Category: UK & Europe

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Gold breaks to a new high

Key Points

  • Gold broke through resistance at $3,500 per ounce, reaching a new high of $3,546.
  • Silver is testing resistance at $41 per ounce.
  • Sovereign debt is losing favor, with the UK 30-year gilt yield above 5.7% for the first time in 27 years.

After its recent breakout, the Dow Jones Industrial Average has retraced to test support at 45K. Respect is likely, but a breach would raise questions about the validity of the Dow’s recent bull market signal.

Dow Jones Industrial Average

September is also the worst month of the year for stock performance, most likely due to investment managers cleaning up their portfolios before the financial year-end.

Stock Market Performance by Calendar Month

While September has the worst average return, we are also wary of October, which has delivered some of the most severe crashes in memory, including October 1929 and 1987.

Financial Markets

Bitcoin is testing support at 110K, warning that investors’ risk appetite is shrinking. A follow-through below the recent low would be a strong bear signal for stocks.

Bitcoin (BTC)

Treasury Markets

10-year Treasury yields are consolidating in a narrow band above support at 4.2%, anticipating a Fed rate cut in September, causing a decline in long-term yields.

10-Year Treasury Yield

However, long-term yields are in a secular uptrend, with the US 30-year testing resistance at 5.0%.

30-Year US Treasury Yield

Global investors are increasingly shunning long-term sovereign debt. The UK 30-year Gilt rose above 5.70% for the first time since April 1998.

30-Year UK Gilt Yield

Japan’s 30-year JGB yields are climbing steeply due to the Bank of Japan tightening monetary policy.

30-Year JGB Yield

The 30-year German Bund is on a similar path.

30-Year German Bund Yield

A secular bear market in bonds will also likely be bearish for stocks.

Dollar & Gold

The US Dollar Index continues in a bearish narrow consolidation above support at 97. Trend Index peaks below zero warn of long-term selling pressure, and a breach of support at 97 would strengthen our long-term target of 90.

Dollar Index

Gold broke through resistance at $3,500 per ounce, reaching a new high of $3,546. A higher Trend Index trough signals buying pressure. Expect retracement to test the band of support between $3,400 and $3,500, but respect will likely confirm another advance, further strengthening our target of $4,000 by the end of the year.

Spot Gold

Silver made a similar breakout above $40 per ounce. Again, we expect retracement to test the new band of support between $39 and $40, but respect will likely confirm another advance. Our year-end target is $44.

Spot Silver

ISM Manufacturing

The manufacturing sector continues to signal a contraction, but the rate of decline slowed, with the ISM Manufacturing PMI rising to 48.7%.

ISM Manufacturing PMI

The outlook improved, with forward orders rising to 51.4%.

ISM Manufacturing New Orders

However, employment prospects remain low, with the employment sub-index at 43.8%.

ISM Manufacturing Employment

Input prices are still rising, but the prices sub-index surprisingly improved to 63.7%. A similar improvement in Services next week would indicate that inflationary pressures are easing, increasing the likelihood of a Fed rate cut.

ISM Manufacturing Prices

Conclusion

Long-term government bonds are in a secular bear market, which will likely be bearish for stocks.

Gold reached a new high above resistance at $3,500 per ounce, reflecting investor caution towards sovereign debt. A retracement that respects the latest support level would confirm our year-end target of $4,000.

Acknowledgments

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Give War a Chance | Edward Luttwak

UN Peacekeepers in Bosnia

UN soldiers at a NATO base near Brcko, Bosnia, March 1998 | Juergen Schwarz, Reuters

This 1999 opinion in Foreign Affairs magazine, by Edward N. Luttwak, a senior fellow at the Center for Strategic and International Studies, is relevant to today’s conflicts in Ukraine and Gaza:

An unpleasant truth often overlooked is that although war is a great evil, it does have a great virtue: it can resolve political conflicts and lead to peace. This can happen when all belligerents become exhausted or when one wins decisively….

A cease-fire tends to arrest war-induced exhaustion and lets belligerents reconstitute and rearm their forces. It intensifies and prolongs the struggle once the cease-fire ends—and it does usually end….

