Category: Nugget of the Day

Below you will find the chart of gold as of April 3, 2020 at about 4PM. It had become quite clear that gold had consolidated via an inverse head and shoulders pattern and was preparing for a new leg higher.

It is now April 6, 2020 around 8:45AM and gold appears to be breaking out. With breakouts, retests of the breakout line are common, but not definite.

Many did not understand the major drop that occurred in gold during the stock market crash.

Fundamentally, none of this should come as a surprise as anyone who has been watching the news would have lost track of the fiscal and monetary stimulus by now. We had the $6 Trillion fiscal package out of the government, but what most do not follow closely enough is the FED.

For fun, I will try to answer where gold is headed next.

Target 1 – $1,700 – Recent peak and psychological round number resistance

Target 2 – ~$1,733 – .786 Fibonacci retracement of the 2011 peak to the 2015 trough

Target 3 – ~$1,780 – This area was busy in 2011 and 2012

Target 4 – $1,800 – Psychological round number resistance

Target 5 – $1,900 – Psychological round number resistance

Target 6 – $1921 – New all-time weekly highs

I have written bullishly many times fundamentally about the precious metals complex, but I have only written bullishly twice before on the technical outlook.

One was on 5/31/19, where I wrote http://theboywhocriedgold.com/is-this-it/

The other was on 10/24/19, where I wrote http://theboywhocriedgold.com/the-next-leg-in-gold-possibly-confirmed/

From 5/31/19-9/4/19, Gold would move from ~$1,290 to ~$1,550. ~20%

From 10/24/19-1/8/19, Gold would move from ~$1,490 to ~$1,600. ~7%

I must admit my second call was a bit pre-mature as gold did not breakout immediately after the post. Red vertical lines mark post dates.

I believe it is likely that we either breakout before February 20, or we finish filling out the larger triangle and breakout closer to March 12.

As always, the biggest winning trades will come from the miners and silver.

I will use the first move as reference because of not only ease, but since I believe this move will more likely mirror the first than the second.

From 5/31/19-9/4/19…

Gold Miners (GDX) would move from ~$21.00 to ~$30.50. ~45%

Silver Miners (SIL) would move from ~$22.50 to ~$31.50. ~40%

Silver would move from ~$14.50 to ~$19.00. ~31%

Fundamental catalysts this time?

1. Coronavirus!
2. Federal Reserve Incompetence.
3. Interest Rates

These are new deaths each day reported out of China. Statistics of all kinds out of China are always to be looked at with skepticism. I am not going to get into it, but these numbers are likely significantly lower than the truth. The effects of fear would be enough to hurt an economy as people would be more prone to staying in, but large cities are on lockdown anyways. I do not yet have a motive attributed to portraying the spike in deaths.

Below, is the Federal Reserve balance sheet. It grows when the Fed buys assets in the market. They do this to inject liquidity and relieve stress in financial markets. What you need to know is when that line is going up it is bullish for gold. It suggests risky times may be near, and at the least, it suggests money creation.

Lastly, gold competes with bonds. Gold does not pay interest so when interest rates fall it is a tailwind for gold. The US 30-year yield broke down from a longer term triangle.

I zoomed in to show that I envision another such event. If you look closely you will see the head and shoulders technical pattern.

In conclusion, draw your lines. We will know if gold and the precious metals complex is on the move upward again with a decisive break of $1,585. A break below 2% on the US 30-year treasury yield could be seen as a lead or confirmation of the move.

Other markets to watch to confirm the move.

A breakdown above $7 on the Yuan. Proxy for trade war and now coronavirus.

A failed breakdown at $110 for the Yen. Proxy for risk-on/risk-off.

A breakout above $10,500 on bitcoin. Proxy for global liquidity.

For reference…

Gold Miners (GDX)

SIlver Miners (SIL)

Silver

In my last piece, I wrote that the fall downtrend was coming. I took the liberty of not forecasting a specific time. I am now going to make a call that the turn will come any given day.

To my fascination, it is looking like bond yields could top out on today (November 7) just as they did on November 7 of last year.

11/7/18 – The US Treasury 30 Year Yield topped out at about 3.46% and began descent

11/7/19 – The US Treasury 30 Year Yield is at the top of channel resistance formed by last year’s move. The yield is currently 2.42%

What does this mean?

Think about stocks and bonds as competing for capital against each other. If bond yields rise then they can steal capital from stocks.

After bond yields peaked last year, stocks went on to fall. I marked 11/7/18 on the SPX chart.

