producer group’s third consecutive downward revision. China, the world’s largest crude oil importer, accounted for the bulk of the 2024 downgrade as OPEC trimmed its growth forecast for the country to 580,000 barrels per day (bpd) from 650,000 bpd. China’s crude imports for the first nine months of the year fell nearly 3% from last year to 10.99 million bpd, data showed. Declining Chinese oil demand caused by the growing adoption of electric vehicles (EV), as well as slowing economic growth following the COVID-19 pandemic, has been a drag on global oil consumption and prices. (Reuters)

Base Metals

Copper is testing short-term support at $9,500 per tonne after it respected resistance at $9,900. Breach of support would offer a target of $9,250.

Copper

Aluminum similarly retreated from resistance at $2,650 per tonne and will likely test support at $2,500.

Aluminum

China’s deflationary pressures also worsened in September, according to official data released on Saturday. A press conference the same day left investors guessing about the overall size of a stimulus package to revive the fortunes of the world’s second-largest economy.

“The lack of a clear timeline and the absence of measures to address structural issues, such as weak consumption and reliance on infrastructure investments, have only increased ambiguity amongst market participants,” noted Mukesh Sahdev, the global head of commodity markets-oil at Rystad Energy. (Reuters)

Iron Ore

Iron ore is expected to retrace to test support at $100 per tonne following a sharp rise after China’s stimulus announcement.

Iron Ore

Conclusion

Financial markets show signs of a promising rise in liquidity, with falling corporate bond spreads and Bitcoin breakout above its six-month trend channel. The S&P 500 responded with breakout above 5800, strengthening our commitment to a target of 6000.

Gold and silver display strong uptrends but hesitate in response to a rising Dollar. Increased fears of an inflation rebound are behind the recent rally in long-term Treasury yields and the Dollar. We expect the uptrend in gold and silver to continue, with low real interest rates, whether or not inflation fears fade.

We expect that China will struggle to recover from its current economic slump. The announced stimulus program remains vague and does not address the underlying issue of weak domestic consumption. Deflationary pressures will likely keep a lid on crude oil and industrial metal prices for several years.

Low crude oil prices are also likely to keep inflation in check, leading to low long-term interest rates in the West.

Acknowledgments

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China sizzle turns to fizzle

China’s announcement of economic stimulus and hints at an even larger “bazooka” ahead caused a sizzling rally on the Shanghai exchange, with the CSI 300 leaping 20% in the last week of September.

Shanghai Shenzhen CSI 300 Index

Hong Kong’s Hang Seng Index displays an even steeper rally.

Hang Seng Index

However, a failure to follow through this week with sufficient detail of the stimulus package caused the rally to fizzle, with a sharp correction on both indices. Today, the Hang Seng is testing support at 20500.

China Stimulus

Crude Oil

Brent crude reversed sharply as prospects faded for a demand recovery in China.

Brent Crude

Treasury Markets

Ten-year Treasury yields stalled and will likely re-test new support at 4.0%.

10-Year Treasury Yield

According to the theory of interest developed by Swedish economist Knut Wicksell, the equilibrium or natural rate of interest—at which inflationary and deflationary pressures are in balance—is when the cost of borrowing is higher than the average return on new investment. This means that the 10-year Treasury yield–the risk-free rate–should be roughly equal to nominal GDP growth, approximating the return on new investment. The chart below shows that the 10-year Treasury yield, at 4.0%, is significantly lower than nominal GDP growth of 5.7% for the 12 months ended in Q2.

Wicksell Analysis: Nominal GDP Growth & 10-Year Treasury Yield

With the economy showing little sign of slowing, the likely outcome is either higher long-term interest rates or a build-up of long-term inflationary pressure.

Stocks

The S&P 500 gained almost 1.0% on Tuesday, with a shallow retracement and rising Trend Index troughs signaling buying pressure.

S&P 500

Nvidia led the advance of mega-cap stocks, breaking above its August high, while all seven advanced yesterday.

Top 7 Technology Stocks

The equal-weighted index lagged as large caps failed to match mega-cap gains.

S&P 500 Equal-Weighted Index

Financial Markets

Bitcoin continues to test the upper border of its trend channel. A breakout would be a bullish sign for financial market liquidity.