Read more at Foreign Affairs

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Gold rises to a new high while Dow and ASX 200 retreat

The rising uncertainty in financial markets undermined stocks despite solid consumer spending. However, gold rose to a new high, while Germany’s DAX and Hong Kong’s Hang Seng Index also enjoyed strong advances.

The two-day rally on the S&P 500 faded, with a lower close warning of another test of support at 5500. A breach of support would confirm the bear market.

S&P 500

The Dow Industrial Average is in a similar position, hesitating below resistance at 42,000. A reversal below the recent low would again confirm the bear market.

Dow Jones Industrial Average

The Fed is expected to keep interest rates unchanged at this week’s FOMC meeting. The spread between the 2-year (purple) and fed funds rate (gray) shows the market pricing in an average 40 basis points of rate cuts over the next two years.

2-Year Treasury Yield minus Fed Funds Rate below zero warns of Fed rate cuts

Treasury yields remain low, with the 10-year continuing to test support at 4.1%.

10-Year Treasury Yield

However, credit markets are tightening due to rising uncertainty, with high-yield spreads leaping by 160 basis points since the end of January.

Junk Bond Spreads

Consumers

Consumer spending remained reasonably strong in February. New housing starts (purple) recovered due to lower mortgage rates, while February new housing permits (green) held at similar levels.

Housing New Starts & Permits

Thirty-year mortgage rates have eased to 6.65%, in line with softer 10-year Treasury yields.

30-Year Mortgage Rate

Light vehicle sales similarly recovered to nearly 16 million annual units in February.

Light Vehicle Sales

Dollar & Gold

The Dollar Index continues to test support at 103. Breach would offer a target of 100.

Dollar Index

Gold is among the few beneficiaries of the weak dollar and rising uncertainty, advancing to a new high of $3,033 per ounce.

Spot Gold

Australia

The Australian ASX 200 index found short-term support at 7700, but the rally soon faded. A breach of 7700 would confirm the bear market.

ASX 200 Index

The Financials Index displays a dead cat bounce at 8000. Breach of support would further strengthen the bear signal.

ASX 200 Financials Index

Germany

Germany’s DAX is another beneficiary of the uncertainty, threatening a breakout above 23,500 after Germany’s parliament voted in favor of a 500 billion euro fund for infrastructure and easing strict borrowing rules to allow for increased defense spending.

DAX Index

Hong Kong

Hong Kong’s Hang Seng Index also displays a strong advance.

Hang Seng Index

Conclusion

Consumer spending remains robust, but financial markets face rising uncertainty. Widening credit spreads warn of a likely contraction in new investment.

The Dow and S&P 500 rally is fading, and reversal below recent support levels would confirm a bear market.

Australia’s ASX 200 index displays a similar pattern and breach of support at 8000 on the ASX 200 Financials Index would confirm the bear market.

Gold rose to a new high of $3,033 per ounce, while the current turmoil also boosted Germany’s DAX and Hong Kong’s Hang Seng Index.

Acknowledgments

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Loaded for bear

Donald Trump’s on-again-off-again trade war with Canada and Mexico has ramped up uncertainty, causing a violent swing to risk-off in financial markets.

Canada is in no mood to back down. Foreign Minister Melanie Joly responded to the latest twist in the tariff saga: “That’s enough! Canadians have had enough. We are a strong country. We will defend our sovereignty. We will defend our jobs. We will defend our borders…”

The S&P 500 retreated below support at 5800, signaling a primary downtrend.

S&P 500

The Nasdaq QQQ ETF reinforced the bear signal, breaking support at 500.

Invesco Nasdaq 100 ETF (QQQ)

The Dow Jones Industrial Average is the last major index that has not breached its primary support level, at 42K.

Dow Jones Industrial Average

Europe & Australia

The response of international markets is mixed, with the Dow Jones Stoxx 600 Euro Index in an uptrend.

DJ Stoxx 600 Euro Index

However, Australia’s ASX 200 breached primary support at 8050, signaling a bear market.

