All fall down? Is the predicted crash starting to hit?

Edited and updated article which first appeared on the Sharps Pixley websire earlier i n the week

As I switched on my computer this morning I was faced with a sea of red ink!  Equity prices were down across the board – in the U.S., Asia and Europe and no doubt elsewhere too. Most major stock indices were down by between 1 and 3% yesterday and in early trade today with the NASDAQ being particularly hard hit.  The markets are currently mostly moving on whether a trade and tariff war between the U.S. and China is imminent or not and prospects and views on this are mixed.  Tech stocks too, which have been responsible for much of the peaking of the markets earlier this year, have also been falling out of favour.

Bitcoin (BTC) was this morning stuttering down below the $8,000 level (it has since fallen to the low 7,000s) – around 60% off its high point achieved only a month and a half ago – and if Ethereum is a pointer, with it down at $450 as I write, the next leg down for BTC could well be to around $6,000.  (When Bitcoin and Ethereum were at their respective peaks early in the year BTC was trading at about 14x the Ethereum price.)

In the precious metals, gold, silver and the pgms were all down as well, although perhaps not by nearly as much in percentage terms as the equity markets.  The dollar Index was one of the few positives showing a tiny gain but it was still stuttering well below the 90 level and thus around 13% lower against other currencies than it was when President Trump came into office some 14 months ago.  Obviously a strong dollar is not part of ‘making America great again’.

So what has changed?  The U.S. Fed seems to be committed to raising interest rates perhaps at a faster rate than had previously been anticipated with higher rate targets for 2019 and 2020.  Wall Street may not be liking this prospect.  But perhaps it is the sudden recent downturn in the FAANG stocks (Facebook, Apple, Amazon, Netflix, Google), following Facebook’s problems, which is a primary cause of the falls in the Dow, S&P and NASDAQ (in particular). High flyer Tesla is also a significant contributor to the Wall Street sell-off and when Wall Street falls equities worldwide tend to follow its lead.

Is this the start of the equities crash many commentators have been predicting – and if so how will it affect gold and the other precious metals?  It’s probably too early to say, but after almost nine years of virtually uninterrupted rises in the equities indices we suspect something will have to give – indeed it may already have started.  We’ve already seen the bitcoin bubble burst and, as noted above, we feel the cryptos may yet have further to fall until the bottom is reached.  Are equities next?

What will have changed with the latest downturns is investor sentiment.  Equity increases look to no longer be the ‘sure thing’ that they were, buoyed up by the Fed’s Quantitative Easing policy which poured increased liquidity into the markets.  Now the Fed’s policy is in reverse with what many observers now refer to as Quantitative Tightening.  If history is anything to go by, equities markets may well suffer as a consequence of a rising interest rate path, at least initially.

Precious metals have moved up from their lows, but down again from their subsequent interim peaks, with gold reaching around the $1,355 mark which has proved to provide strong resistance on the upside.  It has since fallen back to the low $1,320s and is still looking vulnerable, with silver following a somewhat similar pattern.  The pgms seem to be treading a slightly different path as befits their industrial metal status.  The gold:silver ratio (GSR) remains above 81 which usually suggests silver is a better buy than gold – the late Ian McAvity used to say buy silver if ratio above 80, but buy gold if ratio 40 or below which has proved to be pretty wise advice over the years, although the 40 level hasn’t been seen since 2011 when it touched 33.7.  We’d probably suggest a range of buying silver with a GSR of 80 and above and gold with a GSR of 60 and below as being good advice under more recent price patterns and with more modest expectations!

Where are we now?  If I were an investor in U.S. equities or in bitcoin I’d be nervous and with global markets tending to follow Wall Street that nervousness would tend to extend to any major global markets.  Watch U.S./China trade negotiations and don’t necessarily trust either side to keep to any promises made to the other.  I would prefer gold and silver as safer investments than equities and see bitcoin as pure speculation with the potential to crash much further than it has already.  Precious metals may well see some falls but these are unlikely to be of the kind of magnitude which could befall equities so we’d continue with the theme of using gold, and perhaps silver, as wealth insurance.  They may not see major gains if equities collapse, but they shouldn’t see major falls either and, as in 2009 in the aftermath of the last big financial meltdown, they will probably recover far faster.