Bitcoin (BTC)

Dollar & Gold

The Dollar Index is expected to retrace to test new support at 102. Respect would confirm an advance to 104.

Dollar Index

Gold is headed for a test of support at $2,600 per ounce, but respect will likely confirm a re-test of $2,700.

Spot Gold

Silver is testing support at $30 per ounce, with respect again likely to signal a re-test of resistance at $32.

Spot Silver

Metals

Copper retreated in response to China’s disappointing stimulus. Expect a correction to test support at $9,250 per tonne.

Copper

Iron ore also reflects disappointment, retreating to $106.30 per tonne.

Iron Ore

Conclusion

A disappointing lack of detail on China’s newly announced stimulus led to a retreat in Chinese stocks and global crude oil, copper, and iron ore.

Ten-year Treasury yields are expected to retrace to test support at 4.0%. While yields are likely to remain low as the Fed cuts interest rates, the long-term equilibrium rate is expected to be higher—between 5% and 6%.

Respect of support at 5650 on the S&P 500 confirms our year-end target of 6000, but the advance is exceedingly narrow and precarious.

Gold is headed testing support at $2,600 per ounce, but respect is likely and would signal a re-test of $2,700.

Acknowledgments

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China’s manufacturing contraction

China faces growing push-back from trading partners in its efforts to export its way out of a recession. Dumping excess production in export markets has provoked increased tariffs on manufactured goods such as EVs and commodities such as steel. Declining demand in export markets caused a sharp fall in the Caixin/S&P Global manufacturing PMI for September, with the New Orders sub-index falling to its lowest level in two years.

Caixin/S&P Global manufacturing PMI

BEIJING, Sept 30 (Reuters) – China’s manufacturing activity shrank sharply in September as new orders at home and abroad cooled, pulling down factory owners’ confidence to near record lows, a private-sector survey showed on Monday. The Caixin/S&P Global manufacturing PMI fell to 49.3 in September from 50.4 the previous month, missing analysts’ forecasts in a Reuters poll of 50.5. The reading marked the lowest since July last year.

…Even though production expanded for the 11th straight month in September, new orders fell significantly from August’s gain. The sub-index of new orders was the lowest in two years.
While exports have been a bright spot for the economy, new orders from abroad declined at the fastest pace since August last year. Chinese manufacturers said that a deterioration in foreign demand led to the fall in export orders.

Stimulus

George Magnus, former UBS chief economist, author, and commentator on China, writes that Chinese authorities are clearly spooked:

Early last week, the authorities announced the biggest monetary policy stimulus since Covid, comprising interest rate and mortgage rate cuts, reductions in the downpayment for second homes, additional help for state enterprises to buy unsold homes, and 800 billion yuan ($113 billion, £85 billion) of liquidity facilities to allow non-bank financial firms to buy equities and listed firms to buy back their own shares. A 1 trillion yuan ($142 billion, £106 billion) bank re-capitalisation program is also considered likely.

These measures were rocket fuel for stock markets, favouring not least the state enterprises and institutions that constitute much of the ownership of shares. Yet, while the measures generally may bring temporary relief, they will not really boost the economy much. China’s economic problems are not due to interest rates being too high, a shortage of liquidity, or credit supply constraints and China’s property market needs much more than patchy support designed to stop it from adjusting to decades of overbuilding and a bursting bubble.

There are some positives, Magnus notes:

The government is expected to announce during or soon after the Golden Week holiday in the first week of October, a 2 trillion yuan ($284 billion, £212 billion) borrowing programme, split roughly equally between measures to support consumption, and help to alleviate local government indebtedness problems.

The latter amounts to a shift in a limited amount of debt ownership from local to central government, which Beijing has previously railed against, but which is more financial engineering than economic stimulus. The consumption part, however, could have a more meaningful impact. Some is about extending the hitherto sparsely used new-for-old trade-in support for consumer durables and business equipment upgrades. At best this borrows future consumption. The reported introduction of a monthly 800 yuan ( $113, £85) child benefit payment for all but first children, equivalent to about 30 per cent of median post tax monthly income, could certainly give household consumption a shot in the arm.

Stock Market Rally

The Shanghai Composite has made an impressive rally since the announcement.

