Category: Crude Oil & Natural Gas

Posted on

Gold & Oil – a new paradigm

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

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

Financial Markets

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

Chicago Fed Financial Conditions Index

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

Bitcoin

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

10-Year Treasury Yield

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

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

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

S&P 500

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

Top 7 Technology Stocks

The Dollar

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

Dollar Index - Weekly

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

USDCNY

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

Crude Oil

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

Brent Crude

Gold

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

Spot Gold

A New Paradigm

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

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

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

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

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

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

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

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

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

Gold Futures - Dump

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

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

BRICS+

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

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

Central bank (CB) gold purchases are growing.

Central Bank Gold Purchases

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

Central Bank Gold Purchases including estimates of Undisclosed Purchases

PBOC purchases account for a large percentage of unofficial buying.

PBOC Gold Purchases & Holdings

Crude Oil Payments

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

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

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

Physical Gold Flows

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

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

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

Shanghai Gold Exchange: Yuan/Gram of Gold

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

Conclusion

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

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

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

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

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

Acknowledgements

Posted on

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.



Posted on

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.

 



Posted on

Strong US jobs data but signs that growth is slowing

The S&P 500 retreated Friday, the bearish engulfing candle and a lower peak on the Trend Index warn of a test of support at 5050. The longer-term outlook remains bullish, with rising Trend Index troughs above zero signaling unusual buying pressure.

S&P 500

S&P 500 (purple below) outperformed the broader Equal-Weighted S&P 500 (lime green) in February, a bullish sign. Periods when $IQX outperforms the general index ($INX) can highlight when the top stocks are no longer participating in the advance — a strong bear signal.

S&P 500 & S&P 500 Equal-Weighted Index

Labor Market

The economy added 275,000 jobs in February, a strong result.

Employment

Of the cyclical sectors that normally lead the economic cycle, manufacturing showed a small loss of 4K jobs but construction and transport & warehousing showed gains of 23K and 20K respectively.

Employment: Cyclical Sectors

The unemployment rate increased to 3.9% as more people entered the workforce. The 3-month moving average of the unemployment rate has increased 27 basis points (red below) from its preceding low. According to the Sahm Rule — developed by former Fed economist Claudia Sahm — a 50 basis point increase signals the start of a recession, while 35 points provides an early warning.

Unemployment Rate & 3-Month Moving Average

Average weekly hours worked ticked up to 34.3 hours but the downward trend warns that the economy is slowing.

Average Weekly Hours Worked

Another good indicator is the quit rate which soars when the labor market is tight and jobs are readily available. The down-trend since 2022 indicates that the heat is coming out of the job market.

Quit Rate

The decline in average hourly earnings annual growth is slowing.

Average Hourly Earnings

But the February monthly rate fell sharply, after a strong January. The 3-month moving average growth rate of 1.0% — 4.0% annualized — suggests further easing ahead despite a robust economy.

Average Hourly Earnings - Monthly Change

Aggregate weekly hours worked (purple below) are growing at an annual rate of 1.2%. We are unlikely to see productivity benefits from AI this year and real GDP growth (blue) is expected to converge with the slower labor growth rate.

Real GDP Growth & Aggregate Weekly Hours Worked

Financial Markets

10-Year Treasury yields found short-term support above 4.0%. Retracement to test the new resistance level at 4.20% is now likely. Respect of resistance would confirm the target of 3.80%.

10-Year Treasury Yield

The Chicago Fed Financial Conditions Index ticked up to -0.47 but continues below zero, signaling easy monetary policy.

Chicago Fed Financial Conditions Index

Commercial bank cash assets — primarily reserves at the Fed — are leveling off at $3.6 trillion.

Commercial Bank Cash Assets (Primarily Reserves at the Fed)

Strong growth in bank reserves over the last 6 months is unlikely to be repeated, with a decline expected after the Fed’s reverse repo (RRP) balance is drained. Money market funds are switching to T-Bills. After the RRP is depleted, further Treasury issuance is likely to be taken up by private investors — either through direct purchases or by switching from bank deposits to money market funds.

Reverse Repo (RRP)

Bank time deposits are still growing but the rate of growth, especially in retail deposits (blue below), has fallen dramatically over the past 12 months. Negative growth would be a strong recession warning.

