Category: US & Canada

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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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Weekly Stock Market Snapshot

Bull/Bear Market Indicator
Stock Market Pricing Indicator

The above two dials provide a snapshot of our market view and attitude to risk.

Bull/Bear Market

The Bull/Bear Market indicator fell to 40% last Friday from 80% on November 9th.

The most recent bear signal is heavy truck sales, which plunged to a seasonally adjusted 32.5 thousand units in October 2024 from a peak of 46.1 thousand in May 2023.

Heavy Truck Sales

There are now three of five indicators signaling Risk-off:

Bull/Bear Market Indicator

Stock Pricing

The Stock Pricing indicator compares stock prices to long-term sales, earnings, and economic output to gauge market risk. We use z-scores to measure each indicator’s current position relative to its history, with the result expressed in standard deviations from the mean. We then calculate an average for the five readings and convert that to a percentile.

Stock pricing remains in the extreme range, at the 97.83 percentile compared to 97.67 last Friday, warning that stock prices have the potential for large drawdowns.

Stock Market Value Indicator

Conclusion

We are headed for a bear market, with our allocation to risk assets declining to 40%.

Stock pricing is also extreme, warning of the potential for large drawdowns.

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The last guardrail

In the above ABC interview, Professor Nouriel Roubini said it would be interesting to watch Trump deal with financial markets:

He said if Trump was “really serious” about 60 per cent tariffs on China, and 10 to 20 per cent tariffs on other trading partners, about sharply weakening the value of the US dollar, about “draconian restrictions” on migration and “mass deportation”, and about tax cuts that weren’t funded by raising other taxes or cutting spending, it could lead to situations Trump wouldn’t like.

“If he tries to follow these policies that are stagflationary, interest rates are going to be much higher, bond yields are going to be higher, the Fed will have to raise rates rather than cutting them, the stock market is going to correct,” he said.

“He cares about the bond market. He cares about the stock market. And therefore market discipline, as opposed to political discipline … [will] be the main constraint [for him].”

Long-term Treasury bonds continued their downtrend after November 5.

iShares 20+Year Treasury Bond ETF

Ten-year yields are testing resistance at 4.5%. A breakout above 4.5% would likely cause a correction in stocks.

10-Year Treasury Yield

Fears of rising inflation are not the only factor driving Treasury yields higher. Since 2020, Treasury issuance has been skewed towards short-dated T-bills, with the issuance of notes and bonds (green) kept as low as possible to suppress long-term yields.

Treasury Issuance

A study by Hudson Bay Capital concluded that rolling back the excess $1 trillion in T-bill issuance would cause a 50 basis point rise in the 10-year yield—equivalent to a 2.0% rise in the Fed funds rate—before settling at a permanent 30 basis point increase.

Also, Fed QE almost exclusively focused on purchasing notes and bonds to keep long-term yields as low as possible. Reducing the Fed’s balance sheet through QT increases the supply of notes and bonds, driving long-term yields higher.

Fed Holdings of Treasury Notes & Bonds and T-bills

Rising long-term yields constrain the S&P 500, which is testing support at 5850. Breach would signal a correction to 5700.

S&P 500

Financial Markets

Bitcoin remains above 90K, signaling strong liquidity in financial markets.

Bitcoin (BTC)

Dollar & Gold

The Dollar index retraced to test support at its rising trendline, but breakout above 107 remains a threat, offering a target of 115.

Dollar Index

Gold rallied off support at $2,550 per ounce. Penetration of the descending trendline at $2,650 would indicate a base forming.

Spot Gold

Silver similarly found support at $30 per ounce.

Spot Silver

Energy

Brent crude remains in a bear market, which is likely to keep inflation in check as long as global demand remains subdued.

Brent Crude

Base Metals

Copper also reflects weak global demand, with another likely test of support at $8,600 per tonne.

Copper

Conclusion

Donald Trump’s election campaign was based on reviving a “weak” economy, which has proved surprisingly resilient. The Fed and Treasury succeeded in taming inflation without crashing the economy—a rare feat. However, their efforts have built up imbalances in the financial system that lie in wait for the unwary.

Stimulating an economy already close to full employment will inevitably cause higher inflation, preceded by a surge in long-term Treasury yields. The result would be a sharp fall in stock prices and a likely recession.

The Republican party may control the House and the Senate, but the final guardrail is the bond market. They ignore that at their peril.