ASX 200 Index

Conclusion

A Dow Jones Industrial Average breach of support at 42,000 would confirm a bear market in the US.

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Big Picture reading: Ukraine

Here is some interesting analysis on Donald Trump and his “peace plan” for Ukraine:

Phillips O’Brien, professor of strategic studies at University of St Andrews, Scotland: What Europe Can do in a Worst-Case Scenario

Nataliya Gumenyuk, Ukrainian journalist and co-founder of The Reckoning Project: Putin’s Ukraine – The End of War and the Price of Russian Occupation

Timothy Snyder, American historian and expert on European history: Crossing a line

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Scientists say they can use AI to solve a key problem with nuclear fusion | CNN

Inside the JET tokamak, used to conduct major nuclear fusion experiments in the UK - United Kingdom Atomic Energy Authority

Inside the JET tokamak, used to conduct major nuclear fusion experiments – UK Atomic Energy Authority

CNN — Scientists pursuing fusion energy say they have found a way to overcome one of their biggest challenges to date — by using artificial intelligence.

Nuclear fusion has for decades been hailed as a near-limitless source of clean energy, in what would be a game-changing solution to the climate crisis. But experts have only achieved and sustained fusion energy for a few seconds, and many obstacles remain, including instabilities in the highly complex process….

Read More at CNN

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Eleven reasons for optimism in the next decade

This might seem more like a wish list than a forecast — there are always risks that can derail predictions — but we believe these are high probability events over the long-term.

Our timeline is flexible, some events may take longer than a decade while others could occur a lot sooner.

Also, some of the reasons for optimism present both a problem and an opportunity. It depends on which side of the trade you are on.

#1 US Politics

The political divide in the United States is expected to heal after neither President Biden nor his predecessor, and current GOP front-runner Donald Trump, make the ballot in 2024. The first due to concerns over his age and the latter due to legal woes and inability to garner support from the center. A younger, more moderate candidate from the right (Nikki Haley) or left (Gavin Newsom?) is likely to be elected in 2024 and lead the reconciliation process, allowing Congress to focus on long-term challenges rather than political grandstanding.

Nikki Haley
Gavin Newsom

Nikki Haley & Gavin Newsom – Wikipedia

#2 The Rise of Europe

Kaja Kallas

Prime Minister of Estonia, Kaja Kallas – Wikipedia

Europe is expected to rediscover its backbone, led by the example of Eastern European leaders who have long understood the existential threat posed by Russian encroachment. Increased funding and supply of arms to Ukraine will sustain their beleaguered ally. NATO will re-arm, securing its Eastern border but is unlikely to be drawn into a war with Russia.

#3 Decline of the Autocrats

We are past peak-autocrat — when Vladimir Putin announced Russia’s full-scale invasion of Ukraine on February 23, 2022.

Vladimir Putin

Vladimir Putin announces invasion of Ukraine – CNN

Russia

The Russian economy is likely to be drained by the on-going war in Ukraine, with drone attacks on energy infrastructure bleeding Russia’s economy. Demands on the civilian population are expected to rise as oil and gas revenues dwindle.

Fire at an oil storage depot in Klintsy, southern Russia

Fire at an oil storage depot in Klintsy, southern Russia after it was hit by a Ukrainian drone – BBC

China

The CCP’s tenuous hold on power faces three critical challenges. First, an ageing population fueled by the CPP’s disastrous one-child policy (1979-2015) and declining birth rates after the 2020 COVID pandemic — a reaction to totalitarian shutdowns for political ends.

China's birth rate

Second, is the middle-income trap. Failure to overcome the political challenges of redistributing income away from local governments, state-owned enterprises and existing elites will prevent the rise of a consumer economy driven by strong levels of consumption and lower savings by the broad population.

Third, the inevitable demise of autocratic regimes because of their rigidity and inability to adapt to a changing world. Autocratic leaders grow increasingly isolated in an information silo, where subordinates are afraid to convey bad news and instead tell leaders what they want to hear. Poor feedback and doubling down on past failures destroy morale and trust in leadership, leading to a dysfunctional economy.

