Tuesday, March 21, 2017

The $'s April Showers Can Bring May Flowers to Gold

Regardless of how hawkish the Fed frames possible future rate hikes this year, we suspect a cyclical breakdown in the US dollar index to unfold. Moreover, by our estimates of the leading market breakdown in US Treasuries last November, the window for a dollar break appears to be now open and extended through April.

Similar to the failed breakout in long-term Treasuries last summer that subsequently resulted in the severe correction in bonds, the dollar index has followed the retracement pattern in long-term Treasuries as it currently flirts with last November’s upside breakout ~100. Should the index break below current levels, long-term trendline support will be tested directly below ~98.50 and likely fail.
*Click to enlarge images*

As we’ve noted over the years, the relationship between Treasuries and the dollar is highly dynamic, and at times – quite muddled – depending upon the time frame and markets you look at. Granted, this is true for all markets, yet even more so with Treasuries, in part due to the range of durations and also when intermarket correlations are interpreted through yields that inherently behave inverse to their corresponding bond. Simply put – it’s complicated to read and even more confusing to describe.

That said, from a macro perspective we have viewed the dollar following cyclical trends in long-term yields by several years, while over the intermediate term the dollar has followed more structural pivots in Treasuries by several months. 
Shorter-term – and as frequently seen in most intermarket relationships, correlations fluctuate between the positive and negative poles, with long-term Treasuries and the dollar index most recently exhibiting an inverse correlation extreme coming into January – the last of which was present during the previous cyclical top in the dollar in the first half of 2002. Consequently, when Treasuries broke down from the failed breakout last November, the dollar broke out. Since then, however, the dollar fell short of making new highs this month as long-term Treasuries recently made new lows.

Our interpretation is that the dollar is set to follow Treasuries breakdown lead with the last lagged pivot (~5-6 months) of the cycle, which should mark a pattern break as the dollar turns cyclically lower without a corresponding leading move lower in Treasuries. As we described in previous notes, while we wouldn’t be surprised to see a final leg lower in Treasuries manifest along the lines of the 1987 breakdown to complete the move, over the longer-term we like them from a relative performance perspective to equities. Moreover – and further out on the risk continuum, we still like the prospects of precious metals and commodities that should benefit as the US dollar turns down.

While over the near-term and through an anticipated cyclical pivot lower in US equities, we favor gold here – as it tends to find greater support through broader market weakness than higher beta commodities like silver and oil, on a relative performance basis over the long-term they should all outperform stocks.

Wednesday, March 1, 2017

The Next Market To Break *Should* Be Stocks

It was the summer of 1987 and despite some flirtation with teenage adolescence, we found ourselves on the weekends renting table space in large hotel conference rooms, selling small plaques of cardboard to mostly middle age men seeking to speculate on the prospects of the likes of Bo Jackson and Jose Canseco. No sales pitch required; all that was asked was plenty of product – i.e. baseball cards, and the capacity to keep a straight face while raising prices each week to seemingly absurd levels. If our parents didn’t know better or weren’t driving us, we were either selling drugs or worst. Our take – roughly a few hundred each weekend, went a long way for a 12 year old kid in the burbs, even at the glitzy Short Hills Mall.

Although unbeknownst to our more youthful perceptions of the world, our little racket in North Jersey was less an anomaly and more indicative of the times. Conspicuous speculation, wealth and greed were all on daily display, manifesting later that year as life imitated art with the crash on Wall Street, just as we would be introduced to Hollywood’s Gordon Gekko. It was also the year of Donald Trump’s coming out party in the media as a brash, young and ambitious billionaire businessman, eager to leave his mark on the country he professed to understand better than anyone.

Some 30 years later, the writing on the wall and skyscrapers by the developer’s son from Queens, appears to have fulfilled his own ego’s expectations in 1987. And while he tripped and nearly crumbled in debt just a few years after his larger than life entrance, the P.T. Barnum of real estate and panache is having a monumental third act return. Whether he can deliver on his promises of “Making America Great Again” – is another debate entirely. What’s not in question, however, are some of the touchstones in the markets from 1987 that have resonated with us over the past year, just not from the typical perspective that most analysts have viewed them against.