Commercial Bank Time Deposits

Gold & the Dollar

The Dollar Index broke support at 103, warning of a decline to 100. Retracement that respects the new resistance level at 103 would confirm the target.

Dollar Index

Gold continues to climb, reaching close to $2200 per ounce on during the day. A weaker close signals some profit taking but is so far insufficient to set off retracement. Follow-through above $2200 would lead us to revise our short-term target to $2250 — calculated as $2050 + ($2050 – 1850).

Spot Gold

Our long-term target of $2450 is calculated as $2050 + ($2050 – $1650).

Spot Gold

Crude & Commodities

Brent crude continues in a narrow range between $82 and $84 per barrel. Downward breakout would offer short-term relief but supply issues threaten a rally to test resistance at $90 per barrel — warning of higher inflation in the months ahead.

Faster-than-expected land inventory drawdowns due to seaborne trade disruptions from the Red Sea crisis have prompted Goldman Sachs to revise up its forecast for summer peak Brent Crude prices to $87 per barrel, up by $2 from earlier expectations.

“OECD commercial stocks on land have drawn somewhat faster than expected as the redirection of flows away from the Red Sea has increased inventories on water,” analysts at the investment bank wrote in a Sunday note, as carried by Reuters. ~ Oilprice.com

Brent Crude

Copper broke through resistance at $8500 per metric ton, signaling an advance to $9000, but expect retracement to test the new support level first.

Copper

China’s real estate/financial woes are weighing more heavily on iron ore which continues to test support at $114 per metric ton.

Iron Ore

Uranium has fallen about 20% from its peak earlier in the year, with the Sprott Physical Uranium Trust (SRUUF) testing support at 20. Respect of support would suggest another advance with a target of 30.

Sprott Physical Uranium Fund

Please note: This is not a recommendation to buy SRUUF. It is simply being used as an indicator of physical uranium prices.

Growth in electricity demand is likely to have more than doubled in 2023 as data centers, crypto-mining and re-shored manufacturing facilities joined the grid.

Washington Post: US Electricity Demand

Conclusion

Demand for stocks and Gold is booming. Investors seek real assets ahead of anticipated June rate cuts by the Fed and a likely resurgence in inflation.

The labor market remains tight but there are signs that upward pressure on average hourly earnings is easing as growth in aggregate weekly hours worked slows.

Declining reverse repo (RRP) balances at the Fed warn that bank reserves are likely to decline in the not-too-distant future. Liquidity is expected to tighten unless the Fed slows QT after the RRP is drained. The current $95 billion per month reduction in the Fed holdings of securities cannot be sustained without hurting liquidity in financial markets. A liquidity contraction is unlikely before the November elections but would cause a sharp fall in stock prices.

An alternative for the Fed would be to encourage commercial banks to buy Treasuries by excluding USTs from bank SLR leverage calculations. But that seems less likely than tapering QT, especially after the Silicon Valley Bank disaster where SVB took huge losses on their holdings of long-duration Treasuries and mortgage-backed securities.

We are overweight Gold, Critical Materials and Defensive stocks. We feel that Technology stocks and Industrial Real Estate are over-priced and will wait for better opportunities in 2025.

Acknowledgements

 

Posted on

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

Posted on

Gold and stocks jump as Treasury yields plunge

The Fed is talking down the strong January PCE inflation result:

Feb 29 (Reuters) – “I expect things are going to be bumpy,” Atlanta Federal Reserve Bank President Raphael Bostic said during an interview at a banking conference in Atlanta, Georgia, after a Commerce Department report showed the core personal consumption expenditures price index rose more than 5% on an annualized basis….Bostic said his eye remains on the longer-term trends and repeated his view that he sees the U.S. central bank beginning to cut rates “in the summer time,” if the economy evolves as he expects.

Cleveland Fed President Loretta Mester, speaking with Yahoo! Finance later in the day, said three rate cuts is still her baseline view…..Mester said she expects employment and wage growth to cool in coming months, easing price pressures and giving her more assurance that inflation is headed sustainably back to the Fed’s goal.