Shanghai Composite Index

Shadowed by a similar move on Hong Kong’s Hang Seng Index.

Hang Seng Index

Industrial Metals

Copper broke resistance at $9,500 per tonne after an initial rally caused by a spike in AI data center construction in the US.

Copper

Alumini=um shows a similar breakout, above $2,500 per tonne.

Aluminum

Iron ore so far shows a muted response.

Iron Ore

Crude Oil

Brent crude remains solidly in a bear market.

Brent Crude

Conclusion

Efforts to revive business investment by lowering interest rates are unlikely to have much of a long-term effect when the underlying problem is a shortage in domestic consumption. The private sector will be reluctant to invest when industries already suffer from overcapacity due to insufficient demand.

Overcapacity will also likely worsen as export orders decline due to increased tariffs from trading partners.

Measures to boost consumption through old-for-new “cash for clunkers” exchanges and child benefit programs are a step in the right direction. However, the roughly 1 trillion yuan ($142 billion) is a drop in the ocean compared to the scale required.

Most of the announced stimulus is aimed at papering over the cracks and meeting short-term GDP targets rather than the fundamental change in direction needed to address the underlying consumption deficit.

We expect short-term relief to be followed by a resumption of the deflationary contraction.

Acknowledgments

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Australian job growth surprise

Australian jobs grew by a surprising 50.2K, compared to consensus estimates of 20K, with total employment reaching 14.4 million.

Australian Jobs

But employment per capita remains steady at 64% because of the huge swell in immigration.

Australian Jobs per capita

The unemployment rate ticked up to 4.1%, while trend remained steady at 4.0%, as the participation rate grew.

Unemployment Rate

Total hours worked increased to 1.97 billion, a 1.3% increase in the trend since June 2023.

Total Hours Worked

Average hours worked (trend) declined to 136.6 hours in June, from 138.6 hours 12 months ago, reflecting slowing demand growth.

Total Hours Worked

Conclusion

Westpac believe that the strong June labor report points to a soft landing ahead. We are more skeptical. Soft landings are often promised and seldom materialize.

China has reported deflation for the fifth quarter in a row. When your biggest trading partner suffers from deflation, it generally is bad news for you as well.

China Deflation

Acknowledgements

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In Gold we Trust

Rising demand for gold and silver reflect the failure of central banks to maintain price stability and efficient functioning of credit markets. Private investor mistrust of fiat currencies was historically an emerging market problem, with countries like India and China holding large private savings in the form of precious metals or real estate.  But now growing US fiscal problems have caused mistrust to spread to the global reserve currency as central banks reduce exposure to the Dollar and increase purchases of gold bullion.

Stocks & Treasuries

The S&P 500 respected support at 5250, the short harami candle indicating uncertainty. Breakout above Thursday’s high would confirm our target of 5500.

S&P 500

Ten-year Treasury yields are testing resistance at 4.5% but the short candle and weak close look tentative and respect is likely.

10-Year Treasury Yield

Gold & Silver

Gold is likely to test support at $2,300 per ounce. Respect is likely and would confirm that the up-trend is intact.

Spot Gold

Silver is similarly poised to test support between $29 and $30 per ounce. Respect of support is again likely to confirm the up-trend.

Spot Silver

Gold Demand from the East

Ronnie Stoeferle — managing director of Liechtenstein-based asset manager Incrementum AG and author of the annual In Gold We Trust report — says that 70% of gold demand is now from the East. Mainly China and India but supported by buying in Vietnam, Thailand and lately Japan.

De-Dollarization

Jeff Currie — chief energy strategist at the Carlyle Group and former Global Head of Commodities Research at Goldman Sachs — says that central banks are now recycling commodity surpluses into Gold, not Dollars. When prices are high, crude oil producers generate trade surpluses which they historically have invested in Dollar-based assets — mainly US Treasuries — but are now investing in gold.

The Saudis and Russia are increasingly selling crude oil and gas in Yuan and Rupees which they then use to import goods from China and India. Any remaining surplus is then used to purchase gold as they do not want to hold the currencies in their official reserves. Physical gold is flowing from West to East, to meet increased demand, and driving up prices.

The change has caused a dramatic divergence between gold (brown below) and real long-term interest rates, represented by the TIPS yield (blue) below.

