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

Gold, Crude, Copper and the Elephant

Gold, crude and copper is where the action is, while stocks and Treasuries take a back seat for the present.

Markets are signalling a reluctance to take on risk, while long-term Treasury yields threaten to trend higher.

We also revisit rising Treasury debt — the elephant in the room — and examine the CBO’s budget projections in more detail.

Crude Oil

Brent crude respected resistance at $84 per barrel, signaling a decline to below $80.

Brent Crude

Nymex light crude breach of support at $78 per barrel would confirm the reversal. A decline in crude oil is likely and would ease inflationary pressures, with the expected fall in long-term yields bullish for stocks, bonds and precious metals.

Nymex Light Crude

Crude oil production remains steady at a massive 13.1 million barrels per day according to the EIA report for the week to May 3.

EIA: Crude Oil Production

Inventories (including SPR) recovered to above 1.6 trillion barrels, while market concerns eased over Iran-Israel tensions.

EIA: Total Crude Oil and Petroleum Products (Incl. SPR) Inventory

Copper

Copper is testing short-term resistance at $10K per metric ton. Breakout is likely and would test major resistance (green) at $10.5K.

Copper

The rise, however, is caused by a production halt at Cobre Panama. Production could be resumed if the mine-owner First Quantum can reach agreement with the new president-elect Jose Raul Mulino. From Reuters:

Mulino, a 64-year-old former security minister, won Panama’s election on Sunday [May 5] with 34% of the vote and said his government would be pro-investment and pro-business, adding that the Central American country would honor its debts, while he vowed to not forget the poor. He won with the help of popular former President Ricardo Martinelli who was barred from running due to a money laundering conviction. Mulino, who served as security minister during Martinelli’s administration from 2009 to 2014, had been Martinelli’s vice presidential candidate and took his place.

Gold & the Dollar

The Dollar Index continues to test support at 105. Respect remains likely, with Trend Index troughs above zero signaling buying pressure, unless Janet Yellen at Treasury intervenes to weaken the Dollar in support of the UST market.

Dollar Index

Gold broke resistance at $2350 per ounce, signaling another advance. But first expect retracement to test the new support level. Respect would confirm a target of $2500 per ounce.

Spot Gold

Shanghai Gold Exchange domestic contract Au99.99 is trading at 553 RMB/gram, equivalent to a USD price of $2380 per ounce at the current USDCNY exchange rate of 7.2268.

Stocks

The S&P closed above 5200 on Friday but a doji candlestick and lower Trend Index peaks indicate a lack of enthusiasm from buyers.

S&P 500

The Russell 2000 small caps ETF (IWM) reflects the lack of broad market support for the rally, with Trend Index peaks below zero warning of selling pressure. Another test of support at 200 is likely.

Russell 2000 Small Caps ETF (IWM)

Financial Markets

Ten-year Treasury yields continue to test the band of support between 4.4% and 4.5%. Recovery above 4.5% would signal another test of 4.7%.

10-Year Treasury Yield

Bitcoin is testing support at $61K. Follow-trough below say $60K would confirm the decline — initially signaled by breach of support at $64K — and warn that financial markets are moving to a risk-off position.

Bitcoin (BTC)

Commercial bank reserve balances at the Fed, however, grew by $78 billion in the week to May 8, indicating that financial market liquidity is improving.

Commercial Bank Reserves

Consumers

Consumer sentiment retreated to 67.4 in the University of Michigan survey for May 2024, but the up-trend continues.

University of Michigan: Consumer Sentiment

Five-year inflation expectations jumped to 3.1% but the three-month moving average, ranging between 2.9% and 3.0%, signals little change in the long-term outlook.

University of Michigan: 5-Year Inflation Expectations

The Elephant in the Room

Last week we published a note suggesting that investors were distracted by short-term noise and ignoring the elephant in the room — the precarious level of US federal debt. The bipartisan Congressional Budget Office (CBO) projects that Treasury debt will grow to a clearly unsustainable 172% of GDP by 2034.