Chicago Federal Reserve Bank President Austan Goolsbee also shrugged off January’s inflation data as indicative of a setback, and said he believes the disinflationary effect of last year’s supply chain improvements and immigration-fueled rise in labor supply have a “decent chance” of continuing into this year. And that, he said, means there is still scope for the U.S. economy this year to continue on what he has dubbed the “golden path” of falling inflation alongside a robust labor market and economic growth, a historically unusual pattern.

March 1 (Bloomberg) – The S&P 500 topped 5,100 — hitting its 15th record this year. Traders looked past weak economic data amid bets policymakers will be able to cut rates as soon as June. US two-year yields sank as Fed Governor Christopher Waller noted he’d like a shift in the central bank’s holdings toward a larger share of short-term Treasuries…

The 2-year yield is testing support at 4.5%.
10-Year Treasury Yield

10-Year Treasury yields broke support at 4.20%, closing at 4.18% on Friday.

10-Year Treasury Yield

The S&P 500 broke resistance at 5100 — our target from December 2023 — to make a new high at 5137. Trend Index troughs above zero flag strong buying pressure.

S&P 500

Russell 2000 Small Caps ETF (IWM) closed above resistance at 205 but we expect retracement to test the new support level.

Russell 2000 Small Caps ETF (IWM)

Gold

Spot Gold shot up to $2083 per ounce. We expect retracement to test support at $2060 but respect would be a strong bull signal, confirming a target of $2100.

Spot Gold

Financial Markets

Commercial bank cash assets, consisting mainly of reserve deposits at the Fed, continue their up-trend with an increase to $3.6 trillion.

Commercial Bank Cash Assets

Reverse repo (RRP) balances at the Fed declined to $570 billion as money market funds switched into higher-yielding T-Bills. The outflow cannot continue at the same rate for long and the Fed is likely to reduce the level of QT — from the current $95 billion per month — in order to offset this.

Fed Reverse Repo (RRP)

Moody’s Baa corporate bond spread fell to 1.55% — the lowest level in more than twenty years — indicating abundant liquidity in credit markets.

Moody's Baa Corporate Bond Spread

Europe

DJ Stoxx Euro 600 — the top 600 stocks in Europe — is making new highs as well.

DJ Stoxx Euro 600

Australia

In Australia, the ASX 200 broke resistance at its previous high of 7700, offering a target of 8000.

ASX 200

Crude Oil & Commodities

Nymex light crude is testing resistance at $80 per barrel. Breakout would confirm a fresh advance, with a target of $90.

Nymex Light Crude

Brent crude is also testing resistance at $83 per barrel. Narrow consolidation is a bullish sign (in an up-trend) and breakout would offer a target of $93.

Brent Crude

Copper continues to test resistance at $8500 per metric ton despite weak manufacturing activity in China.

Copper

China Beige Book

Conclusion

The bond market is getting excited about rate cuts around mid-year after plenty of dovish guidance from Fed officials. Ten-year Treasury yields broke support at 4.2%, warning of a decline to test primary support at 3.8%, but retracement is likely to test the new resistance level.

Strong growth in average hourly earnings, CPI and PCE inflation in January, warn that early rate cuts would be premature. Investors are piling into real assets as a hedge against an expected resurgence of inflation.

Stock indices broke to new highs, including the S&P 500, DJ Stoxx Euro 600, and the ASX 200 in Australia.

Gold jumped to $2083 per ounce. Retracement that respects support at $2060 would confirm an advance to $2100 per ounce.

Crude oil threatens a breakout that would likely see a $10 rise in the price per barrel, increasing expectations of a sharp rebound in inflation.

The Fed is under pressure to support the Treasury market, lowering long-term yields to reduce rising debt servicing costs for the US Treasury. Latest CBO projections show how interest servicing costs (pink) are likely to expand deficits in the years ahead.

CBO: Budget Deficit (% of GDP)Treasury debt held by the public is projected to rise to a precarious 160% of GDP by 2050.

CBO: Debt/GDP

As we mentioned in a recent post, the only way to solve this is through high inflation — which would expand GDP relative to nominal debt — and negative real interest rates.

