Month: May 2019

It goes without saying that one of the main themes of this website is the gold market and its eventual breakout to new all time highs.

Before trying to decipher “Is this it?” We must define the drivers of the yellow metal that are in play at any given time.

These drivers are…

1. The investing public’s confidence in central banks
2. The general public’s confidence in governments
3. The volatility of equity markets causing some investors to hedge
4. The ability to find real yields
5. Inflation
6. Technical resistance and support levels

So what has occurred recently to suggest that this may be “it?”

The chart below has surfaced on twitter and it is perfect for the top 3 drivers. In 2015, volatility reared its ugly head in the stock market. Zone 1 on the gold chart displays the results. Then, President Trump was elected in November of 2016. One could say this created a confidence in government. The result was soaring equities and a sideways move in the gold market as can be seen in zone 2. Finally, in October the middle peak in the triple top of the equity market broke. This brought equity market volatility, and gold began to rise. The powerful thing about this zone is that it marks the beginning of the end of the central bank experiment. The public wanted, whether they actually did or not, to believe that FED balance sheet normalization was possible. This facade is finally coming to an end as the markets have woken up to the notion that the balance sheet will be expanding again, and we will be going back down to zero on the Federal Funds rate faster than we have previously believed.

It was just March when the market was pricing in virtually no chance of a rate hike by the September FOMC meeting. Now, the probability is nearly 70%.

Let’s recap.

1. Equity Markets are volatile
2. The market now knows the FED will not normalize the balance sheet
3. Do we have confidence in our government?

Well, we have a President playing tariff games with China and now Mexico. And to add insult to injury, Trump went rogue on this one apparently…

So, we don’t have confidence in our central bank, we don’t have confidence in our government, volatility is back, as rates get cut real yields will be harder to find, Bloomberg may have just marked the bottom on inflation from a contrarian perspective, and we have just broken out of the descending triangle. (I sort of sound like the anti-Kudlow…link below)

First things first. Let’s hope the breakout sticks, then on to test the 5 year resistance band around 1350-1370.

As any market follower knows, there has been an abundance of news over the past 3 months essentially telling market participants that a trade deal is imminent. It is tough to say why such obvious market jawboning was dismissed, but the time is here to wake up to reality. I also want to bring up that these past 3 months have made me wonder if news algorithmic trading programs have the ability to exhibit headline skepticism, but that’s another conversation.

Below, you will find the tweet that has caught market participants off guard. It is now apparent that the trade war is in fact not coming to an end any coming Friday, but in fact getting taken to the next level.

So why did this happen and what are the ramifications?

One can speculate that Trump was not getting all he asked for in the deal room with Xi. I think what is important to remember is that Trump is up for reelection in 2020 and Xi is a lifetime leader. If Xi is unsatisfied, then he can simply wait for the next President.

Forecasts for the 2020 election become key in understanding the dynamics of the situation. We know that Trump is largely running on the use of an economic scorecard. If the scorecard looks good by 2020, then Trump is likely going to win and vice versa. The economic scorecard basically consists of the stock market, GDP, and unemployment.

Please view an overly simplistic decision tree below.

Trade Deal-Market Rally-Trump Wins 2020 Election

Trade War Intensifies-Market Sells Off-Trump Loses 2020 Election

The point is that Xi has the luxury of time and will use that to his advantage to basically choose who opposes him in the deal room.

Moving on. Why did this really happen?

Is Trump performing some sort of “Art of the Deal?” Maybe in his mind.

But perhaps, he is aware that GDP is due to come in weaker in quarters to come with the huge inventory builds. He does not appear able to get Powell to cut rates in order to pull demand forward, so maybe he has decided to attempt to influence the GDP number. One thing that I think is fairly straight forward is that if we are in an official recession by 2020, then Trump has no chance of winning the election. So, let’s assume that Trump knows that future GDP may be under threat, and he understands that he does not have monetary policy in his arsenal at the moment, then what does he do?

He tariffs (taxes) domestic producers’ imports in order to influence them to build inventories again. Theoretically, this could short-term boost GDP as it did with the last round of tariffs. From the chart below, it is apparent that the level of contribution of inventory to GDP mean reverts around 0%. This should make sense intuitively as businesses build inventories one period, they are less likely to need to build inventories in the next period as well.

I will wrap this up with some things to watch out for.

Will the yuan depreciate against the dollar again to offset the tariff?

Will tariffs of this magnitude spur inflation as producers have to pass tariff costs to consumers?

Will producers who are already sitting on large inventory hordes build again?

At what level on the major indexes will Powell announce that QT will end before the expected September 30 date?