Gold & TIPS Yield

Source: Gainesville Coins

The scale of increased demand and its impact on gold prices is not hard to imagine when one considers that global crude oil production is more than 13 times the Dollar value of total gold output.

USD Value of Gold & Crude Oil Production

Source: FFTT

Central Bank Purchases

China and India are ranked among the top 10 countries in terms of official gold holdings.

Official Gold Reserves by Country - Top 10 Holdings

Source: Gold.org

But many purchases are not made through official channels and go unreported. Jan Nieuwenhuijs estimates that the PBOC actually held close to 5,550 metric tons1 at the end of Q1 2024.

Quarterly Central Bank Gold Buying

Source: Gainesville Coins

Private Purchases

Private gold holdings in China and India dwarf official reserves.

China’s private sector holds approximately 25,700 metric tons2 at the end of Q1 2024, according to Nieuwenhuijs.

India’s gold market is similar in size, with private investors holding between 24,000 and 27,000 metric tons of gold jewellery and bullion according to Blue Hill Research.

Conclusion

Gold demand is driven by a lack of faith in fiat currencies — whether it be US Dollars, Chinese Yuan or Indian Rupees — to maintain their value. Private investors are buying gold as a store of value while central banks are recycling trade surpluses into gold, rather than holding fiat currencies.

Silver and Copper are becoming the “poor man’s gold”, with price-sensitive buyers switching from gold into silver and copper as they grow relatively cheaper.

Countries with high private gold investment are likely to experience low rates of growth. Keyne’s Paradox of Thrift illustrates how savings parked in assets like gold and silver crowd out investment in productive assets, leading to lower growth in output.

Savings invested in debt and equity markets, by comparison, are largely channeled into investment in productive assets3 that contribute to GDP growth.

Efficient credit markets are the lifeblood of the economy, ensuring the transfer of savings into productive investment. Demand for speculative assets — such as precious metals and much real estate — reflect the failure of central banks to maintain price stability. Inflation increases investment risk in debt markets, leading to higher interest rates and increased demand for speculative assets, lowering economic growth. Inflation also accentuates the boom-bust cycle as central banks flip-flop between restrictive and stimulative monetary policy in an attempt to undo the consequences of their failed monetary policies.

The world is edging back towards a “gold standard” of sorts, where trade surpluses are converted to gold — or some other commodity like silver, copper or crude oil — rather than held as currency reserves. While not a perfect system, this would impose greater fiscal discipline on sovereigns, including the US, and contribute to increased price stability. It would also reduce the role of the US Dollar as global reserve currency and help to stem the damage done to the US economy over the past forty years by this “exorbitant privilege”.

Notes

  1. Estimated total PBOC gold holdings are 5,358 metric tons at the end of 2023 plus 189 tons in Q1 of 2024.
  2. Estimated total private gold holdings in China are 23,745 metric tons at the end of 2022 plus 1,411 tons in 2023 and 543 tons in Q1 of 2024.
  3. Debt that finances investment in speculative assets — producing low returns, like many real estate investments — does not contribute much to economic growth.

Acknowledgements

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S&P 500 storm in a teacup

Markets were spooked by “hawkish” comments in the latest FOMC minutes, where some participants indicated a willingness to tighten policy should such action become appropriate:

Participants discussed maintaining the current restrictive policy stance for longer should inflation not show signs of moving sustainably toward 2 percent or reducing policy restraint in the event of an unexpected weakening in labor market conditions. Various participants mentioned a willingness to tighten policy further should risks to inflation materialize in a way that such an action became appropriate. ~ Minutes of the Federal Open Market Committee: April 30–May 1, 2024

This is nothing new: all FOMC members should be prepared to hike rates if inflation spikes to the point where tighter policy is appropriate. What seems to have spooked markets is the fact that it was considered appropriate to discuss this out in the open.

10-year Treasury yields rallied to test 4.5%, ending the series of declining Trend Index peaks. Breakout above 4.5% would signal another test of 4.7% but breach of support remains likely and would signal a decline to test support between 4.0% and 4.1%.

10-year Treasury Yield

The large engulfing candle on the S&P 500 is a bearish sign. Expect a test of support at 5200 but respect is likely and would confirm our target of 5500.