Gold and silver fell as the Dollar soared in response to higher long-term Treasury yields. But yields are rising in anticipation of rising inflation. We remain bullish on gold and retain our $3,000 per ounce target.

Acknowledgments

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GDP gradually slowing

Real GDP growth slowed slightly to 2.66% over the twelve months ending in Q3, compared to 3.04% for the previous quarter.

Real GDP Growth

Real quarterly growth is essentially unchanged at 0.70% (2.8% annualized) in Q3.

Nominal GDP & Real GDP, Quarterly

Nominal GDP growth (gray below) slowed to 4.94% for the four quarters ending in Q3. Ten-year Treasury yields are lower, indicating that monetary policy remains supportive.

Nominal GDP & 10-Year Treasury Yield

This is borne out by the Chicago Fed National Financial Conditions Index at a low -0.56.

Chicago Fed National Financial Conditions Index

Credit markets also signal strong liquidity, with Moody’s Baa corporate bond spread narrowing to 1.49%.

Moody's Baa Corporate Bond Spreads

Conclusion

Real GDP growth is slowing gradually, as expected during a rate-cut cycle. Financial market liquidity remains strong, and there is nothing particularly concerning.

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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

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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Stabilizing crude oil prices

Volatile crude oil prices damage production capacity and economic growth and cause volatile consumer price inflation.

At the height of the 2020 pandemic, Nymex WTI crude oil prices fell to an unprecedented low of -$13.10 per barrel as demand dried up and oil storage facilities reached capacity. Producers faced a dilemma: either shut down wells or sell at a loss, effectively paying end users to consume their oil.

Nymex WTI Crude

The Department of Energy failed to capitalize on this opportunity to replenish the Strategic Petroleum Reserve (SPR), buying only 21 million barrels of crude over four months. US field production fell from 13 million to below 10 million barrels per day as shale producers shut wells rather than produce at below cost. The damage done to balance sheets meant that it took several years to restore production as prices recovered.

US Crude Oil Production

Russia’s invasion of Ukraine in February 2022 caused a spike in crude oil prices, with WTI crude peaking at close to $125 per barrel. In response, the Biden administration released 290 million barrels from the SPR. This tipped the oil market into surplus despite OPEC+ production cuts, with Nymex crude prices falling below $75 per barrel.

Strategic Petroleum Reserve (SPR)

Shrinking demand from China and rising non-OPEC production, led by the US, has maintained prices at close to $75 per barrel. Now, hostilities between Israel and Iran threaten to escalate to the point that crude oil supplies from the Middle East could be affected.

Joseph Webster from the Atlantic Council argues that the DoE should not hesitate to make further releases from the SPR to stabilize prices in the event of a supply threat. Net crude imports to the US (blue below) have shrunk to 2 million barrels daily from 8 million in 2017, meaning the SPR provides more than 23 weeks of cover if all imports were to be terminated.

US Crude Net Imports

Further releases from the SPR would not only help to keep prices low but also stabilize them, which can be highly profitable for the US government. SPR releases under the Biden administration, at an average of close to $90 per barrel, will net about $20 per barrel if the SPR is replenished at current prices—a profit of nearly $600 million.

Conclusion

Releases from the Strategic Petroleum Reserve (SPR) should be used to stabilize crude oil prices in case of an interruption to crude oil imports. This would likely have four benefits:

First, SPR releases would ensure an interrupted supply to industry and minimize the impact on the economy.

Second, replenishing reserves when prices are low would help to maintain a floor under prices and support shale producers, avoiding the shut-down of wells when prices fall too low to cover operating costs.

Third, stabilizing energy prices can be achieved at no cost to the taxpayer. Selling when prices are high and buying when prices are low will likely show a profit.

Lastly, SPR releases would help to keep a lid on inflation. Energy prices impact the consumer price index directly through gasoline and heating prices to the consumer but more significantly through the energy cost component of goods and services. The chart below shows how energy CPI (orange) increased ahead of headline CPI in 2021 and similarly led the decrease in 2022-2023.

CPI & CPI Energy

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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Houthis and the blow-back

Stocks retraced to test support on concerns over an escalation of hostilities between Israel and Iran and its potential threat to the flow of crude oil from the Middle East.

Stocks

The S&P 500 retraced to test support at 5670/5700, but rising Trend Index troughs signal buying pressure. Respect of support will likely confirm another advance, with a target of 6000.

