Some Cracks Appear
From the April 7, 2017 HRA Journal: Issue 267
I was about to hit the send key on this one when the proverbial crap hit the fan in the form of a US missile attack on Syria. I think that is a tempest in a teapot but it could have some secondary effects that will make things more interesting. The US rallies around its president when bullets start flying so this action might give Trump’s terrible approval ratings a big bounce. Trump seems to view the world in simple terms. Here’s hoping he doesn’t decide an air strike is a nice little pick me up every time he feels unloved...
Like most who follow gold and gold stocks I’m no fan of “political” price moves or crisis price moves. They almost always get unwound in short order. While I had to do some editorial rewriting thanks to the missile attack I want to be clear that isn't the reason I’ve been constructive on gold while so many others were negative. I’m watching hard data out of the US. Take a look at the most current GDPNow chart on page 3 and you’ll see what I mean.
With a more constructive gold market we got more news from the juniors we follow again. The update section grew rapidly over the past few days. I’m still leaning towards adding both a precious metals and base metals story in the next issue or two. Hoping for slightly better prices but may not get them on the precious metal one with all the craziness out there right now. Stay tuned. And register for MIF!
Markets continued to chug along through the second half of March, basically going sideways. Volatility continues to be low, but we started to see some larger swings as we moved into April. Now we have missile strikes added to politics added to weakening hard economic data. It feels like the period of calm may be about to draw to a close.
In the past week or two there have been political developments that could have far reaching impacts for several markets. Things still look placid on the surface but the currents below are getting more roiled. We’ll have to keep an eye out for potential trouble for the next couple of months. Some of the main parts of the bullish narrative suddenly look shaky.
As the chart below shows, gold has been able to keep advancing after the latest Fed rate increase but only just. Its met heavy resistance around its 200 day moving average and hasn’t yet been able to break through and hold a higher level. Even the US lobbing Tomahawk missiles at the Hom airbase in Syria wasn’t enough.
Traders will only put up with so many failed attempts to move higher before they start writing sell tickets. I still favor a higher gold price as the more likely medium-term scenario, though I seem to be almost alone in believing that.
I can’t argue with the concerns of technical traders that fear a short term pullback, though it sounds like most don’t expect a large one. I prefer to keep focusing on stocks that I think can make headway for their own reasons. When gold has a higher upside move that will be a bonus. My reasons are more macro and political than market and chart related anyway.
As this issue was being completed, news crossed the wires that the US has bombed the airfield in Syria believed to be the staging area for recent poison gas attacks by the Assad regime. I held the issue back to see how markets would react to it.
So far the reaction is a shrug. No one looking at the SPX chart below would think anything of consequence happened on the last day the chart covers.
I don’t know yet how this will play out. The US seems serious about pushing for regime change in Syria after the gas attacks. Given how heinous those attacks were I don’t think Trump will find many in the West who disagree with him.
Things are more sticky with Russia and China who both back the current government. That must have made for interesting meetings between Trump and Premier Xi this weekend. Russia issued predictable condemnations but that was just diplomatic rote.
The US went out of its way to ensure no Russian airmen, based at Hom, were injured and they succeeded. There are plenty who hope Putin was as angry as he acted. There’s been a lot of discomfort about the cozy relationship between Trump’s staff and the Putin regime. Some distance there would actually help Trump.
I mention this late development only because it impacted the gold market and sent the price through $1260 while the issue was being completed. That move only lasted a few hours. Technical analysts interpret that as a bearish reversal that could lead to lower prices immediately.
We do need to be aware of that but I discount political price spikes and you should too. They are nearly always reversed in short order so I hesitate to put much import on them. I think gold still has the potential to move higher and stay there but the move won’t be based on missile strikes. It will come from renewed unwind of the Trump reflation trade.
The first crack to appear was the failure of the Trump White House to pass its health care bill. The bill had no shortage of problems, to be sure, but the fact the Republicans couldn't corral enough votes to pass it is a bad sign for Trump’s legislative agenda.