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Gold hit lowest level ytd – will it recover?

March has been a pretty bleak month for investors in almost all asset classes.  Equity investment, which had been a such a sure thing for the past few years, has been wavering and stocks in general are well off their highs and looking vulnerable to further falls, bitcoin has seen its bubble burst and has halved in value – and we think there could be more pain yet to come for the past year’s speculative investment star, and even precious metals have come down with gold languishing at the time of writing at around $1.312 (spot gold had fallen to around $1,307 an ounce at one stage yesterday morning) and could well breach that on the downside this week although it has made a small recovery since.

The bond market is also weaker on the prospect of continuing Fed interest rate rises.

The only positive spot seems to be the U.S. dollar, but people have short memories.  The dollar index did see a small recovery to sit back above the 90 level  but has been under pressure again and it is still around 12% below the level it was when President Trump took office only 15 months ago.  While there now seems to be a consensus that the dollar could continue to see a short term rise, along with whatever decision the FOMC meeting next week makes on U.S. interest rates, there are still many commentators who feel that a rising dollar is not sustainable long term and that it could quickly start coming down again.  If so that is certainly gold positive – at least in dollar terms

As for gold and the other precious metals we have noted before that they are facing headwinds, but perhaps not insuperable ones.  Global demand – particularly in the Middle East and Asia in general – remains relatively positive and there is the distinct impression that global new mined gold production has at last peaked and may be beginning to turn down, albeit at a pretty marginal rate.

Some commentators sing the praises of silver as perhaps the best speculative bet, with a current gold:silver ratio of over 80.  They feel the ratio is too high and recent pricing history tells us it is likely to come down from this level thus enhancing the percentage growth prospects for silver over gold.

Of the other precious metals, although it has some adherents, platinum tends to follow the ups and downs in the gold price to an extent, while palladium, for the time being at least, looks to be in a better fundamental position due to a perceived production deficit and stronger industrial demand in the autocatalyst sector.

So gold could fall back further – much will depend on whether the FOMC meeting seems to be suggesting a further two, three or even four more rate hikes this year, although given that equity and bond markets are looking vulnerable to more than the generally expected two more rate increases this year, we suspect that discretion may prove to be the better part of valour in this respect.  Certainly if the Fed looks at the historical effects of a rising rate scenario, caution may well reign.  Under such circumstances gold could see something of a recovery back to the $1,350s by the mid-year – but don’t put your shirt on it!

The above article is a lightly edited version of an article posted a day earlier to the Sharps Pixley website

Lawrieongold: Gold/silver articles published on other sites

As readers of lawrieongold will know I also publish articles on other websites.  A couple of recent ones are linked below:

Metals Focus sees strength in Chinese gold demand in 2018

 

SGE gold withdrawals down in Feb but up YTD

Both the above articles were published on www.sharpspixley.com.

However, I also write occasional articles for U.S. site – www.usgoldbureau.com, but this site is blocked for access from outside North America unless one uses a browser, like Tor, which can be set to mimic access from other countries.  So for North American readers, or Tor users, a link to my latest article on this site follows:

Equities and Bitcoin Looking Vulnerable, Put Your Trust in Precious Metals

The Fed rate increase: An historical perspective

By Frank Holmes – CEO and Chief Investment Officer, U.S. Global Investors

What were you doing in June 2006?

That’s when the Federal Reserve last raised interest rates, just a year after the last Star Wars flick hit theaters. The biggest movie at the time was Adam Sandler’s “Click,” the hottest song, Shakira’s “Hips Don’t Lie.” The best-performing S&P 500 Index stock for the month was C.H. Robinson Worldwide. And as for Janet Yellen, she was president of the Federal Reserve Bank—of San Francisco.

Up to a third of money managers working today are more likely to have attended a midnight screening of the last Star Wars movie than experienced rising interest rates.

If June 2006 doesn’t seem that long ago, consider this: Up to a third of asset managers working today have never experienced a rate hike professionally.

On Wednesday, Chair Yellen announced that, for the first time in seven years, easy money will become slightly less easy. The target rate will be set at between 0.25 and 0.50 percent, which doesn’t sound like much, but it’s important that the Fed ease into this cycle cautiously and gradually. Plus, this comes at a time when fellow industrialized nations and economic areas around the globe are considering further monetary easing measures.