Our long-term outlook is overweight real assets — stocks, Gold, critical materials, and industrial real estate — and underweight long-duration financial assets like USTs.

Acknowledgements

Posted on

S&P 500 rallies while consumer sentiment falls

The University of Michigan Index of Consumer Sentiment declined to 61.3 for November. Levels below 70 in the past have signaled a recession.

University of Michigan Consumer Sentiment

Consumer sentiment is in sharp contrast to robust personal consumption expenditures which at 93% of disposable personal income are well above pre-pandemic levels.

Personal Consumption Expenditure/Disposable Personal Income

Mortgage rates above 7.0% failed to dampen discretionary spending, with most households having locked in low fixed mortgage rates over the pandemic.

30-Year Mortgage Rate

Home Sales

Existing home sales declined to an annual rate of 3.8 million, with households are reluctant to give up their cheap fixed-rate mortgages.

Existing Home Sales

New home sales surged as a result, boosting residential construction.

New One-Unit Home Sales

Inflation Expectations

The University of Michigan November survey shows 1-year inflation expectations increased to 4.50%.

University of Michigan Inflation Expectations 1-Year

Five-year expectations increased to 3.2%, with the 3-month moving average of 3.0% well above the Fed’s 2.0% target.

University of Michigan Inflation Expectations 5-Year

Rising inflation expectations mean that the Fed is unlikely to cut interest rates in the foreseeable future.

Interest Rates

10-Year Treasury yields continue to test support at 4.40% after Treasury weighted new issuance towards the front-end of the yield curve — largely funded by money market funds currently invested in repo. Breach of support would offer a target of 4.0% — bearish for the Dollar.

10-Year Treasury Yield

Stocks

The S&P 500 is testing its July high of 4600. Breakout is uncertain but would not signal a bull market unless confirmed by other indices.

S&P 500

The S&P 500 Equal-Weighted Index ($IQX) has recovered less than 60% of its last decline.

S&P 500 Equal-Weighted Index

The Russell 2000 Small Caps ETF (IWM) is even weaker, retracing less than 50% of its last decline, suggesting that investors have little appetite for risk.

Russell 2000 Small Caps Index iShares ETF (IWM)

Dow Jones Transportation Average has also retraced less than 50%. The Trend Index below zero continues to warn of selling pressure.

Dow Jones Transportation Average ($DJT)

Gold and the Dollar

The Dollar Index retraced to test resistance at 104. Respect is likely and breakout below 103 would offer a target of 100.

Dollar Index

The weakening Dollar is bullish for Gold which is testing resistance at $2000 per ounce. Breakout would offer a short-term target of the previous high at $2050.

Spot Gold

Commodities

Dow Jones Industrial Metals Index ($BIM) fell sharply, warning of another test of primary support at 153. Breach would warn of a global recession, especially if mirrored by a similar breach in Copper.

Dow Jones Industrial Metals Index ($BIM)

Copper is testing its descending trendline at 8300. Reversal below primary support at 7800 would warn of a global recession. China consumes about 50% of the world’s copper production, most of it used in construction. So a lot depends on China’s efforts to rescue their ailing property sector.

Copper

The downward spiral of China’s ailing property sector shows no sign of abating despite the government’s rollout of a seemingly endless series of supportive but as yet ineffective measures, with the crisis stretching for over three years…..

The market for Chinese developers’ dollar-denominated bonds has seen a meltdown over the past two years, losing 87% of its value. The rout has wiped out $135.5 billion of value from $154.9 billion of outstanding notes, according to analysis by Debtwire. (Caixin)

Brent crude is testing resistance at $83 per barrel. Respect would warn of another downward leg to $72 and strengthen a bear market warning from Copper and base metals.

Brent Crude

Conclusion

Personal consumption expenditures remain strong despite falling consumer sentiment. The S&P 500 is testing resistance at 4600 but the advance is narrow, with investors avoiding risk in the broader market.

The Dollar weakened on the back of falling long-term Treasury yields, boosting demand for Gold which is testing resistance at $2000 per ounce. Breakout would offer a short-term target of $2050.

Copper and base metals are expected to again test primary support as doubts remain over China’s ailing property sector. Breach of support would warn of a global recession.