Iran

Ayatollah Ali Khamenei

Iranian Ayatollah Ali Khamenei – Wikipedia

Demographics are likely to triumph in Iran, with the ageing religious conservatives losing power as their numbers dwindle. The rise of a more moderate, Westernized younger generation is expected to lead to the decline of Iranian-backed extremism and greater stability in the Middle East.

#4 High Inflation

The US federal government is likely to avoid default on its $34 trillion debt, using high inflation to shrink the debt in real terms and boost GDP at the same time.

US Debt to GDP

#5 Negative real interest rates

High inflation and rising nominal Treasury yields would threaten the ability of Treasury to service interest costs on outstanding debt without deficits spiraling out of control. The Fed will be forced to suppress interest rates to save the Treasury market, further fueling high inflation. Negative real interest rates will drive up prices of real assets.

#6 US Dollar

The US Dollar will decline as the US on-shores critical industries and the current account deficit shrinks. Manufacturing jobs are expected to rise as a result — through import substitution and increased exports.

US Current Account

#7 US Treasury Market

USTs are expected to decline as the global reserve asset, motivated by long-term negative real interest rates and shrinking current account deficits.

Foreign Holdings of US Treasuries

Central bank holdings of Gold and commodities are likely to increase as distrust of fiat currencies grows, with no obvious successor to US hegemony.

#7 Nuclear Power

Investment in nuclear power is expected to skyrocket as it is recognized as the only viable long-term alternative to base-load power generated by fossil fuels. Reactors will be primarily fueled by coated uranium fuels (TRISO) that remove the risk of a critical meltdown.

TRISO fuel particles

TRISO particles consist of a uranium, carbon and oxygen fuel kernel encapsulated by three layers of carbon- and ceramic-based materials that prevent the release of radioactive fission products – Energy.gov

Thorium salts are an alternative but the technology lags a long way behind uranium reactors. Nuclear fusion is a wild card, with accelerated development likely as AI is used to solve some of the remaining technological challenges.

#8 Artificial Intelligence (AI)

Scientific advances achieved with the use of AI are expected to be at the forefront in engineering and medicine, while broad productivity gains are likely as implementation of AI applications grows.

#9 Semiconductors

Demand for semiconductors and micro-processor is likely to grow as intelligent devices become the norm across everything from electric vehicles to houses, appliances and devices.

McKinsey projections of Semiconductor Demand

#10 Industrial Commodities

Demand for industrial commodities — lithium, copper, cobalt, graphite, battery-grade nickel, and rare earth elements like neodymium (used in high-power magnets) — are expected to skyrocket as the critical materials content of EVs and other sophisticated devices grows.

Expected supply shortfall by 2030:

Critical Materials - Expected Supply Shortage to achieve Net Zero by 2030

Prices will boom as demand grows, increases in supply necessitate higher marginal costs, and inflation soars.

#11 Stock Market Boom

Stocks are expected to boom, fueled by negative real interest rates, high inflation and productivity gains from AI and nuclear.



Conclusion

There is no cause for complacency — many challenges and pitfalls face developed economies. But we so often focus on the threats that it is easy to lose sight of the fact that the glass is more than half full.

Our long-term strategy is overweight on real assets — stocks, Gold, commodities and industrial real estate — and underweight long duration financial assets like USTs.

Acknowledgements

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Santa rally: Monetary easing offsets China woes

China’s economy is struggling despite injection of moderate stimulus and efforts to support a collapsing real estate sector. Shrinking demand from China threatens a global economic contraction. G7 central banks have responded with monetary easing, causing a broad rally in stocks. This is most likely a bear market rally, with far shorter duration than a bull market.

China’s Shanghai Composite Index is testing primary support at 2900, warning of an economic contraction. The Trend Index peak near zero confirms selling pressure.

Shanghai Composite

Copper, however, has penetrated its descending trendline. Follow-through above 8500 would test resistance at $8750 per metric ton, threatening a wide double-bottom reversal with a target of $9500. Breakout above $8750 would signal global economic recovery, while reversal below $7800 would warn of a global recession.