CBO: Debt-to-GDP

The US fiscal deficit is projected to grow from $1.6 trillion in 2024 to $2.6 trillion by 2034. Remember: all projections are wrong, but some are useful.

CBO: Projected Deficits

Often the most useful part of a projection is the underlying assumptions.

Real GDP growth below is a modest 1.5% in 2024, reaching 2.2% by 2026 — nothing controversial there. But the inflation projection is Pollyannaish, assuming a steady CPI decline from 3.2% in 2023 to 2.2% by 2034 — totally unrealistic if the budget deficit is to remain at close to 6.0% of GDP.

CBO: Economic Projections

Assumed inflation (above) also impacts on projected nominal interest rates, with the projected fed funds rate declining to 2.9% by 2027 and 10-year Treasury yields to a low 3.8%. Every 1.0% overshoot in inflation would be likely to cause a similar increase in both long- and short-term interest rates.

The budget projection below is equally unrealistic. Defense spending, the CBO would have us believe, declines to 2.5% of GDP by 2034. Given rising geopolitical tensions with Russia-China-Iran, defense spending is likely to exceed the long-term average of 4.2%.

CBO: Budget Projections

Net interest is budgeted to grow from 2.4% of GDP to 3.9% of GDP by 2034 but is based on unrealistic interest rate projections.

CBO: Interest Rate Projections

Treasury debt is likely to grow a lot faster than projections — because of the likely understatement of both defense spending and interest costs. That means that debt held by the “public” will have to grow a lot higher than the $48.3 trillion projected by 2034. If real interest rates are too low, any shortfall in take up by the public will have to be absorbed directly or indirectly by the Fed.

Conclusion

Rising inventory and easing Middle East tensions have weakened crude oil prices. A long-term decline in crude would be likely to relieve inflationary pressures and allow the Fed to cut interest rates.

Copper is rising steeply due to supply shortages, but prices could fall just as rapidly if the Cobre Panama mine is reopened by the new president-elect.

Gold broke resistance at $2350 per ounce, signaling another advance. Retracement that confirms the new support level at $2350 would offer a target of $2500.

Long-term Treasury yields are testing support. Respect of support is likely and would confirm the recent up-trend.

Perceptions of market risk are rising, with Bitcoin testing support at $61K and the Russell 2000 small caps ETF (IWM) warning of selling pressure.

Financial market liquidity, however, recovered slightly in the last week.

Consumer sentiment continues to trend higher, while long-term inflation expectations remain steady at close to 3.0%.

The elephant in the room remains Treasury debt, with CBO projections understating likely deficits due to unrealistic assumptions for inflation, interest rates and defense spending. Debt issuance by Treasury is expected to exceed demand from foreign investors and the general public, leaving the shortfall to be absorbed by the Fed or commercial banks.

The result is likely to be higher long-term inflation, boosting real asset prices while eroding the value of financial assets.

We are long-term bullish on Gold, Defensive stocks, the Heavy Electrical sector, and Critical Materials (Lithium and Copper). The last two stand to benefit from the energy transition. We are also overweight short-term financial assets with duration of 2 years or less:  Mortgages, Term Deposits and Money Market Funds.

We remain underweight Growth stocks — which we consider overpriced — and long-duration financial assets.

Acknowledgements

ASX sector performance

The ASX 200 jumped sharply yesterday but ran into resistance at 7800 today. Declining peaks on the Trend Index warn of secondary selling pressure and another test of support at the recent lows (orange line) is likely.

ASX 200

The 6-month chart shows the up-trend losing momentum. Breakout above 7900 is less likely but would offer a target of 8200.

ASX 200

Economy

The real cash rate (cash rate minus CPI) remains close to zero, reflecting easy monetary policy despite rate hikes in 2023.

Real Cash Rate

But declining credit growth warns that economic growth is slowing.

