Colour Me Surprised (Ok, Not)
From the March 19, 2017 HRA Journal: Issue 266
The Fed raised rates as expected and the world didn’t come to an end, also as expected. Metals have had a nice bounce post Fed that I’m fairly comfortable will continue in gold’s case at least and perhaps base metals as well.
As always there was a deluge of PDAC news, much of it less than noteworthy. The update section is pretty long. The conference itself was positive with slightly higher attendance than last year. Most were concerned about “the Curse” as gold and most metal prices were falling every day during the show. The recent reversal has calmed some nerves though, if its maintained.
I didn’t see too many stories I didn’t know about already but I am following up on several companies I met there. I’m tracking several companies closely, both precious metal and base metal. Odds are you see one or two companies added to the HRA list in the next month or so.
I’m feeling fairly positive about the sector going forward, though we’re still waiting for confirmation that the Curse is fading. I think it is. As I note in the editorial the factors that underpin my positive view should be good for the bigger markets too. That said, we’re starting to see Trump’s favourability ratings fall more steeply. The jury is out on whether Wall St can grow cold on The Donald and still maintain the reflation trade. No one said the market wouldn’t be tricky.
To absolutely no one’s surprise, the US Federal Reserve raised interest rates 25 basis points in its March 15th meeting announcement. Like the only other two rate increases since the Great Financial Crisis the move was heavily and widely telegraphed. The bond market was pricing in 100% odds of a hike and you’d have to have been living under a rock not to see it coming.
Many market participants seemed a bit more surprised by the reaction of the gold market. I expected a bounce on “buy on news” alone and we got one. I don’t think the move is over yet either. Gold had a $120 move coming out of the December rate hike. So far, we’ve only moved $30 higher after the latest rate move. While I can’t promise another $120 move in the short term I wouldn’t be shocked if it happened, for several reasons.
The primary reason, and the reason we saw a $20+ lift right after the Fed announcement, is the FOMC came out “dovish”. They DID raise rates but their forward guidance on rates wasn’t lifted at all. Indeed, some interpreted the forward projections released after the meeting to be a step back by the Fed.
They weren’t really, but every Fed member that gave a speech before March 15th sounded quite hawkish. After all the hawkish Fed speeches, traders expected dot plots to indicate four rate hikes this year and perhaps another four in 2018. Instead, they were nearly identical to the December version. That generated a relief rally in pretty much everything.
Also helping was that the election in the Netherlands took place the same day. Going into the elections there was concern that Gerd Wilders populist party might get enough votes to try and form a government.
The polls weren’t that favorable for Wilders for some time now but, after last year’s Brexit shock, traders are much more focused on potential black swans and tail risks.
Similar concerns are being voiced about the French election that is due in a couple of months. Here too I suspect the media is overplaying things and making more of an issue out of it than is realistic. I agree that things are still fluid in France but its not like Marine Le Pen’s National Front is actually leading the polls.
Like Wilders, she will have to see a huge lift in her popularity from current levels to actually win the election. Anything is possible in politics but Le Pen’s party is both populist and right wing. I have trouble believing the land of weekly student and farmers strikes is going to vote for someone that reactionary, even if they are upset about immigration. I don’t think the situation in France is equivalent to the Brexit vote. The Brexit polls were always within the margin of error. France’s election polls are not that close.
I mention this because a relief rally in the Euro was part of the cause of USD weakness late in the week. That in turn helped the gold price. Euro bears still hugely outnumber bulls, in part because of the French election. If markets continue to view the Fed as dovish and nothing goes awry with the French vote we could see more Euro strength and perhaps Yen strength. Gold trades with both and would be helped by that scenario.
The other potential cause of Dollar weakness is summed up by the two charts on this page. The Atlanta Fed’s GDPNow forecast has continued to weaken as March economic stats are released. Its been sitting at 0.9% for the past week, a full percentage below Wall St consensus and miles away from the growth rates the White House is promising.
I’ve noted before that this is not the script that Wall St is following or the narrative being spun. The talk on Wall St and in Washington is still about immanent growth acceleration.
The lower chart immediately below the GDPNow chart helps explain how they are holding that narrative together. It compares “hard” readings like trade deficits and retail sales to “soft” readings like PMI surveys and consumer and business confidence readings.
