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Marco and Gold deep-dive Analysis

Low CPI and the Bullish Gold Case

Gold completed our predefined swing trade price target $1800. What from here? 

Today’s CPI came lower than expected as the YoY CPI data dropped to 7.1%. The market reacted positively to the data, USD dropped significantly, which boosted the stock market, and some commodities like Gold, Silver and risk currencies as well. 

In my recent Gold analysis and trade setup, I shared an extremely bullish view supported by my bullish trade. When fundamentals meet technicals confidence is also going up significantly. Let’s have a look at what I have shared about the expected from me the bullish Gold price back on October 26th

What could impact the Gold price positively:  

 – the US gets into an outright recession, which could force the Fed to pivot, that’s good for Gold and still not so great for stocks. (The valuations may stop falling, but the earnings will be disappointing which is not bullish for stock.)

 In conclusion, Gold is still far from being the risk-free long position. Still, I like Gold due to the economic conditions where Fed may be forced to pivot on their monetary tightening due to liquidity problems in Treasury markets. 

Supported by the Daily Chart Analysis

Buyers are happy, targets are met. What from now? 

As you can see from my previous analysis I am extremely bullish on Gold. Let’s have a look at why I still like Gold for long-term. 

The price of gold is approximately flat year-to-date, which is better than most stocks or bonds, which are down.

When priced in most other currencies besides the dollar, gold is up year-to-date:

This is how the Gold daily chart in dollar terms looks now:

Let’s have a look at the macro situation in case you missed my XM Live Beginners Room session on Monday, December 11, 2022. 

The US yield curve continues to be inverted, which at least for the spread between the 10-year yield and the 3-month yield, has been an extremely reliable predictor of the past eight US recessions. The St. Louis Fed shows four decades of data, but the underlying data go back further than that.

the-inverted-yield-curve

During the prior eight yield curve inversions, the stock market bottomed within 315 to 963 days after the yield curve inversion:

The stock market bottomed vs yield curve

In other words, the US stock market tends to bottom about one or two years after the initial yield curve inversion. In extremes, it can be a little more (963 days is just over 2.5 years) or a little less (315 days is around 10.5 months).

If we assume that the stock market bottom that occurred this year was *the* bottom for the cycle, then this cycle will have been an anomaly compared to the past eight cycles stretching back to the 1960s. It will have been a case where the stock market bottomed several days before the yield curve inversion, which would be about a year earlier than the next earliest bottom, historically speaking.

Here’s a visual that stretches back to the early 1980s, with red dots representing yield curve inversions and yellow dots representing recessionary stock market bottoms:

Wilshire 500 vs 10-3 Treasury Constant Maturity

Basically, the probabilities from this data suggest that it is more likely that the stock market has not bottomed yet, and instead will reach lower lows in the next year or two.

However, I continue to stress that we have to be careful about back-tests like this because this macroeconomic environment is unlike anything since the 1940s. 

There’s an unclear path over the next year or so, but as we look out longer, the US and much of the western world are likely to enter a sustained period of runaway sovereign deficits and the monetization of those deficits. It’s very hard to get out from under this high of a sovereign debt load without a substantial degree of financial repression, which means holding sovereign bond yields well below the nominal GDP growth rate.

My high conviction expectation is that the stock market will continue to struggle in inflation-adjusted terms, with long sideways choppy nominal action. My lower conviction expectation is that we probably will see lower nominal lows in 2023 as part of that choppiness discussed multiple times in XM live sessions already.

Another importnat chart worth to keep an eye is the 2-year Treasury vs Federal Funds Rate.

The 2-year Treasury yield tends to be a good proxy for what the market thinks the Fed will do (which is partially but not completely based on what the Fed says they will do).

When the 2-year Treasury yield rolls over and goes below the Fed’s interest rate, that usually ends up marking the top. We’re not there yet, but by Q1 2023 we most likely will be.

Fed Funds Rate vs 2-year bonds

The Federal Reserve performs a quarterly survey of up to 80 US banks and another 20+ US branches of foreign banks to determine whether they are tightening or loosening their lending standards.

They cover a variety of different metrics, but the most commonly cited one measures the percentage of banks that are tightening standards for commercial/industrial loans to large and mid-size firms. When this number is above zero, it means that banks in general are tightening their lending standards, meaning that they are being more critical of applications for loans:

senior-loan-officer-survey

The recent rapid tightening of lending standards is in recession territory at this point. All four of the prior times that the percentage of banks that were tightening lending standards reached this level within the past three decades, ended up being a leading or coincident indicator for a US recession.

The closest exception was in late 1998 during the collapse of Long-Term Capital Management, where lending briefly tightened and then immediately loosened (and the Fed, led by Alan Greenspan, cut interest rates and organized a bailout of LTCM).

The consumer lending data goes back further, about four decades. In this chart, below zero means that banks in aggregate have less willingness to make consumer installment loans:

consumer-loans-chart

When this level of willingness enters contraction, it usually signals a recession. The exception was 1996.