Notwithstanding the current move in equities that through Monday had matched a January 1987 record in the Dow of 12 consecutive record high closes, we have looked at 1987 from time to time over the past year not exactly through the prism of equities, but mostly long-term Treasuries – which coming through last spring looked vulnerable to a breakdown similar to the one that took hold in the spring of 1987.
One historical period that we have been following for possible insights is the market environment headed into the spring of 1987, where investors had pushed long-term Treasuries significantly higher over the previous two years on the back of a sluggish global economy and a collapse in oil prices. It wasn’t until the global economy stabilized and oil prices began moving higher that the Fed began to raise rates in April 1987. This shift, following several years of disinflationary market conditions that had greatly buttressed the trend in Treasuries – came to an abrupt end that spring. Headed into October, the price on the 30-year Treasury bond had fallen by over 20 percent.The Next Market To Break Might Not Be Stocks 5/12/16
From an intermarket perspective – and in the wake of the major breakdown in Treasuries that manifested last summer akin to 87', we would argue that the move in equities is likely much more mature than the echo of the record January 1987 sounding that some have recently pointed to for more bullish intermediate bearings. Their reasonings being, that although the markets may be near-term extended, like in January 1987, they still gained another 30 percent over the following 8 months. The old market adage applied  overbought can still become more overbought. That said, what the data mining ignores here is similar to the benevolent rotation out of bonds and into equities that supported the reflationary blowoff that began after Treasuries broke down in the Spring of 1987, stocks have been under this same strong reflationary momentum since last summer.

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What’s happened this week of note, and which has helped firm our own near-term expectations, is that several Fed presidents have more than candidly implied that the March meeting is very much in play for another rate hike. And although we had recently suspected that more hawkish posturing would adversely impact precious metals over the short-term, long-term Treasuries now again look vulnerable as well, which would closer resemble the final leg lower in Treasuries in 1987 and the curtain call for equities that fall.

In 1987, the initial breakdown leg in the 30-year Treasury bond registered a decline of ~14 percent. After remaining in a trading range for another 3 months, bond prices fell roughly another 10 percent, before finding a low as the equity markets broke down. Through the end of last year, the 30-year Treasury bond had fallen ~16 percent from its highs last summer. Although we still believe long-term Treasuries offer good relative value to investors as the limits of the US's mature economic expansion become increasingly visible this year, the more than 2 month trading range now appears susceptible to further near-term weakness, akin to the final leg lower in 1987.
Moreover – and as we described last May in The Next Market To Break Might Not Be Stocks, a final leg could find support at the long-term trend line extending from the 1987 crash low. In the four previous occasions that the 30-year Treasury bond exhausted with a long-term RSI momentum extreme, it eventually found support at this rising trend line, which we guesstimate would come into play another 6 percent lower ~ 140. That said, tactically we do not feel the opportunity warrants taking another swing on the short-side of Treasuries here as the market is still listing with short positions and as we feel the economic data will again eventually disappoint. As such  and from a comparative risk/return perspective, the more compelling intermediate-term strategy is short US equities, not Treasuries. 

Similar to the broad reflationary move in 1987 that drafted oil higher with equities, extreme caution is warranted in oil as well, as we suspect the eventual pivot to be broad based. This also applies to precious metals higher beta assets like silver, which could disproportionally underperform in the turn. Although we had in our previous note looked for a breakout in the silver:gold ratio to accompany the next leg higher in precious metals, when contrasted with the set-up in 1987, the recent breakout may prove to be short lived.


As a parting postscript, we thought we would also offer up our opinion to those chasing what we believe to be the speculative du jour of the day – bitcoin. 

Get out while you can. 

Thirty years later and those same baseball cards are worth a fraction of what we had sold them for in 1987. For bitcoin investors, we fear the fall will be even greater – as in, worthless. 

Thursday, February 16, 2017

Connecting the Dots - 2/16/17

Released yesterday morning, the CPI report for January indicated that prices for goods and services rose by the most in 4 years. On a year over year basis, the consumer price index rose 2.5 percent, its biggest gain in 5 years. Although equities have so far managed to shrug off any inflationary concerns to date, the rubber appears to be getting very close to meeting the proverbial road when it comes to the negative impacts of higher realized inflation  which is difficult to square in any positive light for stocks, especially the red hot financial sector, as creditors become adversely impacted through lower real yields. 