You can see from the chart that the readings usually move together which makes sense. Until recently that is. The gap between the higher “soft” data and weaker “hard” data is as high as its ever been. These two measures are going to come together again before much longer. The question is where they meet up. If we can take the GDPNow reading at face value it’s the soft readings that will be falling.
Based on the Fed’s apparent flatter trajectory of rate increases and current inflation readings there seems to be little danger we’ll see significantly positive real interest rates in the near future. Yellen changed her wording on the inflation target during the latest Fed meeting press conference, in a slight but potentially important way.
She referred to the current 2% inflation target, using the Personal Consumption Expenditure deflator the Fed favors as being a “symmetric” target. That implies the Fed would have some comfort with inflation on either side of 2%. Many (including me) read that as Yellen saying 2% is no longer a hard—or soft—ceiling. The Fed would be ok with overshooting it at least for a while. That too sounded pretty dovish. The core PCE reading is still below 2%.
We didn’t see a lift in hourly wages this month and there was a large drop in oil prices. Without either, or both of those measures accelerating higher it could be a while before we see a real lift in inflation rates.
Interestingly, that view matches the forecasts generated by surveying inflation expectations. Even though consumer confidence has rocketed higher since the US election inflation expectations have never been lower. I have no idea how to make sense of that but that and other market dichotomies make me edgy and apparently make the US Federal Reserve edgy too.
The combination of factors that led to a topping US Dollar and potential for a longer run of negative real rates was good news across the metals space. Gold and base metals staged recoveries in the past few sessions. Gold stock and mining stock indices all had strong bounces after the Fed meeting. We’re not out of the woods yet, however.
As I noted in the last issue the concept of a “PDAC Curse” for mining stocks is very ingrained for good reason; most years it happens. From mid February to mid March the Venture index dropped about 7%. That is not a huge pullback by historic standards. If that is as bad as it gets it will be mild by usual standards.
That’s what I expect but I won’t be comfortable until we exceed the February highs on the Venture, GDX and GDXJ. We’re still some way from doing that. I don’t think the rise in gold prices is over but we need to see another $20 or $30 tacked onto the gold price in the next couple of weeks for a resumption of strong upward momentum. I think that is the most likely outcome but its definitely not a certainty.
There are a pile of FOMC member speeches coming up next week. Members will have a chance to expand on—or rebut—Yellen’s press conference comments. That could alter the picture and so could, as always, the shifting US political landscape. We should be hearing about the US budget and tax plans over the next few weeks.
Its widely agreed that Americans have been expecting the Trump administration to do something magical. That is certainly the message of the high confidence numbers. Expectations have gotten very high. For the first time in years we’re seeing record inflows of retail money into US equities. Is that a good thing? Maybe, but, historically, when retail arrives on Wall St en masse we’re starting the closing act of the bull market, not the opening one.
None of this is lost on the Fed governors and its also not lost on some of the smarter money on Wall St. Insider selling has been hitting highs right along with retail money flows. Mom and Pop are buying the insiders stock. I probably don’t have to tell you how that usually ends.
It’s not all doom and gloom. Whatever insiders may be doing the positioning of professional money is largely positive. Large speculators are still decidedly long US Dollar, long oil and short Euros and Treasury bonds even after trimming positons lately. I’ve noted many times that asymmetric positioning like this always gets unwound at some point.
In this case, unwinding would mean a lower US Dollar accompanied by lower Treasury yields and oil prices. None of that (if oil doesn't crash) is negative for Wall St. Traders coming back to their senses, if that is what happens, could actually help stem selling by those disappointed by the end of the reflation trade.
The combination of lower USD and bond yields would obviously be good for gold prices. It might be good for base metals too as long as the weaker USD outweighs lower growth expectations. I’m not worried about zinc, which as strong fundamentals. Copper, nickel and bulks like coal an iron ore would be hit harder by lower growth expectations, if they occur.
Public optimism has been remarkably resilient so far. The growth differential between the US and Europe has narrowed which could soften the USD even if we keep muddling through in North America. One thing to watch is Trump’s popularity ratings. They have started to fall rapidly as we move through March. Is the honeymoon over? It could be over on Main St but not Wall St if Trump delivers the tax and regulatory plans the bankers want. Either way, I think the gold market will be at least steady and more likely bullish.
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