Generally speaking, the Fed’s higher interest rates lead to less willingness of banks to make consumer loans.

And that is basically the Fed’s intention- to reduce the availability of credit and to try to cause a slowdown in the economy to tame inflation. Historically, they rarely get the soft landing they desire. Instead, it usually contributes to recession, forcing them to pivot and put out a fire that they lit.

Also the manufacturing purchasing managers index is one of the most important macroeconomic charts to keep track of, and it recently went below 50, which means it’s in a mild contraction.

ISM Manufacturing PMI Index

During the past three recessions (2001, 2008, and 2020), the US PMI reached sub-45. During mid-cycle slowdowns that don’t result in a recession, the upper-40s tends to be where it reverses. Those mid-cycle slowdowns that reversed back up into not being a recession, however, haven’t historically had an inverted yield curve associated with them.

The non-manufacturing (services) PMI is less cyclical overall, and while it’s not exactly booming at the moment, it’s by no means the weak point for the US economy

The freight index tends to correlate with the manufacturing PMI rather significantly. Right now the data only go through October, but it seems to be rolling over in year-over-year percent terms:

freight-index

The number of continued jobless claims bottomed in spring/summer 2022 at a very low rate and has since been rolling upward.

This move isn’t large enough to confirm a recession, but combined with the other indicators, it’s something to keep watching.

I think the jobless claims and unemployment data are somewhat understating actual unemployment levels because unlike many recessions, the layoffs in this recession have mainly been in the technology sector, as well as certain financial sectors (e.g. mortgage origination) which are typically high-paying jobs with a multi-month severance package.

 

jobless-claims

Atlanda Fed GDP Estimates

The Atlanta Fed’s GDP estimate for Q4 continues to hold up well, at a bit over 3% annualized. This is based on various economic data that roll in over time.

gdpnow-forecast-evolution

Chart Source: Atlanta Fed

Summing this together, the inverted Treasury yield curve, banks’ tightening of lending standards, the uptick in unemployment and jobless claims from a very low base, and the low reading for manufacturing PMI, all point towards a likely recession in 2023. The readings from the Atlanta Fed and services PMI, on the other hand, still point towards a reasonably strong consumer and services sector for the moment.

With the Fed still tightening monetary policy into that data set, my base case points towards a US recession within 2023, unless or until new data start to suggest otherwise.

 

 With all mentioned above It makes sense for gold to be catching more of a bid, when we consider some of the prior macro charts about yield curve inversion and the 2-year Treasury yield, which imply that the Federal Reserve’s interest rate will likely peak within Q1 2023.

Additionally, the dollar index has, for the moment at least, reached a significant local top:

Chart Source: XM MT5

The rise in the dollar index has been among the main negative variables on gold in dollar terms this year. As the Fed completes their rate-hiking cycle, there’s decent reason to think it will mark a local top in the dollar index.

Today also I got a question about Stock Market or Gold, well going back to my earlier comments about bear market rallies, we can also measure the prospect for bear market rallies in stocks if we denominate stocks in gold terms. This chart shows the S&P 500 divided by the price of gold, or in other words how many ounces of gold it takes to buy the S&P 500:

S&P500 to Gold Ratio

My base case, unless or until I see evidence suggesting otherwise, is that the late-2021 high in that ratio (at little over 2.6x) was probably a structural high point for a while and that the ratio will gradually roll over from here with lower lows and lower highs.

That of course is merely a probability assessment, but overall my view is that profit margins and earnings growth will be under some degree of pressure, and global central banks will continue their gradual shift towards gold accumulation as part of their FX reserves that they’ve been doing since 2008.

World Official Central Bank Gold Demand

US profit margin continues to slide to its trend which is 8% from levels like 12%. So the US profit margin is down almost 50% and this probably will continue in early 2023.

Lastly, while I remain bullish on energy prices over the long run, the ratio of gold to oil has shifted its momentum towards gold on the monthly chart for the first time since 2019. When this ratio is going up, it means gold is outperforming oil, and vice versa:

Silver and platinum are both also enjoying significant momentum shifts vs oil, and I’m bullish on them as well.

Previous Articles to read: 

The year 2022 was a story about valuation compression. As the Federal Reserve raised interest rates at the fastest pace in decades, it forced the market to re-rate various assets at lower multiples of their cash flows, and this is especially so for expensive long-duration assets. It also popped various sources of leverage and resulted in liquidations, especially in the crypto industry. Additionally, it put some downward pressure on gold in dollar terms.

Going forward, the year 2023 may instead be a story about corporate earnings stagnation. Valuations may not be what drives asset prices, but rather, a stagnant economy and weak earnings, especially among the biggest tech companies, maybe what drives asset prices. This can change the game for what types of assets keep doing poorly vs what types of assets can make a reversal.

All mentioned above in my opinion is in a favour of Gold and Gold companies. If you want to learn more details about my investing and trading approach, join my Private Section and get all the Private Analysis, of my personal mid and long-term positions

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