Credit & Broad Money Growth

Consumer sentiment is lower than in the 2008 financial crisis — the result of high inflation from negative real interest rates after the pandemic.

Consumer Sentiment

Sectors

The 6-month chart of Financials shows the up-trend losing momentum, as with the ASX 200.

ASX 200 Financials

Net interest margins of the major banks remain under pressure.

Major Bank Net Interest Margins

Consumer Staples are in a down-trend after breaking primary support (red below). Trend Index peaks at zero warn of selling pressure.

ASX 200 Staples

A-REITs are still in an up-trend but declining Trend Index peaks warn of selling pressure.

ASX 200 A-REITs

Health Care threatened a primary down-trend after breaking support at 42K but has since recovered — a bullish sign.

ASX 200 Health Care

Consumer Discretionary is also losing momentum — similar to Financials.

ASX 200 Discretionary

Telecommunications are in a strong down-trend, with the Trend Index breaking below zero.

ASX 200 Telecommunications

Information Technology is outperforming, with accelerating trendlines and rising Trend Index troughs above zero.

ASX 200 Information Technology

Utilities is another bright star, displaying similar accelerating trendlines and rising Trend Index troughs above zero.

ASX 200 Utilities

Energy is testing primary support at 10K with a bearish Trend Index declining below zero.

ASX 200 Energy

The ASX 300 Metals & Mining index is attempting a recovery. Breakout above 6100 would be a bullish sign, while respect would warn of another test of primary support at 5600.

ASX 300 Metals & Mining

The All Ordinaries Gold index is in a strong up-trend. Respect of support at 7500 would signal another advance with a target of 8500. Breach of support, however, would signal another test of 7000.

All Ordinaries Gold Index

Conclusion

The ASX 200 is losing momentum. So are Financials, A-REITs and Consumer Discretionary.

Staples and Telecommunications are in a down-trend and likely to be joined by Energy.

Health Care and Metals & Mining show signs of recovery but further confirmation is needed.

The All Ordinaries Gold index is in a strong up-trend. Respect of support at 7500 would confirm another advance but breach of support, while less likely, would test 7000.

Acknowledgements

The elephant in the room

A weak seasonally-adjusted increase of 175K in non-farm payrolls had a surprisingly bullish effect on stocks. The increased prospect of rate cuts from the Fed excited investors. The opposite of what one would expect from a sign that the economy is slowing.

Markets are focused on the immediate impact of shifts in data and policy but ignoring the elephant in the room — the long term consequences of current monetary and fiscal policy.

Labor market

Job growth slowed to 175K jobs in April, the lowest since October 2023.

Non-Farm Employment

Average hourly earnings growth remained low at 0.20% in April (2.4% annualized), signaling that inflationary pressures are easing.

Average Hourly Earnings Growth

The unemployment rate is still low at 3.9%. The Sahm Recession Indicator is at 0.37. Devised by former Fed economist Claudia Sahm, the indicator signals the start of a recession when the red line below rise to 0.50%.

The Sahm Rule signals the start of a recession when the three-month moving average of the national unemployment rate (U3) rises by 0.50 percentage points or more relative to the minimum of the three-month averages from the previous 12 months.

The rule has proved a reliable recession indicator in the past but we need to remember that: (a) it is not a leading indicator and normally only crosses above 0.5% after the start of a recession; and (b) this is a far from normal labor market.

Sahm Rule & Unemployment Rate

Non-residential construction jobs are way above previous highs as the industry benefits from fiscal spending on infrastructure and the drive to on-shore key industries such as semiconductors.

Non-Residential Construction Jobs

Average hourly earnings growth (green below) slowed to 4.0% for the 12 months to April (for production and non-supervisory employees) indicating that inflationary pressures are easing. In the past, average hourly earnings growth above the unemployment rate (blue) has caused high inflation as in the 1970s (red circle).