In fact, with todays CPI data, the 10-year real yield (nominal-CPI) went negative for the first time (on a downside trend) since May 2011; with the next previous occasion in November 2007  both times not exactly prudent spots to own stocks. Although the inflation data would also appear to negatively affect the performance of Treasuries going forward, we do suspect they will find some shelter, as they have in the past when equities turn down and as the economic data softens. Moreover, as shown below juxtaposed with the year-over-year growth in payrolls, real yields have often led the broader trend in the economy, with the most recent streak of decent economic data likely serving as another high-water mark on the backside of a very mature economic expansion.
With so much attention focused on the sharp spike in yields since this past summer, our counter intuitive suspicion that real yields would still continue to fall as rising inflation outstrips the reach of nominal yields, appears to be playing out. Consequently, our sustained interest in precious metals, which exhibit a strong inverse correlation with real yields, should once again outperform. 
Although it wouldn't surprise us to see the most recent pause in gold cut deeper over the near-term as the inflation data might roil more hawkish expectations with the Fed, we view the move lower in real yields as largely symptomatic of underlying fatigue in the economy  which we don't believe will leave the Fed much capacity to tighten as markets extend through the year. As such, we expect a powerful push higher in precious metals will eventually reflect the breakdown in real yields that has largely been overlooked as equities make new highs. 

The silver:gold ratio, that we follow as a barometer of risk appetites within the precious metals sector, and which in the past has led inflationary trends, is now butting up against overhead resistance from the broader retracement decline that began last summer. While our expectations remain that silver will lead and outperform within the sector, the market may need to digest the recent gains since December before breaking through overhead resistance.

Greasing the wheels and facilitating the move lower in real yields  to what we expect will break the previous lows from 2011, is 1) the US dollar that remains stretched near a cyclical high and poised to weaken; and 2) the secular trough in nominal yields, which from our read of historic long-term cycles (most recently, Here and Here) has limited upside reach. 

Over the past two years, the US dollar index has exhibited a strengthening inverse correlation with long-term Treasuries and gold (currently -0.89 and -0.90, respectively over 20 week rolling period) and naturally a positive correlation (0.90) with the 10-year yield. In fact, the last time long-term Treasuries and the dollar expressed such a strong relationship was in Q4 2001, directly before the US dollar index turned down from a cyclical peak.

From a big-picture perspective, we’ve pointed out in the past that the dollar has followed major upside exhaustion extremes in long-term yields by 2 to 3 years. The 9/81’ secular high in yields was followed by a secular high in the US dollar index in 2/85’ (monthly). The upside exhaustion in yields in 1/00’ was followed by the cyclical high in the dollar index in 1/02’.
Structurally speaking, the pattern in yields has been to test the previous interim low after the exhaustion high, followed by a sharp secondary move that is rejected below the previous extreme.

Today, the 10-year yield is working through the secondary pivot below the previous exhaustion extreme of ~3 percent in 12/13’. Our expectation remains that the US dollar index is following again the long intermarket lag (3yrs) in yields, which points towards a cyclical move lower for the dollar over the next several years.

We have also pointed out in previous notes over the past few years that over the intermediate-term the dollar has followed the structural breaks in long-term Treasuries by several weeks. Resembling the throw-over top breakdown in long-term Treasuries last summer, the US dollar index appears to be working towards a breakdown of its own along similar folds, despite the markets attention with new highs. 

Friday, February 3, 2017

Prepared to Come About

Stemming from the virtual absence of underwhelming economic data… the cumulative weight of growing confidence – as relative as it may be, continues to list US markets towards what we suspect will become another surprise “Come about!” in investors optimistic expectations towards the US economy. How much water markets may take on – or whether it becomes a capsizing Minsky moment, is another question entirely. Considering the Trump cards that could be played along the spectrum of possible outcomes (both bullish and bearish), the gap between risk and reward for nearly every type and duration of investment strategy remains profoundly wide. That being said, we remain largely risk adverse until there's greater clarity on monetary or fiscal policy, and still favor the short side of the dollar and the more safe haven positions in precious metals and long-term Treasuries, as we suspect the long run of "not bad" to mediocre grades comes to pass. The economy is surely not failing, but don't kid yourself – the bar hasn't been raised for some time.

What’s not in question – and which we take our bearings from, is that equities, yields and the US dollar have trended with investors relative expectations with the data, well before the outcome of the US election even came into focus. Looking back, this has increasingly been the case since the Fed left ZIRP in December 2015; with the most recent updraft beginning last summer after investors immediate fears with the Brexit vote went largely unfounded in the markets. And while animal spirits and narratives were certainly rekindled and reframed after the election, a positive reversion was already underway for months with respect towards participants respective expectations within the economy. Vacillating between poles of optimism and pessimism – as the index measures levels relative to consensus, we would speculate that the Citigroup US economic surprise index now reflects that expectations have largely caught up with the data, with a much greater probability that subsequent “surprises” will trend towards the negative pole. 