Another way to think about this phenomenon of rising yields causing danger for stocks is from an economic standpoint. Companies need growth in order to afford their debt. Some GDP forecasts for Q4 are coming in as low as 1%. As growth slows, it is possible that companies can no longer afford prior amounts of debt service costs.

I would also like to touch on an outlook for gold. Gold competes with bond yields in the same way that stocks do. If yields rise, then bonds become more attractive relative to gold. Since I believe that the stock market will be under pressure due to bond yields, I think that the probability of a FED December cut will begin to rise as stock market pressure rears its head. Currently, a December cut is only priced in at 5.2%, which means markets believe that we will have smooth sailing into year end. If the FED language/market action changes the probability of a December cut to the upside, then bond yields should fall and gold should rise.

When the FED or other central banks ease, the concept of a “reflation trade” comes into play. Let’s examine if other markets are front-running the forecast that I am laying out. Good places to look are commodities and emerging markets. The reason is that FED easing is an opening of the dollar liquidity gates, which means that theoretically the dollar should fall, and assets that are inversely correlated to the dollar should rise. The Thomson Reuters/CoreCommodity CRB Index and the EEM have recently broken out.

I have a few other things to highlight. I have previously explained how the USD/Yuan cross-rate is a proxy for trade war risk. In my opinion, we are at a point of maximum complacency with the recent trade narrative and chart to confirm. This means that should things turn sour in the stock market, Trump likely won’t be able to use more good trade news to jawbone the market higher.

Regarding complacency, we are also at a place of extreme risk per VIX contracts. The VIX is the “Fear Index.” When it is low, the market is complacent. When speculators go short VIX contracts, they believe it will go lower. Times of extreme lopsidedness in this market have not preceded good results for stock market investors.

My last note is that things can speed up should the market turn. The market has had a series of gap ups (the elevator looking things on the chart). Markets do not like gaps. Markets like to fill the gaps. To fill the gaps we would need to go down, and these elevators could speed up the process.

The Fed has recently been engaging in a “temporary” Repo program.

Very few can explain the details in full of why this is going on, but what must be known is that this is abnormal and would not occur under the best of conditions. The likely cause of this response is underlying liquidity stress for banks. Below, is some context of how this issue has progressed.

It should be visible that the size of these arguably emergency measures is increasing.

Calling these measures QE or not is irrelevant at this point. What must be known is the FED’s balance sheet is expanding again.

Below is a picture of global central bank balance sheets and gold price rising in tandem. This suggests a correlation. The gold price in $USD appears to be especially correlated with the FED balance sheet.

Since the start of this Repo program the FED’s balance sheet has begun expanding again per the chart below.

Traders have begun to understand what this all means. Per the technicals of the gold price and the GDX (gold miners), it appears that traders have decided that the FED balance sheet will continue to expand for some time and this will be bullish for gold and especially bullish for the GDX.

The breakouts are fresh so the next couple days will be important. Expect a retest of the breakout line and then hopefully follow through with the FED meeting at the end of this month.

The basics of today.

Today, the Federal Reserve cut the Federal Funds Rate from 2.00%-2.25% to 1.75%-2.00%.

This was a disappointing Fed decision based on 2 easy metrics. Trump was immediately angry, but more seriously…

The Eurodollar futures contract, which is a proxy for market participants’ aggregate forecast of the future Federal Funds rate, fell. In other words, market participants had been betting on a lower future Federal Funds rate (higher Eurodollar futures price), but post-decision release and press conference, they were betting on a relatively higher future Federal Funds rate (lower Eurodollar futures price) than before.

Scott Minerd of Guggenheim Partners said on “The Fed Decides” on Bloomberg, “That which is not sustainable cannot be sustained” in reference to the difference between the dot plot and market bets for the future Federal Funds rate.

This resonated with me. As an example, market participants believe, per the Eurodollar futures market, that in December 2021 the Federal Funds rate will be about 1.5%. According to their dot plot, the Fed is currently telling us that the Federal Funds rate is expected to be 2.00%-2.25% at that time. This large gap “cannot be sustained.”

For the gap to close, at least one of the forecasting parties will be proven wrong. The question remains if market participants are betting on more rate cuts than are going to occur, if the Fed is not forecasting enough rate cuts, or if both parties are wrong. (I would take the latter)

When pressed, Powell admitted that more rate cuts may be used as appropriate.

The market (S&P 500) has had recent downturns in December, May, and July.

December was reversed by what some now call the “Powell Pivot” with change from hawkishness to dovishness speak by Powell, and May was reversed with a cacophony of Fed presidents speaking out and seemingly testing various policy ideas, which led market participants to price in a rate cut at the end of July. The most recent reversal is the most interesting because I view it as a turning point. The market began to decline heading into the July Fed meeting. This was due to the hope of a 50 basis point cut, but the result of a 25 basis point cut. The downtrend didn’t reverse on supposed dovishness and the market traded sideways through August as it attempted to qualify Trump trade-war related tweets.