Inflation expectations remain persistent, with five-year expectations at 3.0% in the November University of Michigan consumer survey, well above the Fed’s target of 2.0%. The likelihood of rate cuts in early 2024 is remote unless a major collapse in financial markets forces the Fed’s hand.

Acknowledgements

Macrobusiness: China’s property black hole sucks in the CCP.

Posted on

The Big Picture: War, Energy, Bonds and Gold

Two inter-connected themes likely to dominate the next few decades are War and Energy.

War may take the form of a geopolitical struggle between opposing ideologies, with conventional wars limited to proxies in most cases and nuclear exchanges avoided because the costs are prohibitive. But it is likely to involve fierce competition for energy and resources in an attempt to undermine opposing economies. The impact is likely to be felt throughout the global economy and across all asset classes, including bonds, stocks and precious metals.

War

War can take many forms: conventional war, nuclear war, proxy war, cold war,  economic war, or some combination of the above.

Nuclear war can hopefully be avoided, with sane leaders skirting mutually assured destruction (MAD). For that reason, even conventional war between great powers is unlikely — but there is a risk of it being triggered by escalation in a war between proxies.

Cold war, with limited trade between opposing powers — as in the days of Churchill’s Iron Curtain — is also unlikely. Global economic interdependence is far higher than sixty years ago.

Greg Hayes, chief executive of Raytheon, said the company had “several thousand suppliers in China and decoupling . . . is impossible”. “We can de-risk but not decouple,” Hayes told the Financial Times in an interview, adding that he believed this to be the case “for everybody”.

“Think about the $500bn of trade that goes from China to the US every year. More than 95 per cent of rare earth materials or metals come from, or are processed in, China. There is no alternative,” said Hayes. “If we had to pull out of China, it would take us many, many years to re-establish that capability either domestically or in other friendly countries.”

What is likely is a struggle for geopolitical advantage between opposing alliances, with economic war, proxy wars, and attempts to build spheres of influence. This includes enticing (or coercing) non-aligned nations such as India to join one of the sides.

Such a geopolitical arm-wrestle is likely to have ramifications in many different spheres, but most of all energy.

Energy

You can’t fight a war without energy. A key element of the geopolitical tussle will be to secure adequate supplies of energy — and to deprive the opposing side of the same.

The situation is further complicated by the attempted transition from fossil fuels to low-carbon energy sources.

Since the Industrial revolution, development of the global economy has been fueled by energy from fossil fuels, with GDP and fossil fuel consumption growing exponentially. Gradual transition to alternative energy sources would be a big ask. To attempt a rapid transition while in the midst of geopolitical conflict could end in disaster.

Global Energy Sources

The challenge is further complicated by attempts to replace fossil fuels with wind and solar which generate intermittent power. Base-load power — generated from fossil fuels or nuclear — is essential for many industries. Microsoft are investigating the use of nuclear to power data centers. The US Department of Defense (DoD) has commissioned Oklo Inc. to design and build a nuclear micro-reactor to power Eielson Air Force Base in Alaska. Renewables are a poor option for critical applications.

Russia’s 2022 invasion of Ukraine highlighted Germany’s energy vulnerability despite billions of Euros invested in renewables over recent decades. You cannot run a modern industrialized economy without reliable energy sources.

Low investment in fossil fuel resources — which fail to meet ESG standards — has further increased global vulnerability to energy shortages during the transition.

Inflation

War and pandemics cause high inflation. Governments run large deficits during times of crisis, funded by central bank purchases in the absence of other investors. This causes rapid expansion of the money supply, leading to high inflation.

Geopolitical conflict and the attempt to rapidly transition to carbon-free fuels — while neglecting existing resources — are both likely to cause a steep rise in energy costs.

Energy Prices

Bond Market

The bond market has the final say. The recent steep rise in long-term Treasury yields is the bond market’s assessment of fiscal management in the US. The deeply divided House of Representatives has effectively been awarded an “F” on its economic report card.

10-Year Treasury Yield

Failure of a divided government to address fiscal debt at precarious levels and rein in ballooning deficits raises a question mark over future stability, with the bond market demanding a premium on long-term issues.