S&P 500

The S&P 500 Equal-Weighted Index ($IQX) retreated sharply and is likely to test support at 6600.

S&P 500 Equal-Weighted Index ($IQX)

Financial Markets

Commercial bank reserves at the Fed climbed to $3.39 trillion on May 22, continuing the recovery of financial market liquidity after the sharp fall during April tax payment season.

Commercial Bank Reserves at the Fed

The inverted Chicago Fed Financial Conditions Index (black below) continues to climb, indicating easier monetary policy. The S&P 500 (blue) is expected to follow the FCI upwards.

S&P 500 Index & Chicago Fed Financial Conditions Index (inverted scale)

Wicksell Analysis

The chart below is based on the theory of interest and money published by Swedish economist Knut Wicksell in 1898. Monetary policy is restrictive when long-term interest rates are higher than nominal GDP growth (the marginal return on new investment) and stimulatory when LT rates are below nominal GDP growth.

We plot nominal GDP (silver) against 10-year Treasury yields (purple) below. Stimulatory monetary policy is evident in the 1960s and ’70s — with GDP growth (silver) above long-term rates (purple) — boosting growth and inflation. This followed by restrictive policies in the 1980s and ’90s before long-term rates were again suppressed to stimulate the economy in the last two decades.

10-year Treasury Yield & Nominal GDP Growth

Nominal GDP grew at an annualized rate of 5.5% in Q1 of 2024, while the 10-year yield is below 4.5%, indicating that monetary policy remains stimulatory. Further growth and inflation are likely.

Crude Oil

The counter-argument to the monetarist view is that crude oil prices are falling and likely to ease inflationary pressures in the economy.

Nymex light crude broke support at $78 per barrel, indicating a decline to test long-term support (red) at $68.

Nymex WTI Light Crude

Energy prices were the primary cause of the spike in CPI in 2021 and its subsequent fall in 2022-23.

Conclusion

Crude prices are likely to fall, easing inflationary pressures and leading to lower long-term interest rates.

We expect the Fed and US Treasury to maintain easy monetary conditions until after the November elections.

The current bull market in stocks is likely to continue until end of the year.

Ceteris paribus

The Latin phrase ceteris paribus means “all else being equal.”

If Vladimir Putin and Xi Jinping attempt to influence US elections by disrupting the global economy — through cyberattacks, damage to undersea communication cables, infrastructure, or transport bottlenecks — then all bets are off and we could be in for a wild ride.

Acknowledgements



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Silver stars as stocks retrace

Markets are retracing to test new support levels after a strong surge during the week on weaker than expected inflation data. Silver and Gold are the exception, making new highs, with demand fueled by lower long-term Treasury yields, a weaker Dollar, and strong buying from China.

Stocks

The S&P 500 is retracing to test support at 5200/5250. Higher Trend Index troughs indicate buying pressure. Respect of support is likely and would confirm our target of 5500.

S&P 500

In Australia, the ASX 200 retreated from resistance at 7900. Follow-through below 7700 would warn of another test of support at 7500/7550. Rising Trend Index troughs, however, warn that respect is more likely — that would mean another test of the all-time high.

ASX 200

Financial Markets

Ten-year Treasury yields retraced to test new resistance between 4.4% and 4.5%. Respect is likely and would signal a decline to test support between 4.1% and 4.2%.

10-Year Treasury Yield

Financial market liquidity is improving, with commercial bank reserves at the Fed recovering after a sharp fall during April tax payment season.

Commercial Bank Reserves at Fed

The Chicago Fed Financial Conditions Index is again falling, signaling easier monetary conditions.

Chicago Fed Financial Conditions Index

Bitcoin (BTC) recovered above the former $64K support level, confirming easier financial conditions. Retracement that respects the new support level would strengthen the signal.

Bitcoin (BTC)

Economic Activity

Real retail sales are edging lower but remain in line with their pre-pandemic trend (dotted line) — supported by full employment, lower inflation and government spending to secure critical supply chains.

Advance Real Retail Sales

Light vehicle sales remain below 2019 levels but sales above 15 million continue to reflect robust consumer sentiment.

