Michael Every | Commodities and the US Dollar are key
This is a follow-on to — A New World Order — posted yesterday. The first 13 minutes are worth listening to.
Michael Every, Global Strategist at Rabobank, says commodities and the US Dollar are key investments in the coming decade.
No soft landing
10-Year Treasury yields have climbed in response to the December FOMC minutes which suggest a faster taper of QE purchases and faster rate hikes. Breakout above 1.75% would offer a medium-term target of 2.3% (projecting the trough of 1.2% above resistance at 1.75%).
The Dollar Index retreated below short-term support at 96, warning of a correction despite rising LT yields.
Do the latest FOMC minutes mean that the Fed is serious about fighting inflation? The short answer: NO. If they were serious, they would not taper but halt Treasury and MBS purchases. Instead of discussing rate hikes later in the year, they would hike rates now. The Fed are trying to slow the economy by talking rather than doing — and will be largely ignored until they slam on the brakes.
Average hourly earnings growth — 5.8% for the 2021 calendar year — is likely to remain high.
A widening labor shortage — with job openings exceeding total unemployment by more than 4 million — is likely to drive wages even higher, eating into profit margins.
The S&P 500 continues to climb without any significant corrections over the past 18 months.
Rising earnings have lowered the expected December 2020 PE ratio (of highest trailing earnings) for the S&P 500 to a still-high 24.56.
But wide profit margins from supply chain shortages are unsustainable in the long-term and are likely to reverse, creating a headwind for stocks.
Warren Buffett’s long-term indicator of market value avoids fluctuating profit margins by comparing market cap to GDP as a surrogate for LT earnings. The ratio is at an extreme 2.7 (Q3 2020), having doubled since the Fed stated to expand its balance sheet (QE) after the 2008 global financial crisis.
Stock prices only adjust to fundamental values in the long-term. In the short-term, prices are driven by ebbs and flows of liquidity.
We are still witnessing a spectacular rise in the M2 money stock in relation to GDP, caused by Fed QE. The rise is only likely to halt when the taper ends in March 2022 — but there is no date yet set for quantitative tightening (QT) which would reverse the flow.
Gold continues to range between $1725 and $1830 per ounce with no sign of a breakout.
Conclusion
Expect a turbulent year ahead, driven by the pandemic, geopolitics, and Fed monetary policy. Rising inflation continues to be a major threat and we maintain our overweight positions in Gold and defensive stocks. A soft landing is unlikely — the Fed could easily lose control — and we are underweight highly-priced growth stocks and cyclicals, while avoiding bonds completely.
End game for the Dollar
The end game for the Dollar: China vs the US, with Grant Williams and Luke Gromen:
Gold breaks $1850 per ounce
10-Year Treasury yields remain soft despite the recent CPI spike. The Fed is weighting purchases more to the long end of the yield curve. Breakout above 1.75% (green line) would signal a fresh advance.
10-Year TIPS yield sits at -0.78%, unaffected by the $369bn in overnight Fed reverse repurchase agreements which remove liquidity but mainly affect short-term interest rates.
Gold broke through resistance at $1850/ounce. A rising Trend Index indicates medium-term buying pressure. Long tails on the last three daily candles indicate retracement to test the new support level; respect signals a test of $1950/ounce.
Silver is testing resistance at $28/ounce. Rising Trend Index indicates medium-term buying pressure. Breakout above $28 is likely and would offer a target of $30/ounce in the short/medium-term.
The Dollar index is testing primary support between 89 and 90. Rising Trend Index (below zero) suggests another test of the descending trendline. Respect is likely and breach of primary support would offer a medium/long-term target of 851.
From Luke Gromen at FFTT:
When you are an externally-financed twin deficit nation with insufficient external funding (as Druckenmiller pointed out), there are three potential release valves:
- Higher unemployment.
- Higher interest rates.
- Lower currency (inflation.)
With US debt/GDP at 130%, Options #1 and #2 aren’t an option……
Conclusion
We expect long-term Treasury yields to remain low while inflation rises, causing the US Dollar to sink and Gold and Silver to advance.
Our long-term target for Gold of $3,000 per troy ounce2.
Notes
- Dollar Index (DXY) target of 85 is calculated as the peak of 93 extended below support at 89.
- Gold LT target calculation: base price of $1840/ounce + [TIPS yield of -0.87% – (nominal Treasury yield of 1.64% – real inflation rate of 5.30%)] * $400/ounce = $2956/ounce
Westpac: US Dollar capped by dovish Fed (video)
Good short video from Elliot Clarke & Richard Franulovich at Westpac IQ about Aussie/US Dollar prospects and the outlook for the US economy.
Rising yields are lifting the Dollar but the Fed’s dovish stance is expected to cap the Dollar going forward, with the Aussie likely to strengthen above 80 US cents.
The Biden stimulus is likely to help the US economic recovery this year but will wear off by year-end. There are many obstacles to passing a major infrastructure bill but that would be the best way to lift growth prospects over 2022/3 and beyond and help the US keep pace with growth in Asia, where there are more development opportunities.
S&P 500 fueled by the Fed
The S&P 500 continues, unwavering, in a strong up-trend.