The rating downgrade of the United States reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to ‘AA’ and ‘AAA’ rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions. (Fitch Ratings)

CBO projections show federal debt held by the public rising from 98% of GDP today to 181% in thirty years time.

CBO Debt Projections

Rising long-term yields also add to deficits as servicing costs on existing debt increase over time. The actual curve is likely to be even steeper. CBO projections assume an average interest rate of 2.5%, while current rates are close to 5.0%.

Yield Curve

Continuing large fiscal deficits in the next few decades appear unavoidable. The result is likely to be massive central bank purchases of fiscal debt — as in previous wars/pandemics — with negative real interest rates (red circles below) driving higher inflation (blue) and rising inequality.

Moody's Aaa Corporate Bond Yield & CPI

Political instability

Interest rate suppression effectively subsidizes borrowers at the expense of savers. Only the wealthy are able to leverage their large balance sheets, buying real assets while borrowing at negative real interest rates. Those less fortunate have limited access to credit and suffer the worst consequences of inflation, further accentuating the division in society and fostering political instability as populism soars.

Commodities

Resources are likely to be in short supply, from under-investment during the pandemic, geopolitical competition, and the attempted rapid transition to new energy sources. Prices are still likely to fall if global demand shrinks during a recession. But growing demand, shrinking supply (from past under-investment) and inflation pushing up production costs are expected to lead to a long-term secular up-trend.

Copper

Gold

High inflation, negative real interest rates and geopolitical competition are likely to weaken the Dollar, strengthening demand for Gold as a safe haven and inflation hedge. Breakout above $2000 per ounce would offer a long-term target of $3000.

Spot Gold

Conclusion

We expect large government deficits and shortages of energy and critical materials — such as Lithium and Copper — the result of a geopolitical struggle and attempt to transition to low-carbon energy sources over several decades.

Rising government debt will necessitate central bank purchases as the bond market drives up yields in the absence of foreign buyers. The likely result will be high inflation and interest rate suppression as central banks and government attempt to manage soaring debt levels and servicing costs.

Our strategy is to be overweight commodities, especially critical materials required for the transition to low-carbon fuel sources; short-term bonds and term deposits; and defensive (value) stocks.

We are also overweight energy, including: heavy electrical; nuclear technology; uranium; and oil & gas resources.

Gold is more complicated. Rising long-term interest rates will weaken demand for Gold, while geopolitical turmoil will strengthen demand, causing a see-sawing market with high volatility. If long-term yields fall — due to central bank purchases of US Treasuries — expect high inflation. That would be a signal to load up on Gold.

We are underweight growth stocks and real estate. Rising long-term interest rates are expected to lower earnings multiples, causing falling prices. Collapsing long-term yields due to central bank purchases of USTs, however, would cause negative real interest rates. A signal to overweight real assets such as growth stocks and real estate.

Long-term bonds are plunging in value as long-term yields rise, with iShares 20+ Year Treasury ETF (TLT) having lost almost 50% since early 2020.

iShares 20+ Year Treasury ETF

The trend is expected to reverse when Treasury yields peak but timing the reversal is going to be difficult.

Acknowledgements

Posted on

Copper breaks support while crude gets hammered

Copper broke support at $7900/tonne, signaling a primary decline with a target of its 2022 low at $7000. The primary down-trend warns of a global economic contraction.

Copper

The bear signal has yet to be confirmed by the broader-based Dow Jones Industrial Metals Index ($BIM) which is testing primary support at 155.

DJ Industrial Metals Index ($BIM)

Crude oil

Crude fell sharply this week, after a 3-month rally.

Nymex Light Crude

The fall was spurred by an early build of gasoline stocks ahead of winter, raising concerns of declining demand.

Gasoline inventories added a substantial 6.5 million barrels for the week to September 29, compared with a build of 1 million barrels for the previous week. Gasoline inventories are now 1% above the five-year average for this time of year….. production averaged 8.8 million barrels daily last week, which compared with 9.1 million barrels daily for the prior week. (oilprice.com)

Gasoline Stocks

Crude inventories have stabilized after a sharp decline during the release of strategic petroleum reserves (SPR).