S&P 500

The equal-weighted index ($IQX) shows that large caps experienced a similar retracement.

S&P 500 Equal-Weighted Index

Financial Markets

Bitcoin is consolidating in a narrow “descending flag” channel. Marginally lower troughs are typically a bullish sign, reflecting support. Upward breakout from the channel would signal a fresh advance, confirming strong liquidity in financial markets.

Bitcoin (BTC)

Treasury Markets

Increased demand for safety drove 10-year Treasury yields lower, again testing support at 3.7%.

10-Year Treasury Yield

Dollar & Gold

The Dollar strengthened, benefiting from the same flight to safety.

Dollar Index

Gold retraced to test support, but the flight to safety will likely fuel another rally, breaking resistance at $2,700 per ounce.

Spot Gold

Silver found short-term support at $31 per ounce and will likely re-test long-term resistance at $32.

Spot Silver

ISM Manufacturing

The ISM Manufacturing PMI continues to signal contraction, holding steady at 47.2%.

ISM Manufacturing PMI

The New Orders sub-index at 46.1% warns of further slowing ahead.

ISM Manufacturing New Orders

So does the Employment sub-index at 43.9%.

ISM Manufacturing Employment

The Prices sub-index surprised, dropping below 50% for the first time since the beginning of the year, reflecting declining inflationary pressures.

ISM Manufacturing Prices

Labor Market

Job Openings also surprised, increasing to 8.04 million in August. The gap above unemployment indicates continued labor market tightness.

Job Openings

Crude Oil

Brent crude is rallying on fears of an interruption to oil supplies from the Middle East.

Brent Crude

Conclusion

Escalation of hostilities between Israel and Iran is likely to fuel a flight to safety, increasing demand for Treasuries, gold, and silver.

We expect the S&P 500 to retrace to test support at 5670. Crude oil is likely to rally but remain in a bear market unless Iran attempts to interdict shipping in the Straits of Hormuz and the Red Sea through its Houthi proxies in Yemen.

The ISM PMI warns of a slowing manufacturing sector, but there has been no significant decline in cyclical sector employment so far. Job openings also maintain a healthy gap above unemployment, indicating a still-tight labor market. The economy is expected to remain reasonably robust until the new year, when liquidity may tighten as the US Treasury likely reduces T-bill issuance, replacing them with longer-term coupons.

Acknowledgments

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The Great Pumpkin | Eric Cinnamond

Great stock market analogy from Eric Cinnamond at Palm Valley Capital:

As a kid I always looked forward to Halloween. Growing up in a health-conscious “no sweets” household, Halloween was an opportunistic time to load up on my favorite chocolate bars and candy. If I played my bag of treats right, my sweet tooth could be satisfied until Christmas!

Another thing I enjoyed about Halloween was the television special, It’s the Great Pumpkin, Charlie Brown. It was and remains a classic. Released in 1966, the Peanuts special follows its cast members as they celebrate Halloween. Some of the Peanuts crew go trick-or-treating, while others attend a party. But not Linus—he does his own thing.

Instead of celebrating with his friends, Linus spends his Halloween waiting in a pumpkin patch for the Great Pumpkin. According to Linus, “On Halloween night, the Great Pumpkin rises from his pumpkin patch and flies through the air with his bag of toys to all the children.” Unfortunately, the Great Pumpkin never arrives, and Linus is ridiculed by his friends. He’s even called a blockhead!

Our belief in full market cycles, including a bull and bear market, is beginning to feel more and more like Linus’s belief in the Great Pumpkin. However, instead of pumpkins, we sit in a patch of T-bills waiting for the return of sensible equity valuations. And rather than bringing a bag of toys, we expect this cycle’s Great Pumpkin (bear market) will bring patient investors the gift of lower prices and opportunity.

From the outside looking in, believing in full market cycles, bear markets, and even recessions, probably looks foolish. To some, we might even look like blockheads! Nevertheless, we continue to believe equity valuations are very expensive, exposing investors to considerable risk. In fact, we consider this stage of the market cycle to be an asset bubble—the third stock market bubble of our careers. The first two bubbles were verified by significant losses, with the S&P 500 losing half of its value during both bear markets (2000-2002 -49% and 2007-2009 -56%).

Our latest page on stock market valuation supports his view:

Stock Market Value Indicator

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Narrow advance for stocks, bullish consolidation for gold

Falling CPI and plunging crude prices almost guarantee at least a 25-basis-point rate cut at next week’s FOMC meeting. Stocks rallied, led by mega-cap technology stocks, but the advance was narrow, with large caps failing to join the party.