Unemployment Rate & Average Hourly Earnings Growth

Economic Activity

Aggregate weekly hours worked are growing at an annual rate of 1.8%. This is below the rate of real GDP growth, suggesting either that (a) productivity gains from AI and other new technologies are having an effect; or (b) real GDP growth is likely to slow.

Real GDP & Aggregate Hours Worked

The GDPNow model from the Atlanta Fed forecasts an optimistic 3.3% annualized real growth rate in Q2.

GDPNow

But the Lewis-Mertens-Stock Weekly Economic Index is far more cautious at an annualized rate of 1.7% for Q2 (so far).

Real GDP & Weekly Economic Index

ISM Services PMI declined to 49.4% for April, indicating a contraction in the large services sector. Earlier, the ISM Manufacturing PMI was slightly weaker, at 49.2%.

ISM Services

The Services New Orders sub-index remains above zero, suggesting some improvement ahead.

ISM Services - New Orders

The Employment sub-index, however, shows a sharp contraction, falling to 45.9%. The services sector is the major employer in the economy and the negative outlook warns that overall jobs growth could slow rapidly.

ISM Services - Employment

The Prices sub-index, on the other hand, warns of persistent inflation, rebounding to a strong 59.2%.

ISM Services - Prices

Financial Markets

Bitcoin rallied strongly to again test resistance at $64K. Respect of resistance, signaled by a fall below $61K, would confirm the down-trend and warn of contracting liquidity in financial markets.

Bitcoin (BTC)

The Chicago Fed Financial Conditions Index recovered slightly to -0.47, also warning that easy monetary conditions are receding.

Chicago Fed Financial Conditions Index

Ten-year Treasury yields declined on news of the weak labor report, testing support at 4.5%. Breach would indicate a decline to 4.2%.

10-Year Treasury Yield

The S&P 500 jumped above resistance at 5100, suggesting another test of resistance at 5250. But we first expect retracement to test support.

S&P 500

Gold & the Dollar

The Dollar weakened in line with falling Treasury yields, with the Dollar Index testing support at 105. Breach would signal a correction, with follow-through below 104 signaling end of the up-trend.

Dollar Index

Gold continues to test support at $2300 per ounce. If support holds, with recovery above $2350, the shallow correction would be a bull signal, suggesting another strong advance. Otherwise, a test of $2200 is likely.

Spot Gold

Crude Oil

Brent crude broke support at $84 per barrel as tensions in the Middle East ease. Follow-through below support at $82 would warn that the up-trend has weakened and is likely to reverse.

Brent Crude

Conclusion

Financial markets, like Pavlov’s dog, are conditioned to react bullishly to rate cuts. Long-term Treasury yields declined and stocks jumped in response to a weak labor report. However, weak jobs growth is not a bull signal, suggesting that the economy is likely to slow. This is borne out by a weak ISM Services PMI for April, warning of a contraction.

The unemployment rate remains low but average hourly earnings growth is declining, indicating that inflationary pressures are easing. ISM Prices sub indices for both Manufacturing and Services, however, warn of strong producer price pressures.

Brent crude broke its rising trendline and follow-through below the next support level at $82 per barrel would warn of reversal to test primary support at $75. Declining energy prices would help to ease inflationary pressures.

The Fed is likely to hold off cutting rates until the outlook for inflation is clearer.

Gold could weaken to $2200 per ounce in the short- to medium-term — if it can break stubborn support at $2300. But we remain long-term bullish on Gold. The elephant in the room is Government debt which is growing at a rate of more than $1 trillion a year, with little prospect of a bipartisan agreement in Congress to address the shortfall. The chart below shows the bipartisan CBO’s projection of federal debt as a percentage of GDP from 2024 to 2054.

CBO Projections of Federal Debt

The only practical way to solve this is to increase GDP at a faster rate than the debt, through inflation. That would erode the real value of the debt but is likely to send Gold and other real assets soaring.