But compare the growth in the S&P 500 index relative to growth in the money supply (M2). In relative terms, the S&P 500 appreciated only 29%, or 2.6% p.a., over the past decade. Most of the stellar performance over the past 10 years can be attributed to the Fed’s expansionary monetary policy.
Dollar Index
The Dollar Index continues to test support at 90. A Trend Index peak below zero warns of strong selling pressure. Breach of support is likely and would signal another primary decline.
The Chinese Yuan, however, has halted in its appreciation against the Dollar. Trend Index peak below the 7-week MA warns of secondary selling pressure. Breach of support at 15.4 US cents would warn of a correction.
Conclusion
The S&P 500 is likely to continue rising for as long as the Fed expands the money supply. The Dollar, however, is expected to weaken for the same reason.
Gold and the Coronavirus
China’s Yuan plunged on scares of a coronavirus epidemic spreading from its Wuhan epicenter.
The flight to safety took 10-Year US Treasury yields with it. Breach of support at 1.75% warns of another test of primary support at 1.50%.
Flight to safety is also likely to directly strengthen demand for Gold, while lower long-term yields provide a secondary boost by lowering the opportunity cost of holding precious metals. Respect of support at $1540-$1560 would signal another advance.
Silver is weaker but continues to test resistance at $18 to $18.50. Breakout would confirm a bull market for precious metals.
A stronger Dollar, also benefiting from the flight to safety, should only partially offset the rising demand for Gold and Silver.
Australia
Australia’s All Ordinaries Gold Index continues to test resistance at 7200. Breakout above 7200 would strengthen the bull signal from 13-week Trend Index and Momentum recovering above zero.
Patience
Prospects of retracement to re-test support at 6000 are diminishing. Accumulate on breakout above 7200.
Model Portfolios
Our pick of Australian gold stocks is available to subscribers to the Australian Growth model portfolio. I am not sure how many readers are aware that Market Analysis updates are included as part of any model portfolio subscription.
Gold testing resistance despite Dollar rise
Signing of the US-China phase one trade deal did little to quell demand for Gold, with the precious metal continuing to test resistance at $1560/ounce. But a strengthening Dollar makes another test of primary support at $1450 likely.
Silver is similarly testing resistance at $18 to $18.50, but declining Trend Index peaks below zero warn of stronger selling pressure. Expect another test of support at $16.50.
The Dollar Index rallied off support at 96.50. Breakout above 98 would offer a medium-term target of 99.50.
China’s Yuan, on the other hand, is strengthening against the Greenback, with rising Trend Index troughs indicating buying pressure. Expect retracement to test support at 14.35 US cents, but the outlook for the Yuan against the Dollar is bullish and respect of support would offer a target of 15 US cents.
10-Year Treasury yields are ranging between support at 1.70% and resistance at 2.00%. A rising Yuan is bullish for yields and may cause another test of resistance at 2.0%. Breakout would offer a target of 2.50%. But increased use of mortgage-backed securities (MBS) as collateral in Fed repo operations may help to suppress long-term yields.
In summary:
- A rising US Dollar is bearish for Gold.
- Rising treasury yields increase the opportunity cost of holding precious metals and are bearish for Gold.
- Geo-political instability (e.g. ongoing US-China/US-Iran tensions) is bullish for Gold.
- Low oil prices and low inflation are bullish for the Dollar and bearish for Gold.
Australia
Australia’s All Ordinaries Gold Index is testing resistance at 7200 after a brief retracement to 6800. Breakout from the trend channel is bullish for Gold stocks. Follow-through above 7200 would strengthen the signal.
Patience
Gold is in a long-term up-trend and the current correction may offer an attractive entry point. We have a breakout from the downward trend channel but could still experience a re-test of support at 6000. Proceed with caution.
Gold bearish on imminent phase 1 deal
The U.S. and China are finalizing a bevy of long-running corporate deals ahead of a high-profile ceremony to sign a trade deal next week that the world’s largest economies seek to cast as a major breakthrough and a marked warming in the relationship. Along with a Chinese delegation led by top negotiator Vice Premier Liu He, executives from American and Chinese companies will also attend the White House event to sign the phase-one agreement on Jan. 15, said the people, who asked not be named discussing private plans. (Bloomberg)
Gold retreated on news that signing of the US-China phase 1 deal is imminent. A tall shadow on the weekly chart warns of selling pressure. Another test of primary support at $1450 is likely.
Silver also retreated, while declining Trend Index peaks below zero warn of strong selling pressure. Expect another test of support at $16.50.
China’s Yuan broke resistance at 14.35 US cents, while rising Trend Index troughs indicate buying pressure. Expect retracement to test support, but the outlook for the Yuan against the Dollar is turning bullish.
10-Year Treasury yields found support at 1.70% and a rising Yuan is likely to cause another test of resistance at 2.0%. Breakout would offer a target of 2.50%.
Rising treasury yields increase the opportunity cost of holding precious metals and are bearish for Gold.
Australia
Australia’s All Ordinaries Gold Index penetrated the upper border of its downward trend channel but this week’s tall shadow warns of selling pressure and another test of support at 6000.
Respect of support at 6000, with follow-through above 7000, would signal that a base has formed.
Patience
Gold is in a long-term up-trend and the current correction may offer an attractive entry point. But we first need a clear breakout from the downward trend channel to confirm that the up-trend is intact.