Gold is bullish, boosted by falling long-term Treasury yields and a weak Dollar, but silver remains more bearish.

Stocks

Mega-cap technology stocks led the rally, with Nvidia (NVDA) posting solid gains.

Top 7 Technology Stocks

The move lifted the S&P 500 above resistance at 5500, signaling another test of the all-time high at 5670.

S&P 500

Large caps lagged, with the equal-weighted index ($IQX) failing to show much progress.

S&P 500 Equal-Weighted Index

Financial Markets

The Chicago Fed National Financial Conditions Index eased to -0.57, reflecting easy monetary policy.

Chicago Fed National Financial Conditions Index

Bitcoin respected support at $54K [red line], but the bearish declining triangle still warns of tighter financial market liquidity ahead.

Bitcoin (BTC)

Treasury Markets

Ten-year Treasury yields plunged to almost 3.6% before retracing to test new resistance at 3.7%. The steep fall from the 5.0% peak in October last year indicates market expectations of significant rate cuts ahead.

10-Year Treasury Yield

Dollar & Gold

Falling long-term interest rates are driving long-term Dollar weakness. Respect of resistance at 102 on the Dollar Index would confirm another decline, while breach of support at 100 would offer a long-term target of 93.

Dollar Index

A stronger Japanese Yen warns of a more hawkish monetary policy from the Bank of Japan. Rising Japanese interest rates will likely withdraw liquidity from US financial markets and weaken the Dollar.

Japanese Yen

Gold is expected to benefit from falling long-term interest rates and a weaker Dollar. The narrow bullish consolidation below $2,525 per ounce suggests another advance. Breakout above resistance would offer a target of $2,600.

Spot Gold

Silver lags behind gold, struggling to break resistance at $30 per ounce. Breach of support at $28 would warn of another test of long-term support at $26.50.

Spot Silver

CPI Inflation

Headline CPI fell sharply to 2.6% for the 12 months to August, but core CPI lifted to 3.3%.

CPI & Core CPI - Annual

Monthly CPI shows that the sharp drop in the headline rate is caused by the base effects of a spike in July of last year [red circle]. Rising core CPI over the past two months, with August growing at an annualized rate of 3.7%, warns of underlying inflationary pressures.

CPI & Core CPI - Monthly

Sticky prices inflation also increased, to an annualized rate of 3.5% in August, warning that underlying inflationary pressures persist.

Sticky Prices CPI

Shelter

Shelter CPI also increased to an annual rate of 5.2% in August, reflecting a trough in home prices in mid-2023. The Case-Shiller 20-City Composite Index [gray below] tends to lead Shelter by roughly 12 months.

CPI Shelter & Case-Shiller 20-City Home Price Index

Energy

However, the recent sharp fall in crude oil prices warns that inflationary pressures will likely ease in the months ahead.

Brent Crude

Energy CPI grew by -4.0% over the 12 months to August and is likely to fall further in September. The chart below shows how energy CPI [ocher below] plunged from a peak of 41.5% in June ’22, leading to a fall in headline CPI.

CPI & CPI Energy - Annual

Food

Food CPI also declined to an annual rate of 2.1% in August, close to the Fed’s target of 2.0%.

CPI Food

Conclusion

Mega-cap technology stocks lifted the S&P 500 above resistance at 5500, indicating another test of the previous high at 5670. Breakout would offer a target of 6000, but the advance is narrow. Large caps in the index show little in the way of net gains, with the equal-weighted index ($IQX) failing to make much progress.

The Chicago Fed National Financial Conditions Index continues to reflect easy monetary policy, but a bearish triangle on Bitcoin and a stronger Japanese Yen warn of tighter liquidity ahead.

The decline in headline CPI is primarily due to base effects from August last year, while core CPI and the sticky price index warn of persistent underlying inflationary pressures. However, a sharp fall in crude oil prices will likely drag overall CPI lower in September.

Falling 10-year Treasury yields reflect market expectations of significant rate cuts commencing on September 18. The Dollar rallied over the week, but the long-term downtrend is likely to persist as rates decline.

Low long-term interest rates and a weak Dollar are expected to be bullish for gold. A Dollar Index breach of support at 100 would confirm our $3,000 per ounce target for gold.

Acknowledgments

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