Moreover – and as recently described by Matthew Boesler of Bloomberg (see Here), there has been a growing gap between business and consumer confidence surveys and actual economic activity. The difference between these so called “soft” and “hard” data series has only been wider once before in 17 years of data, in February 2011. It seems reasonable to believe that the gap reflects the sharp shift in business and consumer sentiment that took place after the Republicans ran the table in November. The abstract concern being – hope springs eternal, or until reality bites. To that end, we’re more inclined to focus on the US macro environment beforehand that was predominantly characterized by lackluster year-over-year growth that was treading water at best – or decelerating from a cyclical high in a historically mature economic expansion at or near full employment.

Thursday, January 19, 2017

In Search of the New World

Although they’ve skillfully built and maneuvered their rival reputations in bond arenas worldwide, the warring kingdoms that lay siege to the Bond King throne, might just benefit from a less enlightened perspective – say, from the dark ages.

While Gundlach and Gross have a semantic squabble over the upside threshold in yields that might delineate the end of the three-decade old bull market in bonds, perhaps they should stop viewing the bond world as round and come to the apparent reality that it’s more flat than circular here in the trough of the long-term cycle.

* Click to enlarge images

In this construct, the unidirectional sovereign yield winds died – or more appropriately – transitioned, years back in 2011 and 2012. Although short-term yields and the dollar have risen in tandem as the US economic expansion led the world out of the financial crisis, long-term yields have taken a more lateral path into the trough with what we suspect will be doldrum conditions blowing east to west at best – rather than the prevailing winds we experienced out of the north for thirty years. How long the journey along this yield equator will take is anyone’s guess, but by our estimation of previous long-term cycles (most recently, Here), likely has further seas to float before the strong updrafts of the Westerlies can bring us to the higher-latitudes of a "New World".

What’s happened since the US election is that budding optimism that the ship is now sailing away from the "Old World", has helped shorter-term yields and the US dollar “breakout”, which can be viewed as a welcome shift in the economy’s tell-tails. What’s become the “Trump-rally”, led by broad buying in infrastructure and bank stocks, is a reflationary move that actually began before the election, but re-magnified with a new administration about to control both houses of Congress. The bet now is that Trump becomes Columbus and succeeds at rekindling growth on the back of fiscal stimulus and tax cuts. Yes, higher yields and inflation, but alongside stronger growth. Land ho New World - or at least one that feels like the old one of the 1950's...

However – and as we alluded to in previous notes, we believe that’s mostly wishful thinking pulled forward several years, considering the maturity of the current expansion and with the economy at or beyond full employment. While we continue to support a more commodity focused reflationary approach – spearheaded by positions in precious metals, and speculate that the US dollar will turn down again with the US led expansion, we don’t foresee the more healthy expectation that rising inflation will be accompanied with higher growth. Some might call this stagflation; we take a more pragmatic perspective in that it’s just the nature of where we sit in the long-term cycle where inflation could more easily outstrip the reach of nominal yields and growth, causing real yields to decline. 

Moreover, we continue to view the Fed's expectation of raising rates several times a year through 2019 as wildly unrealistic – as well as the markets underlying fears of the 1970’s, where to kill inflation took the mythical axe of Tall Paul Volker and a fed funds rate of 20 percent. This isn’t the 1970’s where yields continued to surge higher, but inflation still had greater reach and more pernicious momentum. Today, we would speculate that a spike in inflation would be more ephemeral and provide a bookend to an equity market cycle that took flight as disinflationary pressures brought yields and growth into the trough of the long-term cycle. 

As mentioned in previous notes, over the past few months gold has again been strengthening its negative correlation with the US dollar. Although the relationship is trending towards an extreme, gold now expresses a positive divergence with the most recent highs in the US dollar index, relative to the dollar's previous highs in December 2015. 

While the correction in precious metals was steep through Q4 of last year, we view them in hindsight as a successful test of the 2015 cycle lows and expect a full retracement and continuation of the young bull market in precious metals. Similar to the market environment headed into 2002, we expect favorable conditions in the currency and Treasury markets that should help propel precious metals to fresh cycle highs.