Acknowledgements



Markets move to Risk-Off

Bitcoin broke support at $64K, warning that financial markets are moving to risk-off . Traders and investors reduce their exposure to risk and focus on protecting their capital. Follow-through below $62K would confirm, warning of a sharp fall (in BTC) and a stock market correction.

Bitcoin

The 10-Year Treasury yield has climbed to 4.67%, confirming our target of 5.0%.

10-Year Treasury Yield

The Japanese Yen fell to 154 against the Dollar, increasing pressure on the Bank of Japan to loosen the cap on long-term JGB yields — to protect the Yen. The result of such a move would be an outflow of Japanese investors from the US Treasury market, increasing upward pressure on UST yields and downward pressure on the Dollar.

USDJPY

Fed Monetary Policy

From CNN:

The US economy’s enduring strength and a “lack of progress” on inflation means the central bank likely won’t cut interest rates at its upcoming policy meeting just two weeks away, Federal Reserve Chair Jerome Powell said Tuesday.

“The recent data have clearly not given us greater confidence” that inflation is headed toward the central bank’s 2% goal, Powell said during a moderated discussion hosted by the Wilson Center. Instead, he said, there are indications “that it is likely to take longer than expected to achieve that confidence.”

Stocks

The S&P 500 broke support at 5100, warning of a correction. Lower Trend Index peaks reflect selling pressure. Our target is 4950.

S&P 500

The Equal-Weighted Index ($IQX) continued its downward path after breaking support at 6650, presenting a target of 6250.

S&P 500 Equal-Weighted Index

US Consumers

Real retail sales ticked up in March to remain on trend.

Real Retail Sales

Light vehicle sales also remain reasonably strong, at 15.5 million units (annualized) in March.

Light Vehicle Sales

Gold & the Dollar

The Dollar Index climbed above 106, strengthened by safe haven demand and the appeal of higher long-term yields. Our target is the October 2023 high at 107.

Dollar Index

Gold is again testing resistance at our target of $2400 per ounce, currently at $2383. The Shanghai Gold Exchange continues to display a premium on its international gold contract (iAu99.99) at 558.3 Yuan which translates to $2399 per Troy ounce (31.10348 grams). The domestic contract trades at an even higher price of 569 per gram but is subject to capital controls. The price premium should ensure a constant inflow of physical gold from other exchanges to China for as long it is maintained.

Spot Gold

Silver retraced from resistance at $29 per ounce and is testing support at $28. The lower Trend Index peak warns of selling pressure. Breach of $28 would warn of a correction to $26. Breakout above $29 is less likely in the short-term but would signal a fresh advance, with a medium-term target of $34.

Spot Silver

Crude & Commodities

Brent crude is in a narrow consolidation (pennant) at $90 per barrel. Continuation is likely and would test resistance at $96 per barrel.
Brent Crude

Nymex crude has retraced to test short-term support at $85 per barrel. Respect is likely and would indicate an advance to our target at $90.
WTI Light Crude

Conclusion

Geopolitical risk dominates, with an Israeli retaliatory attack on Iran expected before the end of the month.

Rising crude oil prices are likely to increase inflationary pressure and the yield on long-term Treasuries, with the 10-year yield expected to test 5.0%.

Safe haven demand from investors is concentrated on Gold, with bond prices falling and stocks warning of a correction. We expect a short retracement to test support levels but respect is likely and would signal another advance.

Bitcoin is diverging from Gold as investors grow more risk averse. Breach of support at $62K would confirm a correction, with support expected at $52K.

Acknowledgements



Rising Crude and Gold warn of inflation

Brent crude continued its advance, closing at almost $89 per barrel on Tuesday. Our target is $94 per barrel would increase inflationary pressure in the months ahead and possibly delay Fed rate cuts.

Brent Crude

Rising crude oil prices have forced cancellation of plans to restock the strategic petroleum reserve (Bloomberg). US crude and petroleum inventory (including SPR) is testing the lows from January 2023.