EIA Crude Inventory

Releases from the SPR stopped in July — which coincides with the start of the recent crude rally. It will be interesting to see next week if a dip in this week’s SPR contributed to weak crude prices.

Strategic Petroleum Reserves (SPR)

Stocks & Bonds

The 10-year Treasury yield recovered to 4.78% on Friday.

10-Year Treasury Yield

Rising yields are driven by:

  • a large fiscal deficit of close to $2T;
  • commercial banks reducing Treasury holdings; and
  • the Bank of Japan allowing a limited rise in bond yields which could cause an outflow from USTs.

Bank of Japan - YCC

The S&P 500 rallied on the back of a strong labor report.

S&P 500

The S&P 500 Equal-Weighted Index test of primary support at 5600 is, however, likely to continue.

S&P 500 Equal-Weighted Index

Expect another Russell 2000 small caps ETF (IWM) test of primary support at 170 as well.

Russell 2000 Small Caps ETF (IWM)

Labor Market

The BLS report for September, with job gains of 336K, reflects a robust economy and strong labor market.

Job Gains

Average hourly earnings growth slowed to 0.207% in September, or 2.5% annualized. Manufacturing wages reflect higher growth — 4.0% annualized — but that is a small slice of the economy compared to services.

Average Hourly Earnings

Average weekly hours worked — a leading indicator — remains stable at 34.4 hours/week.

Average Weekly Hours

Unemployment remained steady at 6.36 million, while job openings jumped in August, maintaining a sizable shortage.

Job Openings & Unemployment

Real GDP (blue) is expected to slow in Q3 to 1.5%, matching declining growth in aggregate weekly hours worked (purple).

Real GDP & Hours Worked

Dollar & Gold

The Dollar Index retraced to test new support at 106 but is unlikely to reverse course while Treasury yields are rising.

Dollar Index

Gold is testing primary support at $1800 per ounce, while Trend Index troughs below zero warn of selling pressure. Rising long-term Treasury yields and a strong Dollar are likely to weaken demand for Gold.

Spot Gold

Conclusion

Long-term Treasury yields are expected to rise, fueled by strong supply (fiscal deficits) and weak demand (from foreign investors and commercial banks). The outlook for rate cuts from the Fed is also fading as labor market remains tight.

The sharp drop in crude oil seems an overreaction when the labor market is strong and demand is likely to be robust. Further releases from the strategic petroleum reserve (SPR), a sharp fall in Chinese purchases, or an increase in supply (from Iran or Venezuela) seem unlikely at present.

Falling copper prices warn of a global economic contraction led by China, with Europe likely to follow. Confirmation by Dow Jones Industrial Metals Index ($BIM) breach of primary support at 155 would strengthen the bear signal.

Strong Treasury yields and a strong Dollar are likely to weaken demand for Gold unless there is increased instability, either geopolitical or financial.

Posted on

A bi-polar world

There is much talk in the media of a multipolar world, with the split between the West and the BRICS, led by China & Russia. That may be relevant in the long-term but the immediate challenge for investors is a bi-polar world, where some markets are rallying strongly while others are collapsing. Even within the US market, we have some sectors rallying while others are collapsing.

The S&P 500 is still in a bear market but the index has rallied to test resistance between 4200 and 4300. Breakout would confirm the bull signal from 250-day Rate of Change crossing to above zero.

S&P 500

The big 5 technology stocks — Apple, Amazon, Alphabet (GOOGL), Meta Platforms, and Microsoft — have all rallied strongly since the start of 2023.

Big 5 Technology Companies

Volatility is elevated but declining peaks on Twiggs Volatility (21-day) suggest that this is easing.

S&P 500 & Twiggs Volatility

However, the rally is concentrated in big tech stocks, with small caps struggling to hold above support. The Russell 2000 iShares ETF (IWM) is testing the band of support between 164 and 170. Breach of support would signal a second downward leg in the bear market.

Russell 2000 ETF (IWM)

The Treasury yield curve is also inverted, with the ever-reliable 10-Year minus 3-Month spread at its lowest level (-1.49%) since 1981. Recessions tend to only occur after the spread recovers above zero — when the Fed starts cutting short term rates — which tells us that the recession is only likely to arrive in 2024.