Effects and Possible Ramifications: Keep Calm and Invest On
Up to a third of money managers working today are more likely to have attended a midnight screening of the last Star Wars movie than experienced rising interest rates.

Rising rates, of course, have a noticeable effect on mortgages, car loans and other forms of credit. Savers will finally start earning interest again.

The question on investors’ minds, though, is what effect they might have on their investments. After all, the last couple of days have been challenging for stocks, with the S&P 500 dropping 1.5 percent on Friday alone. Is the Fed decision to blame?

To answer this, CLSA analyzed what happened to the U.S. dollar and stocks in the S&P 500 Index 60 trading days before and after the initial rate hike in past cycles and then calculated the averages. It’s important to keep in mind that, aside from rising interest rates, a multitude of unique factors—from geopolitics to economic conditions to the weather—played roles in influencing the outcomes. Nevertheless, CLSA’s research is instructive.

The group finds that, on average, the U.S. dollar peaked 10 trading days before the rate hike, and then afterward slid lower for four to five weeks. This created an agreeable climate for gold and other precious metals and commodities, as their prices typically share an inverse relationship with the dollar.

Opportunity for Commodities: U.S. Dollar Average Performance Around Time of First Rate Hike
click to enlarge

As for equities, they traded up for 60 trading days following the initial rate hike, 70 percent of the time.

S&P 500 Index Has Historically Risen for 60 Trading Days Following First Rate Hike
click to enlarge

But CLSA’s analysis looks only at possible near-term scenarios. What about the long-term?

In the past, the results were just as reassuring—most of the time. Barron’s records S&P 500 returns 250 and 500 days following the initial rate hike in six monetary tightening cycles going back to 1983. The findings suggest that the market went through an adjustment period, with average returns falling from 14 percent before the rate hike to 2.6 percent 250 days afterward. But by 500 days, returns returned to their pre-hike average of around 14 percent.

Equities Survived Previous Fed Rate Hikes
S&P 500 Index Returns Before and After Rate Increases
Performance Before/After Initial Rate Hike
Date of Initial Hike 250 Days Before 250 Days After 500 Days After
5/2/1983 36.60% -1.10% 12.20%
12/16/1986 19.10% -5.90% 11.20%
3/29/1988 -11.40% 11.70% 30.60%
2/4/1994 5.30% 0.60% 34.10%
6/30/1999 19.70% 6.00% -10.70%
6/30/2004 14.80% 4.40% 9.10%
Average 14.00% 2.60% 14.40%
Past performance does not guarantee future results.
Source: Barron’s, U.S. Global Investors

Again, many other factors besides interest rates contributed to market behavior in each instance. And this time is especially different, as the market was given an unusually long runway, allowing it to price in the full effects of the liftoff before it finally happened.

I can’t say whether the same trajectory will be taken this time as before, but what CLSA, Barron’s and others have found should be encouraging news for commodities and stocks.

I should also point out that according to the presidential election cycle theory developed by market historian Yale Hirsh, markets do well in a presidential election year.

The consumer price index came out this week and, with an inflation rate of 2 percent, the 5-year Treasury yield is now negative. (The real interest rate is what you get after subtracting inflation from the 5-year government bond.) This bodes well for gold. Also, the 10-year bond yield is lower than it was six months ago.

Investors Flee Junk Bonds and Defaulting Energy Companies, Find Comfort in Tax-Free Muni Bonds

In 2008, the Fed trimmed rates to historically-low levels in response to the worst financial crisis since the 1930s. Most people would agree that this helped put the brakes on the U.S. slipping further into recession.

But low rates were also partially responsible for driving many investors into riskier investments over the last few years—corporate junk bonds among them—as they sought higher yields.

Junk bonds, or high-yield bonds, are known as such because they have some of the lowest ratings from agencies such as Moody’s and Standard & Poor’s. Because they carry a higher default risk than investment-grade bonds, they offer higher yields.

But with corporate default rates nearing 3 percent for the year, and at least one large high-yield bond fund cutting off all redemptions, investors are facing liquidity problems and learning the hard way why these equities are commonly called “junk.”