Crude & Petroleum Inventory

Treasury Market

10-Year Treasury yields broke resistance at 4.35% but is retracing to test the new support level. Respect would confirm an advance to test resistance at 5.0%. Failure of support is less likely but would warn of another test of 4.05%.

10-Year Treasury Yield

Federal debt at 120% of GDP, deficits of 6% of GDP, and a growing interest rate burden limit the available options.

Federal Debt/GDP

The Fed can suppress long-term interest rates but the cost — in terms of inflation — is likely to be high.

Federal Debt Interest Burden

The US is well along the path to fiscal dominance as explained in this 2023 paper from the San Francisco Fed:

Fiscal dominance refers to the possibility that the accumulation of government debt and continuing government deficits can produce increases in inflation that “dominate” central bank intentions to keep inflation low….If global real interest rates returned tomorrow to their historical average of roughly 2 percent, given the existing level of US government debt and large continuing projected deficits, the US would likely experience an immediate fiscal dominance problem. Even if interest rates remain substantially below their historical average, if projected deficits occur as predicted, there is a significant possibility of a fiscal dominance problem within the next decade.

The essence of fiscal dominance is the need for the government to fund its deficits on the margin with non-interest-bearing debts. The use of non-interest-bearing debt as a means of funding is also known as “inflation taxation.” Fiscal dominance leads governments to rely on inflation taxation by “printing money” (increasing the supply of non-interest-bearing government debt).

The rise in Gold — currently at $2270 per ounce — reflects bond market fears of an inflation rebound.

Spot Gold

The same inflation fears are also driving demand for stocks.

S&P 500

US Economy

The US economy continues to display resilience, with job openings holding steady at 8.8 million in February, exceeding unemployment by a wide margin of 2.3 million.

Job Openings & Unemployment

Light vehicle sales remain robust at a seasonally-adjusted 15.8 million annual rate in February, reflecting consumer confidence.

Light Vehicle Sales

However, heavy truck sales (41.6K in February) are trending lower — with the 6-month moving average crossing below the 12- month MA — reflecting declining business confidence.

Heavy Truck Sales

Conclusion

The economy remains robust but fears of an inflation rebound are growing, fueled by rising crude oil prices and large fiscal deficits. The odds of Fed rate cuts in the second half of the year are shrinking but there are still two possible scenarios:

  1. A sharp decline in economic activity could still prompt the Fed to cut rates despite inflationary fears. That would be a strong bear signal for stocks.
  2. Fiscal dominance, with the deliberate use of inflation as a tax in order to restore the ratio of debt-to-GDP to more sustainable levels. This involves shrinking the public debt in real terms by expanding GDP through inflation. A strong bull signal for real assets such as Gold, Stocks and Commodities.

Acknowledgements

Strong liquidity and a weak Yuan boost stocks & Gold

The S&P 500 Equal-Weighted Index ($IQX) closed at a new record high above 6800. The advance signals that the current rally is finding broader support and is not as concentrated on the top 7 mega-cap technology stocks.

S&P 500 Equal Weighted Index ($IQX)

Retracement on the Russell 2000 Small Caps ETF (IWM) respected support at 200, signaling a fresh advance. Our target is the 2021 high at 240. The breakout again signals that investors are growing more comfortable with risk,

Russell 2000 Small Caps ETF (IWM)

Financial Markets

Bitcoin retraced slightly. Respect of support at $68K is likely, however, and would confirm an advance to test $72K.

Bitcoin

The Chicago Fed Financial Conditions Index eased to -0.556, indicating plenty of liquidity in financial markets.

Chicago Fed Financial Conditions Index
The Corporate Bond Market Distress Index reflects healthy credit markets, with Investment Grade (brown below) slightly above the 25th percentile and the High Yield Index (ocher) near record lows, below the 5th percentile on the right-hand scale.
Corporate Bond Market Distress Index

Gold & the Dollar

The Dollar Index continues to test resistance at 104.5. Follow-through above 105 would offer a target of 107.
Dollar Index

Gold is strengthening despite a relatively strong Dollar, with demand from China driving up prices. Breakout above $2200 would confirm our target of $2400 per ounce.