Treasury Yield Spread: 10-Year minus 3-Month

The longer than usual lag may be the result of the “pig in the python” — a massive surge in liquidity injected into financial markets during the pandemic.

Commercial Bank Deposits/GDP

We are already seeing cracks in the dyke as liquidity starts to recede. Regional banks are in crisis, caused by the sharp hike in interest rates and the collapse in value of their “most secure” assets. Risk-weighted capital ratios are meaningless when bank investments in Treasury and Agency securities — which enjoy the lowest risk weighting — fall sharply in value. True levels of leverage are exposed and threaten bank solvency.

The S&P Composite 1500 Regional Banks Index ($XPBC) is testing support at 75 after a sharp decline. Not only do regional banks have solvency problems, caused by losses on Treasury and Agency investments, many are also over-exposed to commercial real estate (CRE) which faces a major fall in value, primarily in the office sector as demand for office space shrinks due to the shift to work-from-home after the pandemic.

S&P Composite 1500 Regional Banks Index ($XPBC)

There is always more than one cockroach — as Doug Kass would say — and regional banks are also threatened by a margin squeeze. Short-term rates have surged to higher than long-term rates, pressuring net interest margins. Banks are funded at the short-end and invest (and lend) at the long-end of the yield curve.

The Fed is unlikely to solve the regional bank problem easily, especially with the political impasse in Congress — needed to support any increase in deposit guarantees.

Commodities

Falling commodity prices warn that the global economy is contracting.

Brent crude is in a bear market, testing support at $70 per barrel. But US cude purchases — to re-stock their strategic petroleum reserve (SPR) — may strengthen support at this level.

Brent Crude

Copper broke support at $8500/tonne, signaling another test of $7000. Sometimes referred to as “Dr Copper” because of its “PhD in economics”, the metal has an uncanny ability to predict the direction of the global economy.

Copper

We use the broader Dow Jones Industrial Metals Index ($BIM) to confirm signals from Copper. The base metals index breached secondary support, at 167, warning of a test of primary support at 150.

Dow Jones Industrial Metals Index ($BIM)

Iron ore has also retraced, testing support at $100/tonne. Breach would warn of another test of $80.

Iron Ore

Dollar & Gold

The Dollar is also in a bear trend, testing support at 101. The recent rally in our view is simply a “dead cat bounce”, with another test of support likely. Breach would warn of another primary decline in the Dollar.

Dollar Index

Gold is in a bull market as the Dollar weakens. Dollar Index breach of 101 would likely cause a surge in demand for Gold, with breakout above $2050 signaling another primary advance — with a medium-term target of $2400 per ounce.

Spot Gold

Australia

The ASX 200 recent (medium-term) bull trend is losing steam, with the index ranging in a narrow band between 7200 and 7400 since April.

ASX 200

Breakout from that narrow band will provide a strong indication of future direction. Breach of 7200 is, in our view, far more likely — because of weakness in global commodity prices — and would warn of another test of primary support between 6900 and 7000.

ASX 200

The All Ordinaries Gold Index (XGD), however, is in a strong bull trend. Respect of support between 6900 and 7000 would strengthen the signal, while breakout above the band of resistance (7500 – 7700) would signal another primary advance, with a medium-term target of 8200.

All Ordinaries Gold Index

Conclusion

The US market is bi-polar, with large technology stocks leading a rally, while small caps and regional banks are struggling. The lag between an inverted yield curve and subsequent recession may be longer than usual because of the “pig in the python” — large injections of liquidity into financial markets during the pandemic.

Commodities are in a bear market, with falling crude and base metals warning of a global recession.

The Dollar is weakening and we expect a primary advance in Gold — with a medium-term target of $2400 per ounce — if the Dollar Index breaks support at 101.

The ASX medium-term rally is weakening and breach of 7200 would warn of another test of primary support. Two major influences are global commodity prices and major Wall Street indices.

Our outlook remains bearish despite the rally in the US technology sector. We are underweight in growth, cyclical and real estate sectors and overweight in gold, silver, defensive stocks, critical materials, cash, money market funds and short-term interest-bearing securities.

Powered by WordPress / WordPress Maintenance Service By Website Helper