Just Go With It
From the April 27, 2017 HRA Journal: Issue 268
Trump hasn’t started a war. Yet. Other market worries like the French election also turned out to be overblown—so far at least.
We’ve seen some zigs and zags in the past two weeks as the market bought into, then dismissed, then bought into the reflation trade. I remain cautious for both political and economic reasons but I also think we need to be realists. Traders have built such high expectations into this trade that its been overwhelming everything else.
That creates dangers but also opportunity. Some markets saw more selling than I think is deserved. I don’t think a US tax cut/infrastructure program will make much difference to the supply demand balance for zinc or copper or several other metals. You’d never know it from how they trade around events in Washington or Trump Tower tweetstorms though.
That brings me to the extended review this issue which is a zinc developer that is about to IPO. I wanted it in this issue because I have invited them to present at the next MIF and wanted you to have the background before that and before the IPO. I doubt there is much, if any, IPO stock available but the tightness of the deal means it should trade well out of the gate.
The end of the editorial notes which HRA companies will be at MIF—we just moved to “waiting list” status. Be sure you’re near the top of that list if you hope to attend.
“Thank the French”. There’s a phrase you don’t hear every day. Even so, its fair to say French voters get at least partial credit for turning equity markets around. You can see from the SPX chart below that it was starting to look like we would see a correction in New York. The SPX had dropped below its 50-day average and was seemingly unable to climb back above it.
That all changed in the wake of the French election. The result was as expected but you wouldn’t know it from the size of the swings in many markets that followed it. The size of the moves indicates fear lurking below the surface of an otherwise placid market. It also shows you how little faith traders have in pollsters after Brexit and the Trump election.
The election results were very close to the predictions of several French polling groups. Based on violent moves in the Euro, equity markets and, yes, gold, there were obviously a lot of traders positioned for the worst, just in case.
The two frontrunners face off on May 7th. Are we going to see traders rebuilding “worst case scenario” trading positons in advance of that? It seems hard to believe since Macron is leading Le Pen by over 20 points but I didn’t expect the positioning that took place before last weekend so what do I know.
Some of the biggest moves after the election were reserved for currencies. The Euro had a huge relief rally. I’ve felt the Euro was undervalued for some time as you know. This week’s move brings it back to levels it was trading at just after the US election. There is still some added political risk in Europe but its economy continues to perform well relative to the US. I don’t see a strong reason for the Euro to retreat right now.
So that move in the Euro meant happy times for the gold market, right? Well,...no.
I’ve written before about how the correlation between the US Dollar and gold is constantly in flux. They often display a strong inverse correlation, but not always. This is one of those “not” times, at least for now.
Gold has been behaving more as a risk barometer than a currency lately. Relief over the French election, the promise of a tax plan and hoped for avoidance of a shut down in Washington (especially the tax plan) generated a “risk on” trading binge on both sides of the Atlantic. The USD weakened, in large part as a reaction to a surging Euro. “Risk off” trades—gold and the Yen –declined.
So far, the pullback in the gold price hasn’t been large. The cheaper USD may be helping contain losses even if the two are trading together. Does that mean we’re destined to see a long pullback in gold prices?
I don’t think so. While the USD and gold are currently trading together that correlation could shift any time, and probably will. The Euro should continue to do well, based on increasing investment flows chasing equities there. The ECB continues to expand its balance sheet. Most EU bonds have negative returns.
Traders are living out the European version of the “TINA” (There Is No Alternative) trade that dominated Wall St while the Fed was in balance sheet expansion mode. Currency demand due to these investment flows, and decent economic readings will help put a floor under the Euro.
The US Dollar will continue to react to political risks, perceptions about the US Feds plans for interest rates, bond yields and general levels of optimism.
Optimism in the US remains very high. Consumers and traders both seem to assume there will be “change” that will improve their circumstances in the near future. Perhaps there will be. Things are very much in flux at a political level in the US. That is a condition we’d better get used to since it’s probably going to last for the next four years.
Wall St still has its own version of TINA. The Fed has raised rates a couple of times but hasn’t started shrinking its balance sheet yet. Bond traders are divided on whether the Fed actually raises rates two more times.