At the end of August, the market began an uptrend spurred by a less anxious trade situation. This can actually be observed by the Chinese Yuan/US Dollar exchange rate. A weakening Yuan means that trade tensions are rising because traders are anticipating that China will retaliate tariffs with a devaluation of its currency. On the other hand a strengthening Yuan means that traders are anticipating that tariffs will not be increased by the US, and thus future weakening of the Yuan will not be necessary.

This can be seen in the chart below. The chart begins in April 2018, where the US-China trade war commenced. The Yuan weakened substantially thereafter. For the purposes of the point that I am making about the August reversal in stocks, you can see that beginning in September the Yuan began to strengthen due to Trump saying that he would delay the next round of tariffs. This helped finish reversing the July downtrend.

There are now 3 ways to get the market to reverse a downtrend: the Fed can introduce more dovish speak, Trump can alleviate trade war stress, or economic data can improve.

The market has reacted to back-to-back 25 basis point rate cuts as not dovish enough based on Eurodollar markets. Trade war stress appears to be trending down. Economic data is not likely to improve in the next 6-12 months. This is due to rate hikes, cuts, and their respective policy lags.

Should a downtrend resume, the Fed could stop it by cutting by 50 basis points. I am extrapolating the idea that back-to-back 25 basis point cuts were not considered satisfactory by markets. Trump could further reverse the trade war, but then he would run the risk of appearing as a loser in the trade war domestically, which he does not want with the election around the corner. As said prior, the economic data could reverse, but that seems unlikely.

If you get in the head of a bull, they are thinking that the Fed will catch us if we fall, therefore that should be priced in and we should currently rally. Unfortunately the bear knows that since that rate cut will not come until we fall… we must fall.

One last note on the move today by the Fed. The rate of interest on excess reserves was lowered by 30 basis points and the rate on overnight reverse repos was lowered by 30 basis points. This was done to address the below Repo issue, which speaks to tightening financial conditions. Beneath the surface of the market, there appears to be some ominous pressures arising. Coincidentally, the last repo blowout occurred around the December downtrend.

Another interesting recent event that many have missed was the Momentum vs. Value relocation.

The 2 largest days of the relocation chalked up a 5 sigma event. That registers a 1 in 3.5 million probability of recurrence if the initial reading was indeed by chance.

In conclusion, the Fed’s toolbox will likely not come back into play without a downtrend in stocks. Trump’s back is against the wall with attempting to “win” the trade war while maintaining a high stock market, since it is becoming more apparent that the two are mutually exclusive. With these ideas in mind, the occurrence of some ominous pressures, and the current technical make-up of the S&P 500 (approaching significant overhead resistance without an imminent new catalyst), I think it is likely that stocks run into trouble soon.

Things are accelerating.

The main topic of discussion for the past year was the US-China trade war. Now, it is all about central bankers.

Globally, to the best of my knowledge, all economies are slowing down, and some are actually contracting.

For the past 30 years or so, globalization and the elimination of trade barriers have been a positive impact on global economies, which feeds in to equity prices. The Trump-led trade war was a major paradigm shift.

Knowing that globalization increases connectivity between economies, one should intuitively be able to understand that economies today are not insulated from one another. If some dominoes begin to fall, then you are a fool to think the rest will not.

We find ourselves in the middle of a road map in which the order of directions is a bit vague, but the endgame could be consequential.

What we do know is the next major chapter in this story has just begun.

China, for the first time since 2008, let the yuan slide through 7 to 1 to the dollar. You have been hearing Trump demand that he wants a weaker dollar. The reason is that he wants to improve the competitiveness of the domestic exporter. Well, he is not the only leader with this thought.

When one country begins to weaken their currency, other countries cannot stand idly by. Global rate cutting has accelerated as other nations do not want to watch their exporters become uncompetitive.

Central bankers set policy rates, which then influence market rates. As central bankers continue to cut policy rates negative or closer to negative, then the aggregate amount of negative yielding debt will continue to rise.

This is very bullish for gold.

In short, the old argument was…

“What do you think about gold?”

“It does not pay a yield, so I do not like it.”

Well, in a world where the percent of alternatives to gold that do pay a yield is falling due to the fact that the amount of negative yielding debt is rising, then gold becomes increasingly interesting.

