Sprott
Precious Metals Watch, August 2017
Trey
Reik, Senior Portfolio Manager
Spot
gold has spent the past seven months in a tight trading range between $1,200
and $1,300 per ounce. Given the stored force inherent in such a trading
pattern (Figure 1, below), history suggests a breakout, whether up or down,
is likely to be characterized by steep slope. The question remains,
which direction will gold follow? Given that a prominent macroeconomic
development during the past several months has been perceived central-bank
hawkishness, consensus appears to favor pending gold-price pressure. On
the other hand, spot gold is now flirting with the $1,300
upward-trading-bound for the third
time in five months. We command no clairvoyance about
future gold prices, but we offer in this note a few observations suggesting
current market positioning may be significantly offside in a number of asset
classes, including gold. Out of respect for August schedules, we will
skew our comments toward visual exhibits.
Figure 1: Spot Gold
(4/18/16-8/17/17) [Bloomberg]
First-up, what is driving current equity market ebullience? In the
context of uninspiring economic statistics, we would suggest a significant
force powering stocks has been unprecedented central bank asset purchases
during 2017. Since the Fed’s final taper in October 2014, there has
been a common misconception that global QE has been winding down. As
shown in Figure 2, below, nothing could be further from the truth. In
fact, aggregate asset purchases by the Bank of Japan (BOJ) and European
Central Bank (ECB) during the past two years have dwarfed prior rates of Fed
QE. Separately, Bank of America’s Michael Hartnett calculates that the
BOJ, ECB, Swiss National Bank (SNB) and Bank of England (BOE) purchased $1.5
trillion of assets during the first five
months
of 2017, or at an
annualized rate of $3.6 trillion, far exceeding any historic rate of global
QE. Our concern is that reigning confidence among equity investors
seriously underestimates the vulnerability of asset markets to any
incremental central bank tightening.
In
recent weeks, we have even noted resurgent espousal of the
perpetual-bull-market hypothesis from various commentators in the financial
media. In the “what could possibly go wrong” category, we would site the
dramatic decoupling since mid-March of soaring equity averages from souring
U.S. economic performance.
In Figure 3, below, we plot the
S&P 500 Index versus the Citi Economic Surprise Index (which aggregates
sequential beats-and-misses-versus-estimates for prominent U.S. economic
statistics). Riding surges in post-election sentiment and soft economic
data, the Citi Index mirrored the ascent of the S&P 500 Index through the
spring. Since mid-March, however, the realities of hard economic
statistics have weighed heavily on the Citi Index while the S&P 500 Index
has advanced unfazed.
Something has to give.
Figure 3: S&P 500
Index versus Citi Economic Surprise Index (5/11/16-8/17/17) [Citibank;
Bloomberg]
Another
market dynamic worthy of reflection has been investors’ face-value acceptance
of the Fed’s telegraphing of three-or-so rate increases in each of the next
few years. We plot in Figure 4, below, midpoint FOMC dot-plot
projections for fed-funds-rates at every FOMC (projection) meeting since
January 2012. Below the cavalcade of skyward pyrotechnics rests the
horizontal realities of FOMC rate movements. We would query, exactly
what has changed in the economic landscape to suggest the Fed can now raise
rates when they have felt unable to do so in the past?
Figure 4: FOMC Midpoint
Dot Plots for Fed Funds Rates (2012-June 2017) [Torsten Slok; Deutsche Bank]
Pulling
this all together, equities continue to set new highs while investors ratchet
up expectations for Fed tightening, all against a backdrop of deteriorating
U.S. economic performance. Amid this unequivocal optimism, we offer a
contrary precis of developing fundamentals. We believe recent FOMC rate
hikes have already begun to crimp a debt-addled and growth-starved U.S.
economy.
In the context of outstanding debt levels, the Fed is already
too tight, and we suspect Fed “tightening” for this cycle has largely
concluded. If we are correct in our significantly non-consensus
analysis, many financial assets are likely to be repriced aggressively in
coming months, to gold’s tangible benefit.
Our
longtime study of U.S. debt levels has convinced us of one incontrovertible
relationship: the U.S. economy cannot bear rising interest rates, on
either the long or short end, without an immediate surge in financial
stress. This past spring, Trump optimism and the Fed’s more hawkish
tilt began to steepen global rate structures.
We wrote at the time that
the 35-year history of 10-year Treasury yields has demonstrated that any
backup in 10-year yields has inevitably catalyzed a crisis (Figure 5,
below). We predicted 10-year Treasury yields could not sustain their
post-election rally, and, indeed, they have not. With debt levels now
considerably higher than financial-crisis peaks, why would any investor
believe rates can rise without inflicting widespread financial damage?
Figure 5:
10-Year U.S. Treasury Yields (1973-Present) [MacroMavens]
With
respect to gold’s prospects during the next six-to-twelve months, we believe
the single greatest catalyst will be consensus recognition that the Fed
cannot truly tighten without significant harm to global financial
conditions. We would suggest two critical variables will provide the
strongest clues to future FOMC policy: inflation statistics and
commercial-bank lending trends. With respect to inflation, CPI measures have
now posted five straight months of shortfalls to consensus estimates, a very
rare sequence.
July CPI core statistics marked the weakest 6-month
performance since August 2010. The Fed’s preferred PCE-measure
registered 1.4% in June, a far cry from its stated 2% objective. We
view recent Fed jawboning about temporary factors restraining inflation as
little more than tacit admission of the Fed’s ebbing confidence in their own
policy decisions. As usual, Saint Louis Fed President James Bullard
pushed the jawboning envelope (8/7/17), “It is hard to find good explanations
for the low-inflation era being experienced by the U.S.”
Figure 6: U.S.
Commercial Lending (Y/Y % Change) vs. Fed Funds (1987-Present) [MacroMavens]
With
respect to commercial-bank lending, we suspect accumulating data are touching
some nerves at the Fed. Bank lending is the lifeblood of economic
activity, and prominent U.S. lending measures have been swooning throughout
2017.
We believe consensus does not recognize how unorthodox recent Fed
rate hikes have been in relation to bank-lending trends. As shown in
Figure 6, above, the Fed generally raises rates into a trend of accelerating
commercial-bank lending.
The most recent “liftoff,” in contrast, has
been floated into the headwinds of a sharp falloff in lending growth.
Even more troubling for the Fed, as shown in our Addenda Graph, nominal GDP
has a very tight correlation with U.S. bank lending trends.
Figure 7: DXY Dollar
Index (1/20/14-8/17/17) [Bloomberg]
All
in all, we perceive a notable change in confidence at the Fed. Recent
struggles in the automotive, retail and restaurant industries appear to be at
least partially related to recent Fed tightening.
To us, weak trends in
CPI and bank lending are all but telegraphing an imminent change in Fed
policy.
In our view, one of the most reliable forward indicators
of Fed policy is relative strength in the U.S. dollar.
Beneath
headlines, the U.S. dollar has performed miserably during 2017 (Figure 7,
above), with the DXY Index declining 11% (from a 1/3/17 high of 103.82 to a 8/2/17
low of 92.58). It seems only a matter of time before consensus
recognizes that the Fed is back in a bind. Gold should respond
enthusiastically.
Addenda
Figure 8: U.S. Commercial
Bank Lending (Y/Y %age Change) versus Nominal GDP (Y/Y %age Change)
(1987-Present) [MacroMavens]
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viernes, 25 de agosto de 2017
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