The combination of weak economic readings, political paralysis and inflation readings that have been dropping since early the year have led yields to pull back again. There was a bounce in the past week but not enough yet to change what looks like a clear downtrend.
The drop in yields has been supportive of equities so far but also speaks to bond traders cynical view of growth projections and Fed promises to raise rates. The implied odds of a rate hike in June moved up a bit in the past few sessions but still only sit at about 50%
By the time you receive this the first estimate of Q1 GDP for the US should be out. After ignoring any negative economic readings for a couple of months Wall St started cutting growth estimates in earnest a few weeks ago.
The consensus estimate is now for 1% growth in US GDP for Q1. The Atlanta Fed GDPNow estimate is 0.2%. I expect the real number to be somewhere between those two. Growth, yes, but pretty weak growth. Wall St has decided that weak Q1 growth is now “a thing”. Perhaps it is though I haven’t seen a convincing explanation why. Weather wasn’t unusually severe this year.
That brings me to the chart below which depicts a trend I’ve been tracking for a few months. Lending across all categories in the US has been slowing dramatically over the last few months. The trend accelerated to the downside recently. In a healthy economy, lending should be expanding at 7-8% annually. Its currently running at 2-3% and falling.
Why is bank lending decelerating so severely? No one seems to know. One argument is that companies are waiting to buy capital equipment because they expect a new tax plan with accelerated depreciation. Perhaps, though they can’t wait forever and that only applies to a few categories of lenders.
Banks might be holding back because they are hoping for a steeper yield curve and bigger loan margins. Again, perhaps, but loan officer surveys don’t indicate they are tightening requirements. Banks love the idea of the Fed raising rates as it will help deliver those margins. That said, I find it hard to believe they are telling customers “come back when we can charge you more”. That’s not great marketing technique. Something else may be going on.
Lending is an important precursor to future growth. Its not a prefect predictor but its more dependable than many other indicators. When lending activity stalls out the economy is usually stalling out too. Its one of those metrics that are making me wonder if Q1 growth will turn out to be a trend rather than a momentary hiccup.
The huge divide between optimism and actions in the US feels like a population waiting for something to happen. After stalling out, the Trump administration is trying hard to convince that it will now start pushing through the legislation promised during the election. We’ll see. Markets reacted favorably ahead of the unveiling of the new tax “plan”. Things cooled after it turned out to be a rehash of campaign promises that didn’t offer much to the middle class and didn't explain how it would be paid for. There are also noises out of Washington about the health care bill getting voted on but the different sides cant’ seem to agree on a message.
Trump is a showman. Perhaps he thinks these sort of charm assaults will work indefinitely. They won’t. You can see that from the way Wall St reacted to the tax plan announcement.
In the next couple of weeks we’ll get the results of the run off election in France and find out whether there will be a government shut down in Washington because the debt ceiling doesn't get raised. I don’t think a temporary shut down means much but the market might disagree if it happens.
We’ll also see the next payroll report and Federal Reserve meeting. That is more than enough market moving events to keep things interesting. Traders remain extremely complacent in the face of that much potential volatility. That has been a stance that worked so far so why not?
Keep a continued watch on those lending trends, and retail sales and consumer spending too. Wall St will have to revise its opinion about Q1 being a blip if we don’t see improvement by the end of May. The market won’t continue to levitate beyond that if we rack up two quarters of sub one percent growth in a row.
While things seem to be slowing in the US, at least for now, news has generally been better from most other areas. That matters, for base metals in particular.
There have been big price swings in metals based on the Trump reflation trade being on or off but that is just hedge funds playing around. The US doesn't represent large scale marginal demand for metals any more. Its unlikely it ever will again as most of the US economy has moved past that.
We need to see continued good news out of China, the developing economies and even Europe to have comfort metals demand will continue growing at a decent rate for the next few quarters. We’ve been seeing that news lately.
With demand seemingly taken care of we’ll still continue to focus on major metals where we like the supply fundamentals. Copper looks ok but zinc continues to look better. Both had pullbacks but have stabilized again in the past week or so. I still expect another move up in prices, especially for zinc. That explains the timing of the extended review that follows. That, and the fact the company is presenting at the next MIF so I wanted you to know about it now.
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