Light Vehicle Sales

Heavy truck sales rebounded to 40.2K units, indicating reasonable business activity. Continuation of the recent down-trend, however, with a fall below 37.5K, would signal that the economy is slowing. Breach of 35K would warn that a recession is imminent.

Heavy Truck Sales

Precious Metals & the Dollar

The Dollar index is retracing to test new resistance at 105. Lower Trend Index peaks warn of selling pressure and respect of resistance is likely, offering a short-term target of 103.

Dollar Index

Silver is the star performer of the week, climbing steeply to close at $31.43 per ounce, following a brief pause on Thursday. Rising Trend Index troughs indicate strong buying pressure and our target of $32 is likely to be broken.

Spot Silver

Gold also displays buying pressure, although the Trend Index rise is not as steep as Silver. Expect retracement to test the new support level at $2400 per ounce, but respect is likely and would confirm our target of $2500.

Spot Gold

The chart below from Jan Nieuwenhuijs shows Gold as a percentage of global central bank reserves, from 1880 to today. There is plenty of potential for holdings to increase as central banks attempt to diversify away from a Dollar-based global reserve currency.

Gold as a percentage of International Reserves

China: Gold Demand

China sold a record amount of Treasury and US agency bonds in the first quarter as it diversifies away from US financial assets. Bloomberg:

Beijing offloaded a total of $53.3 billion of Treasuries and agency bonds combined in the first quarter, according to calculations based on the latest data from the US Department of the Treasury. Belgium, often seen as a custodian of China’s holdings, disposed of $22 billion of Treasuries during the period.

China: Reserves

At the same time, China is rapidly increasing its official Gold holdings.

China: Gold Holdings

China’s domestic Gold price consistently shows a strong premium over the international price, currently RMB 567 per gram (Au99.99) versus 558.8 for the iAu99.99 international contract on the Shanghai Gold Exchange. The cause of strong domestic Gold demand is not hard to find.

China: Home Prices

Chinese investors have in the past favored residential real estate as a store of wealth but growth in real estate prices ended in 2021. Investors are now switching their focus to Gold.

Crude Oil

Nymex light crude respected support at $79 per barrel. Penetration of the secondary (orange) trendline would suggest that a base is forming. Lower crude oil and gasoline prices are likely to ease inflationary pressure.

Nymex Light Crude

Conclusion

Silver is the star performer of the week, rising steeply to close at $31.43 per ounce. Gold also broke resistance — breakout above $2400 per ounce offering a target of $2500.

Stocks are bullish after weaker than expected CPI growth for April. The S&P 500 is likely to respect support at 5200/5250, confirming our target of 5500.

Ten-year Treasury yields are also softening on weaker inflation data. Respect of resistance at 4.4% to 4.5% would offer a target between 4.1% and 4.2%. Lower yields are likely to weaken the Dollar, further boosting Gold and Silver prices.

China continues to switch its official reserves from US Treasuries to Gold. Coupled with strong domestic demand from Chinese investors — disillusioned with real estate and the weakening Yuan — combined official and private investor demand from China is expected to maintain upward pressure on bullion prices.

Acknowledgements

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Progress…. with Chinese characteristics | Jim Grant

….Yet as the world’s second-largest economy continues to slog through the aftermath of its debt-driven economic miracle-cum-titanic housing bubble, policymakers put their best foot forward – with Chinese characteristics. Thus, aggregate financing fell by nearly RMB 200 billion in April from the prior month, data released over the weekend show, marking the first outright contraction in that metric of broad credit availability in nearly two decades.

True to form, the government looks to sweep those inconvenient figures under the rug, as Bloomberg relays that seven separate research notes from local brokerages commenting on that data release were scrubbed from the WeChat social media platform as of this morning.

Then, too, regulators have switched off live trading data showing foreign investment flows on the mainland Shanghai and Shenzhen exchanges via the Stock Connect trading link. That move, which was telegraphed in an April announcement, follows word that foreign direct investment registered at just $10.3 billion during the first quarter, down 56% from the first three months of 2023.

~ Jim Grant, Grant’s Almost Daily

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Gold & Oil – a new paradigm

The expanding BRICS bloc is moving away from the PetroDollar, looking to settle oil imports in their domestic currencies. But that is unlikely to be achieved without the use of an alternative reserve asset that can be used to settle trade imbalances. The only likely candidate is Gold.