Spot Gold

Crude Oil

Crude is retracing, with Nymex Light Crude testing support at $80 per barrel. Respect is likely and would confirm our target of $90. High crude prices are caused by (a) the Red Sea threat to shipping, forcing tankers to take the longer route to Europe around the Cape of Africa; (b) Ukrainian drone attacks on Russian refineries; and (c) OPEC extension of production cuts through June.

Nymex WTI Light Crude

Russian Gasoline Production

Conclusion

Strong liquidity in financial markets maintains upward pressure on stocks, with advances widening to include the broad S&P 500 index and small cap stocks.

Gold continues to test resistance at $2200 per ounce, driven by demand from China in response to a weakening Yuan. Breakout is likely and would confirm our target of $2400 per ounce.

Crude is retracing to test support, but respect is likely and would confirm another advance. Rising crude prices would increase inflationary pressures in the months ahead, making it difficult for the Fed to cut rates. This would add upward pressure to long-term Treasury yields and erode demand for stocks.

Acknowledgements

What really drives inflation?

Every month, after the FOMC meeting, Fed Chairman Jay Powell fronts the media and tells everyone how the Fed is determined to maintain the fed funds rate in the same 5.25% – 5.50% range in order to contain inflation. But he is well aware that the Fed funds rate has had close to zero impact on inflation.

CPI peaked in June 2022 when the fed funds rate was an eye-watering (sic) 1.25%. CPI then plunged sharply when the Fed was still in the early stages of hiking rates. The lag between rate hikes and the resultant decline in inflation is normally 12 to 18 months. Now the Fed would have us believe that CPI declined in anticipation of rate cuts.

CPI & Fed Funds Rate Target (Minimum)

Financial conditions did tighten when the Fed introduced QT, with the Chicago Fed Financial Conditions Index (FCI) rising to -0.1%. But then FCI started a sharp decline in June 2023, when the Fed was still hiking rates, indicating monetary easing.

Chicago Fed Financial Conditions Index

Rising interest rates and tighter financial conditions had even less than usual impact on consumer spending because of a strong upsurge in personal savings during the pandemic. A large percentage of government transfers were not spent but went to increase bank deposits.

Government Transfers & Commercial Bank Deposits

Energy is driving inflation

The primary cause of the strong upsurge in CPI in ’21/22 was energy prices. The chart below shows how energy CPI (orange) led CPI (red) higher, reaching a peak of 41.5% in June 2022 — the same month that CPI peaked at 9.0%. Energy prices then plunged to a low of -16.7% in June 2023. CPI followed, reaching a low of 3.1% in the same month. Since then, CPI energy has recovered to close to zero, producing a floor in the annual CPI rate.

CPI & Energy CPI

Energy CPI is a relatively small component of CPI — 6.6% of total CPI — but it is a major cost component of most other variables. Food, for example, requires energy for planting, irrigation, harvesting, processing, refrigeration and transport. Cement requires energy for heating limestone in kilns, crushing and transportation. Steel needs energy for extraction and transport of iron ore, smelting and transportation. Even online services. The latest AI data centers require up to 1 GW of electricity capacity — enough to power 300,000 homes.

The most important determinant of energy prices is crude oil. Nymex light crude peaked between March and June 2022 at prices of $100 to $120 per barrel before commencing a prolonged decline to between $70 and $80 by December of the same year.

Nymex WTI Light Crude

Conclusion

Raising the fed funds rate has had little impact on actual inflation. Rate hikes are more about restoring the Fed’s credibility as an inflation hawk after a disastrous performance in 2021. High energy prices and easy monetary policy and were a recipe for inflation.

