From the September 6, 2017 HRA Journal: Issue 275
After a few false starts, gold has finally broken through $1300 convincingly, and looks comfortable at its current perch at $1340. It would be easy to blame it all on politics but, as I noted in the last issue, I don’t think that’s the case. It’s an overdue move and the initial move through $1300 occurred before Kim’s provocative launch of a missile over Japan.
Politics is an issue too, as we saw when gold dropped $10 when a bipartisan agreement was reached to push the debt ceiling fight back three months. But, again, it’s important to note gold bounced back from that loss almost immediately. There are a lot of moving parts at play in the market and most seem to favour gold for a change.The strength in base metals is equally noteworthy. Markets don’t seem to be discounting some sort of crash or deep economic slowdown. We wouldn’t see base metals trading as strongly as they are in that scenario.
Discovery stories are delivering large gains again. The broader resource market still needs to strengthen but, if major markets hold up and we get more good news from the field, the bullishness in resource stocks should broaden. Even so, we’ll try to keep our focus narrow and stick to high quality developers and continue looking for potentially exciting new discovery stories like the silver explorer that is added to the HRA list this issue.
The trends discussed in the last issue, especially those that matter most to us as resource speculators, have strengthened. Gold is trading well above $1300 and seems comfortable there. Copper has moved more than I expected and now sits above $3/pound while zinc is holding its gains and trading just above $1.40/lb.
The moves have been driven by a number of factors, some discussed below, but the important point for us is that the resource sector now has a backdrop similar to early 2016. Higher metals prices, a generally “risk-on” market and lots of sideline money have set us up for what should be a strong autumn performance.
The gold chart below shows a clear breakout, something we’ve been waiting months to see. As recently as the date of the last issue it looked like the latest rally might have failed again before things turned positive in dramatic fashion.
Interestingly, and perhaps significantly, traders were at a loss to come up with a reason gold suddenly drove hard through the $1300 level. There were political rumblings and aftereffects of central banker Jackson Hole speeches, but nothing that matches the timing that well.
There would have been a lot of buy stops placed around the $1300 level by traders that were short. That definitely helped the bulls once that level was reached but doesn’t explain the original buying. Note too the volume bars on the right side of the gold chart. The buying volume was heavy though gold still can’t be considered “overbought” technically.
As I noted to SD Alert subscribers at the time this may simply have been an overdue move. Bullish gold traders were concerned that it hadn’t happened already. The move up in gold hadn’t been impressive, given the scale of the drop in the US Dollar. After the latest move up, gold’s move overall matches the drop in the Dollar more closely. Even better, from my point of view, is that gold and the USD moved up together in a couple of recent sessions. That is the sort of market action I want to see.
And, until last week, even tepid increases in the gold price were not getting matched by increases in gold stock indexes. We’re seeing improvements here too, as you can see on the right side of the GDX chart below.
It’s still not impressive; GDX really ought to be 10% higher. At least GDX seems to be breaking out now too, and I’m hoping for more in coming days and weeks. GDXJ has even more ground to make up. The large changes in that index’s composition a few months back seem to have.
The ability of gold and other metals to trade on their own merits is important. While its certainly possible the USD will go lower “short USD” is becoming a very crowded trade. The relative stability in the USD for the past couple of weeks may indicate the short positions are starting to get closed out but there is certainly potential for a strong short covering rally at any time until that market gets more balanced.
At a fundamental basis, there doesn't seem to be a lot of reasons for the USD not to run at least a bit higher. Most economic readings have been decent and it looks like Q3 growth in the US will come in well above 2%. Set against that is the continued complete lack of acceleration on the inflation front.
CPI and PCE readings continue to weaken. You can see the impact of that on short term real interest rates in the chart above. Short term real rates have been climbing since the start of the year, moving from –1% to basically flat.