But first let’s start with a review of financial markets.

Financial Markets

The Chicago Fed Financial Conditions Index fell to -0.53, signaling further monetary easing.

Chicago Fed Financial Conditions Index

Bitcoin found support above $60K and recovery above $68K would signal a re-test of resistance at $72K, indicating ample liquidity in financial markets.

Bitcoin

10-Year Treasury yields respected resistance at 4.35%. Breach of support at 4.20% would signal another test of 4.05%.

10-Year Treasury Yield

Janet Yellen at Treasury is doing her best to keep a lid on long-term Treasury yields in order to ensure a smooth run-up to the November elections. This includes limiting the supply of long-term Treasuries by issuing short-term T-Bills in their place.

Keeping long-term yields low helps to support stock prices. High stock prices in turn boost tax revenues which reduce the deficit and new issuance of USTs.

The S&P 500 weekly chart shows how the index has been rising since late-2023. Shallow corrections, of less than 3%, indicate exceptional buying pressure. That and a strong rise in the Trend Index (above zero) suggest that stocks are getting overheated.

S&P 500

The magnificent 7 technology stocks have been leading the advance but now two — Apple (AAPL) and Tesla (TSLA) — are falling behind. A stumble in more key stocks would be cause for concern.

Top 7 Technology Stocks

The Dollar

The Dollar Index, shown on the weekly chart below, is headed for a test of resistance at 105. Breakout would signal an advance to 107. The sharp rise on Friday is attributed to a surprise rate cut by the Swiss central bank.

Dollar Index - Weekly

The PBOC also relaxed its managed float, allowing the exchange rate to rise above 7.2 Yuan to the Dollar.

USDCNY

It is unusual to see the Dollar strengthening while long-term Treasury yields are falling. We need to monitor this closely.

Crude Oil

Brent crude is retracing to test support at $84 per barrel. But respect is likely and would confirm our target of $94 per barrel. If that occurs, we expect upward pressure on inflation in the months ahead.

Brent Crude

Gold

Spot Gold in London is retracing to again test support at $2150 per ounce. Respect would signal another advance and follow-through above $2200 would confirm our target of $2400.

Spot Gold

A New Paradigm

The global crude oil market dwarfs other commodities, with production of more than 100 million barrels per day (EIA). Gold production is only 5000 metric tonnes per year — a fraction of the crude market — but the two have close historic links.

High crude prices often coincided with high gold prices. It was believed that oil producers increased purchases of gold when they made excess profits but in the last decade, there has been greater divergence between Gold and Crude.

10-Year Treasury Yield minus CPI & Gold 12-Month Percentage Gain

Another historic factor was the relationship between gold and real interest rates. The chart below shows how gold made large 12-month gains (orange) whenever the real 10-year Treasury yield (adjusted for CPI) fell below zero.

Negative real yields were the perfect signal to go long Gold, in expectation of rising inflation, funded by negative real interest rates. But that relationship too broke down, with negative real yields of -5.0% accompanied by falling Gold prices after August 2020.

10-Year Treasury Yield minus CPI & Gold 12-Month Percentage Gain

Gold bulls have long accused the Fed/Treasury of manipulating the gold price. In the 1960s, it was done openly by the London Gold Pool, a consortium of 8 major central banks, led by the Fed, who collaborated to maintain a fixed gold price of $35 per ounce. The Gold Pool collapsed in 1968, allowing gold to appreciate above the fixed exchange rate. This led to Richard Nixon to end US Dollar convertibility to gold in 1971.

It makes sense for central banks to suppress the price of Gold — this would increase demand for US Treasuries and other sovereign debt as reserve assets.

We have also observed unusual activity on Comex futures, with heavy selling into rallies. Any rational seller would sell in smaller quantities and avoid off-peak times — when bids are thin — in order not to interrupt the trend and maximize prices achieved. Large sellers generally take pains to avoid alerting the market as to their intentions. The opposite of some of the “shock and awe” selling in futures markets that we suspect is intended to destroy momentum built up in preceding days.

Gold Futures - Dump

Typical Gold Dump in Futures Market, February 2nd 12:36 PM to 12:45 PM

These are merely suspicions. We have no definitive proof. But those suspicions are now being put to the test.