The week before last, it was announced that a high-yield bond fund—whose assets under management were worth $2.5 billion as recently as 2013—would be closing after suffering nearly $1 billion in outflows this year. This sent the junk bond market into panic mode, with several similar funds experiencing near-record outflows. Fears intensified when legendary investor Carl Icahn tweeted: “Unfortunately I believe the meltdown in High Yield is just beginning.”

To make matters worse, high-yield bonds have fallen into negative territory, giving investors little reward for the risk.

Corporate High-Yield Collapses, Short-Term Munis Climb
click to enlarge

Energy companies, highly leveraged since oil began to spill value in the summer of 2014, top the default list for the year. JPMorgan estimates that the industry’s overall default rate might hit 10 percent next year.

“Junk bonds will likely be dead money for at least several years,” says Tony Daltorio, writing for Wyatt Investment Research. “Put your money elsewhere.”

But where, exactly, is “elsewhere”?

With rates now on the rise, many investors have turned to investment-grade, short-term municipal bonds, which have seen inflows at the fastest pace since January.

U.S. Investors Pile into Muni Bonds Despite Rate Hike
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Savvy investors know that bond prices move in the opposite direction of interest rates, but shorter-term munis are less sensitive to rate fluctuations than longer-term bonds. Put another way, bonds that are more sensitive to changes in the interest rate environment will have greater price fluctuations than those with less sensitivity.

“As municipal bonds head toward the strongest returns in the U.S. fixed-income markets this year, investors say the end of near-zero interest rates will do little to knock state- and local-government debt off its stride,” Bloomberg writes.

Over the past seven years, low rates certainly contributed to one of the strongest bull markets in U.S. history. Now that easy money is coming to an end, we can expect to see more volatility. But as the CLSA and Barron’s data show, there’s still plenty of room for growth.

It’s important, therefore, to stay diversified. Focus on high-quality, dividend-paying stocks; investment-grade, short-term municipal bonds; and, as always, gold—five percent in gold stocks, the other five percent in bullion.

Chinese retail sector growth gold positive

New York closed with the gold price at $1,125.40 down $7.60 yesterday. Gold rose $1.60 in Asia and London held it there. The dollar strengthened to $1.1149 from $1.1171 and the dollar index continues to climb at 96.22 up from 95.96. In London’s morning the LBMA gold price was set at $1,124.60 down $4.70. In the euro this was €1,010.06 up from €1,009.57.  Ahead of New York’s opening gold was trading at $1,125.35 and in the euro at €1,008.60.  

The silver price closed at $14.81 down 38 cents on Tuesday in New York. Ahead of New York’s opening silver was trading at $14.80.

Price Drivers

There was a purchase of 1.193 tonnes of gold into the SPDR gold ETF but none into the Gold Trust on Tuesday. This leaves the holdings of the SPDR gold ETF at 675.799 tonnes and 159.30 tonnes in the Gold Trust. Gold continues to consolidate within the pennant formation. While the dollar is strengthening still, the gold price is edging up in both the dollar and the euro.

The recent turmoil in global markets has left a background of fear against which the slightest negative news about China sets markets down in a tailspin. For gold the story is different. Repeatedly the Chinese government tells us all that the transition away from a manufacturing/exporting nation to one of internal consumption will lead to slower growth. Growth in the retail sector remains at double digit levels, which for gold is positive. To this end we fully expect to see the year end with record annual imports of gold [totaling retail & institutional amounts together].

The difference between the record 2013 numbers and those expected this year is very important. In 2013 the demand was fuelled by the drop in price from $1,450 in April of that year then slowed later in the year. This year the demand has been high throughout the year on a weekly basis both as a result of spendable income on gold going further and the steady expansion of the Chinese middle classes in terms of numbers and wealth. Certainly higher gold prices will reduce demand as the spendable income on gold remains growing slowly and will buy less when prices are higher. Against a backdrop of fear and the gold price close to its lows, the mood for gold amongst institutions has improved.

Silver fell back yesterday, while gold rose removing its strength relative to the gold price. We expect silver prices to move closer to the moves in the gold price today.

Julian D.W. Phillips for the Gold & Silver Forecasters – www.silverforecaster.com and www.goldforecaster.com