Interestingly, this does not seem to be having the negative impact on gold prices that one would expect. This may be due to traders watching the longer term real rates, which have been trending in the opposite direction. That seems counterintuitive but, if short term real yields are strengthening it should actually reduce the necessity for the US Fed to raise rates. The Fed’s interest rate changes have the biggest impact on the short end if the curve. Higher short-term rates, in effect, “do the Fed’s job for it”.
It’s different on the longer end of the yield curve. The 5 year TIPS yield continues to decline and is slightly negative. Why the discrepancy?
The Fed Funds Rate dominates the short end of the curve—yields are not going to drip below the Fed’s discount rate unless there is something REALLY wrong. Farther out the curve the rates are a truer reflection of trader’s expectations. I mentioned in the last issue that I thought the longer-term TIPS yields would fall back to be more in line with the falling USD. That is indeed what has happened.
The general move down in yields reflects reduced inflation expectations, yes, but perhaps reflects changing risk attitudes even more. Between North Korea, horrendous hurricanes, fears of legislative gridlock in the US (partially alleviated now) and a weak non-farm payroll report, bond traders that are long have plenty of good reasons to say “I told you so”.
Bond traders watch wage measures closely and those continue to flatline. Add some insurance buying in the Treasury market due to political uncertainties and we may see short term yields start to stage a reversal much as longer term real yields already have. Bond traders now price in odds of another rate hike by the Fed before year end at only 25%. Again, the short end f the yield curve dropping too would be supportive of gold and other metals if he helps hold down the USD and keep it from bottoming.
The other important factor that we shouldn’t ignore is movement in other currencies. Most major economies in Euroland also keep putting up better economic readings, especially some of the weaker economies. This has been pushing the Euro higher. Mario Draghi is probably hating that but central bankers can’t really stop large currency moves. At best, they can only delay them.
The story is the same in China. While many have concerns about China’s banking system, most independent economic readings have been stronger. The Yuan has been stronger too, moving up several percent in the last couple of months. Last but not least, for me anyway, the Bank of Canada raised rates yesterday as part of its continuing efforts to cool an insane real estate market. The Loonie is now sitting at 82.5 cents, 10 cents above its level of a few months ago.
With so many currencies that make up the USD Index rising, many for reasons that have little directly to do with the US or its economy, is it any wonder the $US can’t seem to get out of its own way?
All this bodes well for continued strength in precious metals. Strength in Europe and, particularly, China is also strengthening the bid for most base metals, especially those that have a supply shortage story, real or imagined.
Take a look at the copper chart below. I like copper but I’m not a “copper bug”. I find the level of strength in the copper chart a bit mind boggling. I’m not complaining, far from it, but I don’t have the level of comfort with the copper price that I do with zinc. There have been labour and weather issues in some areas that may have copper supply/demand close to balanced but the 20% move in the last couple of months is still pretty remarkable. It looks like speculation as much, or more, than fundamentals.
Speaking of weather, we’ve yet to see any impacts for this year’s US hurricane season factored into the markets, at least not yet. Harvey will be very expensive but Irma, if it makes landfall in Florida at its current strength, will take things to a whole different level. Natural disasters tend to have only short term negative effects. They can actually generate growth one or two quarters out because of spending on reconstruction—as long as Washington opens the money taps. More than one wag has made the ironic comment that Trump may finally get the infrastructure program he promised – just not quite the way he hoped.
That brings me to the last chart in this article, shown below. The chart, from realinvestmentadvice.com, compares the flows of “smart” (institutional) and “dumb” (retail) monies in and out of the US equities markets. While I don’t fully agree with the Smart and Dumb labels, these money flows can be instructive is there is a large divergence.
There is a very large one now, with fund money exiting the markets and Mom and Pop piling in. I’m not calling for a crash, but with a pattern like that, entering the two worst months of the year for equity markets historically and lots of uncertainties, the odds of a correction in NY are high. If its “only” a correction it could move gold even higher. We’re set up for a strong autumn but be prepared for more volatility and don’t take your eye off the SPX in case you need to move fast.
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