The market soon got over that scare as Wall St peddled the story that failing to pass the bill would somehow make it easier for Trump to follow through on his promised tax cuts and infrastructure program.
That is one of the most ridiculous tales I’ve seen come out of Wall St, and that’s saying something. Wall St didn't care about the health care bill so it's unsurprising the reaction to its defeat was brief. It definitely DOES care about tax cuts. They have been built into valuation models and underpin the reflation trade. It's now less likely either initiative gets made into law, at least not in the near or medium term future.
It was the right wing of Trump's own party that defeated the health care bill. They are even more intransigent about taxing and spending. Most of them got elected on small government platforms. I don't see them agreeing to large tax cuts without spending cuts that at least match them.
Trump’s missile attack may give him some negotiating leverage. Expect a jump in his approval ratings. That might make some members of Congress less willing to publicly oppose him. Whether it has much impact on the Freedom Caucus that killed the health care bill and the Tea Party types that will fight deficit expansion remains to be seen.
No less than US Speaker of the House Paul Ryan predicted Trump’s tax cut bill would be DOA in Congress. He thought an infrastructure bill would be even tougher. This is the same Ryan who has made changing the tax code the central theme of his entire political career. If tax cuts and infrastructure spending can’t be passed, we have to call the whole reflation trade into question.
The second crack can be summed up with the simple phrase “where’s the beef?” Take a look at the latest iteration of the Atlanta Fed GDPNow reading. It dropped again in the past week and now forecasts growth of just 0.6% for Q1. Where’s the reflation?
I’ve said it before but it bears repeating. Wall St and Main St are chasing their own tails lately. Everyone is optimistic because, well, everyone is optimistic. But that optimism still isn't being reflected in bottom line activity like spending. That hasn’t phased Wall St and maybe it won’t. I’m a big believer in Keynes quip that “the market can remain irrational longer than you can remain solvent”. Traders love the idea of the reflation trade, of increased optimism, the economy turning over a new leaf, etc.
They’re not going to give up on the idea easily. Take a look at the chart below of DJIA futures positioning. The most hated bull market? Hardly.
Speculative long positioning (traders betting on higher Dow and S&P) is the highest in history. That is considered the “dumb money”. It’s not always. You can see a couple of peaks that came before big rallies. Conversely, hedgers short positioning (the so-called “smart money”) is also near all time highs. Speculators are trend followers. They’re not wrong all of the time but they are wrong most of the time. Caution is advised.
Nothing has held back major markets yet and Keynes’ quip should be kept in mind. It may take a couple of really mediocre quarters before Wall St admits we could have another year of near zero profit growth. Wall St never gives up on the double-digit earnings growth narrative easily.
The chart above shows how much earnings estimates fell through the year as actual numbers came in during 2015 and 2016 (the light blue and red lines) and that market strategists are only starting to ratchet down this year’s estimates (the black line). I think that drop has much further to go unless the Trump administration can deliver on its agenda.
Where does that leave us, short and medium term? Gold continues to trade as a currency which means its negative correlation to the USD is, if anything, even stronger than normal. I think the main reason gold reversed its “post missile” gains so rapidly was a rush to the USD in a kneejerk response to a military “crisis”. That crisis looks more and more manufactured, in the sense that it appears the US went to great lengths not to inflict too much damage or casualties. If the market accepts the air strikes as a “one off” it should put some downward pressure on the USD and oil. The situation is still pretty fluid though. This would change if we see follow up air strikes.
Assuming the air strike effect fades we’re back to watching if the market loses faith in the reflation trade and what the US Fed does. Traders were unsettled to find out the FOMC is talking about shrinking the Fed balance sheet when the meeting minutes were released. This could mean fewer rate hikes but potentially higher market rates as the Fed becomes a seller rather than a buyer of bonds.
If the Fed follows through –and that’s a BIG if—it could weaken the US economy, even if “headline” rates don’t increase as much. That is a recipe for a weaker currency not a stronger one. I’m highly cynical about the Fed’s willingness to do this but its yet another reason I’m a little more bullish than most on the gold space. Successful explorers should continue to be rewarded.
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