CPI & Fed Funds Rate Target (Minimum)

The sharp decline in CPI in the 12 months to June ’23 was caused by falling energy prices. Energy CPI fell from an annual increase of 41.5% in June 2022 to a low of -16.7% a year later.

Nymex light crude has now broken resistance at $80 per barrel. Expect retracement to test the new support level but respect is likely and would confirm another advance, with a target of $90 per barrel.

Nymex WTI Light Crude

A sharp rise in crude prices would be likely to cause a significant upsurge in CPI — and long-term interest rates. With bearish consequences for stocks and long-duration bonds.



Crude sets the cat amongst the pigeons

Brent crude broke resistance at $84, signaling a fresh advance. Expect retracement to test the new support level but respect is likely and would confirm our target of $94 per barrel.

Brent Crude

Nymex light crude similarly broke resistance at $80, offering a target of $90 per barrel.

Nymex WTI Light Crude

The threaten upsurge in inflation spooked bond investors, with the 10-year Treasury yield breaking resistance at 4.20%.

10-Year Treasury Yield

We expect a test of resistance at our target of 4.35%.

10-Year Treasury Yield


The Dollar Index jumped above resistance at 103 in response.

Dollar Index

Gold retreated to test support at $2150 per ounce. Narrow consolidation is a bullish sign and follow-through above $2200 would confirm our target of $2400 per ounce. Breach of $2150 is less likely but would indicate a test of $2075.

Spot Gold

The S&P 500 eased in response to higher long-term bond yields. Lower Trend Index peaks warn of a correction. Breach of support at 5100 would confirm.

S&P 500

The Russell 2000 small caps ETF (IWM) reacted with greater alarm, testing support at 200.  Lower Trend Index peaks again warn of a correction and breach of support at 200 would confirm, offering a short-term target of 190.

Russell 2000 Small Caps ETF (IWM)

Conclusion

An upward spike in crude oil threatens higher inflation which in turn would be likely to delay rate cuts by the Fed, causing long-term interest rates to rise.

We are short-term bullish on Crude and Gold; bearish on Stocks and long-duration Bonds.

 



Gold soars as UST yields fall

The S&P 500 has retraced to test short-term support at 5050, accompanied by a retreat in the Equal-Weighted Index and Russell 2000 Small Caps. The outlook remains bullish, however, with Trend Index troughs high above zero signaling extraordinary buying pressure.

S&P 500

Bond market anticipation of June rate cuts is growing. 10-Year Treasury yields broke support at 4.20%, signaling a decline to test support at 3.80%.

10-Year Treasury Yield

Gold is at a new high of $2129 per ounce. We expect retracement to test support at $2080 but respect would offer a ST target of $2180 per ounce.

Spot Gold

Gold versus TIPS

Economic Activity

ISM Services PMI recorded its 14th month of expansion in February, retreating to 52.6% from 53.4% in January. The decline suggests continued but slower growth.

ISM Services PMI

Crude & Commodities

Nymex WTI light crude continues to respect resistance at $80 per barrel. Breach of $78 would suggest a correction to the ascending trendline at $75.

Nymex Light Crude

Copper continues to test resistance at $8500 per metric ton, indicating some resilience in the Chinese economy — by far the biggest buyer of industrial metals.

Copper

In China, Caixin Services PMI eased to 52.5 in February, from 52.7 in January — maintaining the expansion since January last year.

Caixin Services PMI

Earlier, Caixin Manufacturing PMI edged up to 50.9, compared to 50.8 in January. But whipsawing around 50 indicates poor and erratic growth which is affecting metals prices.

Caixin Manufacturing PMI

Iron ore continues to test support at $114 per metric ton. Breach would warn of another test of $100. The Chinese government is likely to do enough to keep the economy from collapse but does not have the means to stimulate on a large scale.

Iron Ore

Conclusion

The 10-year treasury yield is expected to test support at 3.80%, offering further upside for Gold.

Our short-term target is $2180 per ounce and our long-term target is $2450.

Acknowledgements