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

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



Iran attacks Israel

Markets are overshadowed by news that Iran directly attacked Israel in retaliation for the bombing of its embassy in Damascus which killed two high-ranking Iranian generals.

Iran

This is a significant escalation in Iran’s on-going proxy war against Israel.

Russia and its allies are emboldened by the US failure to support Ukraine and are stepping up their attacks on Western allies.

Iran

Mick Ryan (retired Australian Maj. General) writes:

…What is Iran’s ultimate goal here and its strategy to achieve it? This is a major shift in the way the Iranians have attacked Israel for years. Proxy forces are normally Iran’s preference in order to keep it at arm’s length from a potential Israeli response. Why has it decided on such a drastic course change in its strategy to confront Israel?

He lays out four options for retaliation — ranging from no direct response to a massive hammer blow to deter a repeat — and concludes:

All of these are possible in the hours and days ahead. All have advantages, as well as considerable disadvantages, for the Israelis. But one thing is certain, the concept of ‘re-establishing deterrence’ against Iran will be an important guiding idea.

And, it is uncertain whether the Iranians are really prepared for what they may have unleashed against their country and the wider region.

Flight to Safety

Given the high level of uncertainty, we can expect a significant flight to safe haven assets. Stocks are expected to weaken, with the S&P 500 breaching support at 5100 to signal a secondary correction.

S&P 500

The S&P 500 Equal-Weighted Index ($IQX) has already warned of a market move to risk-off after breaching support at 6650. A test of support at 6400 is likely.

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

The Russelll 2000 Small Caps ETF (IWM) has similarly breached support at 200, warning of a correction to 190.

Russelll 2000 Small Caps ETF (IWM)

Brent crude is expected to test resistance at $96 per barrel.

Brent Crude

10-Year Treasury yields are already retracing and headed for a test of new support at 4.35%. Respect is likely, however, and would confirm an advance to test resistance at 5.0%.

10-Year Treasury Yield

The Dollar Index may not follow 10-year Treasury yields, with safe haven demand fueling a test of 107.

Dollar Index

Gold saw significant profit-taking on Friday after reaching our target of $2400 per ounce earlier in the day. Retracement is likely to respect support at $2300, followed by a strong advance fueled by safe-haven demand.

Spot Gold

The international contract on the Shanghai Gold Exchange (iAu99.99) is trading at 562 Yuan/gram. This equates to a USD price of $2415 per troy ounce — a sizable premium over Friday’s close at $2344.

Silver has retraced to test support at $28 per ounce. Respect is likely, signaling a test of resistance at $29 per ounce. Breakout above $29 would offer a long-term target of $36 per ounce.

Spot Silver

Bitcoin is consolidating below resistance at $72K. Breakout is likely and would offer a target of $92K, while reversal below support at $64K would warn of a correction to test $52K.

Bitcoin

Conclusion

Escalation in the Iran-Israel conflict is likely to drive crude oil prices to new highs as geopolitical risk rises. Inflationary pressures are expected to climb as a result, reducing the possibility of Fed rate cuts this year.

Other geopolitical factors could intervene, including the Saudis increasing production to hold crude oil prices below $100 per barrel. Above $100 is considered unsustainable by many producers and believed to lead to sharp falls in demand as the global economy contracts in response.

Financial markets, stocks and precious metals are likely to be dominated by safe-haven demand in the weeks ahead. A shift from small caps — and even the broad S&P 500 to the largest “magnificent seven” tech stocks — is expected as investors grow increasingly risk averse. Demand for Gold & Silver is expected to rise. The Dollar is likely to strengthen, along with short-/medium-term Treasuries. But long-term yields are unclear because of conflicting inflation/safe-haven pressures.

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

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

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.

 



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

 

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

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.