BRICS+

China and Russia have been uncomfortable with US dominance of the global financial system and have long been making efforts to establish an independent reserve currency as an alternative to the Dollar. Their efforts failed to gain much traction until Russia’s full-scale invasion of Ukraine in 2022. US and European sanctions — blocking Russian assets held by European banks and removing Russian banks from the SWIFT payments system — alerted non-aligned countries to their vulnerability should they ever offend the US or its European allies.

The response has been an expansion of the BRICS bloc, with Iran, Saudi Arabia, the United Arab Emirates, Argentina, Egypt and Ethiopia invited to join in August 2023. Argentina has since declined the invitation — after the election of Javier Millei — and the Saudis are “still considering”. The shift is motivated by a desire to reduce dependence on the US Dollar for trade — and US Treasuries as a reserve asset.

Central bank (CB) gold purchases are growing.

Central Bank Gold Purchases

Jan Nieuwenhuijs recently suggested that CB purchases may be far higher than official declarations (red below). He estimates that 80% of unreported purchases are made indirectly on behalf of CBs.

Central Bank Gold Purchases including estimates of Undisclosed Purchases

PBOC purchases account for a large percentage of unofficial buying.

PBOC Gold Purchases & Holdings

Crude Oil Payments

Major oil importers like India and China have signed agreements to pay for oil in their own currencies but that is likely to leave exporters like Russia and the Saudis holding excess Rupees and Yuan that they do not need and are unlikely to want to hold as reserves.

Non-USD trade in oil would only be viable if net trade imbalances are settled by transfer of gold between trading partners, with surplus countries like the Saudis purchasing gold from the Chinese with Yuan that are surplus to their needs. Demand for gold is expected to rise exponentially as the BRICS bloc expands and oil trades are increasingly settled in domestic currencies. Major oil importers like India and China are likely to require larger gold holdings in order to settle trade imbalances with oil exporters like the Saudis and Russians. Oil exporters are expected to recycle gold to fund purchases of goods and services from non-BRICS trading partners but the total “float” of gold in the system is likely to increase.

We continue to see a growing pile of evidence that gold is re-becoming an oil currency, which by virtue of the oil market alone being some 12-15x the size of the global physical gold market annually, suggests a continued relentless bid for gold in coming quarters and years that will puzzle many on Wall Street. ~ Luke Gromen

Physical Gold Flows

Physical gold is flowing out of London and Zurich as Asian buyers bid up prices.

A recent Doomberg interview pointed out that Gold quoted on the Shanghai Gold Exchange is at a premium of between $20 and $40 per ounce above the London Gold price. Friday’s PM Benchmark of CNY 511.40 per gram converts to $2200 per troy ounce, compared to the London spot price of $2165 per ounce — a premium of $35.

Arbitrage will ensure a steady flow of physical gold out of London and Zurich for as long as that premium is maintained.

Shanghai Gold Exchange: Yuan/Gram of Gold

Gold in CNY/gram as quoted on Shanghai Gold Exchange
(red = AM, blue = PM benchmark price).

Conclusion

Stocks continue their bull run, supported by strong liquidity in financial markets and weakening long-term Treasury yields.

The Dollar has diverged, however, rising sharply against the Euro and China’s Yuan. Dollar Index breakout above 105 would warn of an up-trend with an immediate target of 107.

Gold is retracing to test support at $2150 per ounce. Respect would signal another advance. But we need to be careful of the rising Dollar. Breakout above 105 would be likely to weaken demand for Gold.

Brent crude is testing support at $84 per barrel. Respect is likely and would confirm our target of $94. High crude oil prices would be expected to increase inflationary pressures in the months ahead and force the Fed to delay rate cuts. The resultant rise in long-term Treasury yields would be bearish for stocks.

We expect a new paradigm to emerge, where the Gold price is no longer determined by Western buyers seeking an inflation hedge to protect against erosion of currency purchasing power and as a safe haven when risk is high. Marginal buyers are likely to be BRICS+ (the expanded BRICS bloc) central banks, seeking to use gold to settle trade imbalances from oil and gas imports paid for in non-USD currencies. The supply of Gold is inelastic, so the price is expected to rise steeply until a new equilibrium is reached.

Acknowledgements

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