Copper

US Stocks

The S&P 500 is testing it 2022 high at 4800, buoyed by injections of liquidity into financial markets.

S&P 500

The equal-weighted S&P 500 broke resistance at 6300, suggesting a broader rally than just the top 7 stocks. Retracement that respects the new support level would confirm the target at 6665.

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

The Russell 2000 small caps ETF (IWM) threatens a similar breakout above 200, offering a target of 240. Breakout would confirm that investors are growing more aggressive (risk-on) and downplaying risks.

Russell 2000 Small Caps ETF (IWM)

Interest Rates

Ten-year Treasury yields are retracing to test resistance at 3.9% or 4.0%; respect is likely and would confirm the target of 3.5%.

10-Year Treasury Yield
An increase in supply of Treasury Notes will test bulls’ conviction next week:

A raft of fresh, post-Christmas government bond supply will put that comprehensive bullishness to the test. Next week, Treasury will auction $57 billion, $58 billion and $40 billion in two-, five- and seven-year notes, respectively. That’s up 20%, 15% and 7% from their average sizes over the past four monthly auctions. (Grant’s Current Yield)

The 2-year Treasury yield (purple below) is falling in anticipation of Fed rate cuts next year. A peak in the 2-year tends to lead the first rate cuts by 6 to 9 months. The signal misfired with the SVB banks crisis in March but the October peak warns of Fed rate cuts in Q2 or Q3 of 2024.
Fed Funds Rate Minimum Target & 2-Year Treasury Yield

International Stocks

The FTSE 100 is testing resistance at 7700, with a Trend Index trough at zero signaling buying pressure.

FTSE 100

The DJ Stoxx Euro 600 — reflecting the top 600 stocks in Europe — broke resistance at 470. Follow-through above 480 would test the 2022 high of 494.

DJ Euro Stoxx 600

Japan’s Nikkei 225 is testing long-term resistance at 33750. Breakout would signal a fresh primary advance but declining Trend Index peaks show a lack of commitment from buyers.

Nikkei 225 Index

The ASX 200 is testing resistance at 7600, buoyed by strong iron ore prices and falling long-term bond yields. A sharp rise in the Trend Index indicates buying pressure but reversal below 7400 would warn of a correction to test support at 7000.

ASX 200

Gold & the Dollar

The US Dollar Index respected resistance at 102.50, confirming the target at 100. Trend Index peaks below zero signal strong selling pressure.

Dollar Index

Gold broke through resistance at $2050, closing at $2053 per ounce. Expect retracement to test the new support level; respect would confirm another attempt at $2100. A falling Dollar and increased bullion demand from central banks is expected to maintain upward pressure on Gold prices.

Spot Gold

Conclusion

Stocks are rallying in response to falling long-term Treasury yields and in anticipation of Fed rate cuts next year. But falling LT Treasury yields is a medium-term rally in a long-term bear market, with LT yields expected to rise in 2025. Fed rate cuts are also a bearish sign, normally preceding a recession by several quarters — falling earnings are definitely not bullish for stocks.

Investors will need to be agile, to take advantage of the current bullishness in stocks while guarding against:

  • a trend reversal in long-term yields; and
  • signs that the broad economy is falling into recession.

Vacation

This is our last newsletter of the year as we close our office for two weeks over Christmas and the New Year.

We wish all our readers peace and goodwill over the festive season and hope for a less tumultuous year ahead.

The Magpie by Claude Monet

The Magpie by Claude Monet

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Long-term outlook: How does it all end?

What economic path are the US and major allies likely to take over the next decade? Here is my take on how this is likely to pan out.

First, let’s start with a template of what a healthy, growing economy looks like.

A Virtuous Cycle

Growth is dependent on two factors:

  • Demographics — that is a growing, skilled workforce; and
  • Productivity — where output grows at a faster rate than the workforce.

Growth requires not only a growing population but a growing workforce. An ageing population or large population under the age of 25 is unlikely to contribute much to output. What is needed are people of 25 to 55 who hold down productive jobs. We also need to ensure that they have the necessary skills — productivity tends to rise with education levels. Education that is skills-based is worth a lot more than a barista with a bachelors degree.

The most important source of productivity growth, however, is investment. More specifically, private investment — government investment tends to provide a short-term boost to the economy but acts as a long-term drag on growth (Dr Lacy Hunt). Mechanization and automation increase the output per worker, boosting productivity.

The chart below shows US private domestic non-residential investment (blue) at a healthy 13.5% of GDP, while productivity (magenta), calculated as real GDP/total non-farm employees, has grown steadily since the 1950s.

Private Investment/GDP & Real GDP/Total Non-farm Payroll

Savings are needed to fund private investment. Either domestic savings or offshore borrowings. Domestic savings are better than foreign debt, especially if debt is denominated in a second currency which can cause volatile short-term capital flows. Workers tend to consume what they earn, with low rates of savings, while the wealthy tend to have far higher savings rates. High levels of inequality increases the amount of saving but depresses consumption. Low consumption leads to fewer investment opportunities, so it is important to get the balance right. Forcing workers to save (e.g. through compulsory superannuation) is one solution.

Low deficits are essential to ensure that government borrowing does not crowd out private investment. Government investment — as we mentioned earlier — is no substitute for private investment as it leads to low productivity and low growth.

Monetary policy is often used to prime the pump — stimulating consumption and investment through low interest rates. But cheap debt has short-term benefits and long-term costs that are often not carefully considered. First, low interest rates discourage private savings which are the lifeblood of a healthy economy. Second, low interest rates are effected by the Fed (or central bank) growing the supply of money at a faster rate than output (GDP). But that causes inflation after a lag of one to two years, forcing the Fed to contract the supply of money and destabilize growth. Third, cheap debt and high inflation (with negative real interest rates) encourage malinvestment in speculative assets that are expected to grow in price without necessarily growing output. The net result is that productive investment is crowded out by both malinvestment (speculation) and government deficits, harming long-term growth.

There is also a fourth, far more insidious factor, that operates with much greater lags. Home prices tend to grow at a much faster rate than incomes during times of low interest rates, reducing access to homes by younger workers entering the workforce. New household formation slows and so does the birth rate, undermining long-term demographics. This can be remedied to some extent by skilled immigration but often migrants are unskilled and face both language and cultural challenges that lead to poor assimilation and a two-tier economy.

In summary, what is needed is a growing, skilled workforce with rising productivity from healthy private investment. Private investment requires stable growth — to facilitate reliable projections rather than unstable boom-bust cycles — and sufficient funding from private saving. Government deficits need to be kept low and real interest rates reasonably high (say 3%) to ensure low inflation and encourage efficient allocation of capital (to productive private investment).

In the Wilderness

We are a long way from the above ideal.

The chart below shows the decline in 10-year average real GDP growth, since 1960, and rising debt relative to nominal GDP.

Total Debt/GDP & Real GDP Growth

Growth is slowing due to poor demographics, rising government deficits, and malinvestment from negative real interest rates. Geopolitical tensions and the need to secure supply chains and sources of energy mean that government spending is likely to exceed tax revenues by a wide margin for the foreseeable future.

Ballooning government debt is likely to crowd out private investment, ensuring low future growth. The chart below shows CBO projections of debt-to-GDP for the next thirty years.

CBO Projection of Debt/GDP

The Fed will likely have no choice but to suppress long-term interest rates in order to assist government in servicing the massive interest burden on its debt. That is likely to lead to high inflation, negative real interest rates, malinvestment in speculative assets, low growth, and rising instability (Hyman Minsky).

Conclusion

We are likely to face a decade of stagflation, with low growth, high inflation and unstable financial markets.

Hopefully, inflation will boost nominal GDP relative to government debt, increasing serviceability, over time. That would provide an opportunity to reduce fiscal deficits and establish healthy monetary policy.

In the meantime, don’t fight the Fed. When interest rates are low and inflation is high, invest in real assets. Look for value — with stable income streams which can withstand tempestuous cycles — rather than speculative growth.

Acknowledgements

Professor Percy Allan, University of Technology Sydney: Looking Beyond 2024

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