I want to note how fascinating it is that gold reached $1,400 around the same time that aggregate negative yielding debt reached $14 trillion, and $1,500 and $15 trillion, respectively. Let’s see if this correlation continues with such strength.

Around the world, many currencies are already falling against gold. The global currency war is creating a race to the bottom in rates. The dollar may temporarily bid as individuals jump from their pot to our frying pan, but eventually all fiat will substantially depreciate against gold. Please note that despite the dollar’s recent strength, gold has still managed to return about 15% in the past 2 months.

It is just a matter of time until gold is breaking all time highs in all fiat currencies.

As we enter the new paradigm of the world of negative interest rates, it seems that the textbook jargon is evolving in tandem. In the past, rate cuts would be referred to as dovish action by the FED, but today was quickly termed a hawkish cut by market participants.

Today, July 31, 2019, the FED cut rates by 25bps and announced an end to the quantitative tightening program. Gut reaction would normally be to assume that this would be bullish stocks, bullish gold, bullish bonds, and bearish the dollar, but the contrary occurred.

Why?

The market was hoping for more forward guidance (promises) of future rate cuts, but this was not delivered by Chairman Powell and his FED.

This is visible on this Eurodollar Futures chart below. Conceptually, you need to understand that if the price lowers, then it means less future rate cuts are being priced into the market than before. The red trend lines have been drawn at 2PM when the FOMC statement was released. As market participants digested the statement and the ensuing press conference, rate cut expectations fell.

All in all, the press conference was filled with uncertainty and seemingly contradictory statements.

Going forward…

Unless, intra-meeting FED speak occurs to reverse today’s trends, I would expect stocks to weaken and gold to fall towards the lower bound of its new range of 1380 to 1440.

I am short SPY and SOX, hoping to take those potential gains and purchase more gold related securities at lower prices.

One thing I can tell you is that it feels a hell of a lot better to sell when you want to, rather than when you feel you have to.

I have been bearish on the US Stock Market since the summer of 2017. This is when my understanding of macroeconomic fundamentals and markets accelerated. I believe that if I had gained enlightenment sooner, then I would have become bearish earlier. I consider myself to have been luckily ignorant. As they say, “Don’t confuse brains and a bull market.”

My immediate family has been luckily ignorant as well. My dad had been fairly aggressive and to our benefit this landed us with more or less of an overall allocation near 80% equities (largely US) and 20% bonds.

The story goes that I became bearish and wanted to essentially sell everything. Conventional family money managers were disciplined and helped us to not blow our selling load too fast. We took some chips off the table and that probably landed us around 65% stocks, 25% bonds, 5% gold, and 5% cash. We have continued to take chips off the table, but I know many have not. At this point in the cycle, one could very easily argue that 65% is still an extreme over allocation to stocks.

I want to convey why 65% stocks does not make sense. If I told you that you could get to the same end portfolio amount at retirement with less big swings, wouldn’t that make you happier? Basically, if you were on a plane would you rather it be turbulent or smooth?

In portfolio management, we have a measure for this tradeoff. It is called the Sharpe Ratio. The idea is to try to create a portfolio that will reach the highest return above the risk free rate for the least portfolio volatility. This is attractive because if you should need your capital sooner than you had priorly anticipated, then it is less likely that your portfolio will be at a disadvantageous level to draw from. Also, from an emotional standpoint, a higher Sharpe Ratio relieves stress of downturns and removes potentially ill-timed panic sales. So what has been an optimal Sharpe Ratio recently? Play around below if you like, but I will give you some examples.

https://www.portfoliovisualizer.com/efficient-frontier

The simple way to use the Sharpe Ratio is to find a portfolio that fits your return goals and risk tolerance and you let it ride from there. This is lazy.

Using the past 5 5-year periods and a 5-asset class universe consisting of US Stocks, US Bonds, Non-US Stocks, Gold, and REITs, the optimal way to achieve a beloved 10% a year has been…

From 2014-2019, the optimal way to achieve a 10% return was 57.80% US Stocks, 4.82% US Bonds, and 37.39% REITs.

From 2009-2014, the optimal way to achieve a 10% return was 39.16% US Stocks and 60.84% US Bonds.

From 2004-2009, the optimal way to achieve a 10% return was 59.97% US Bonds, 1.03% Non-US Stocks, 36.28% Gold, and 2.72% REITs.

From 1999-2004, the optimal way to achieve a 10% return was 61.66% US Bonds, 1.55% Gold, and 36.79% REITs.

From 1994-1999, the optimal way to achieve a 10% return was 24.30% US Stocks and 75.70% US Bonds.

The optimal portfolio allocation is constantly changing. One must understand that setting a portfolio allocation and riding it to end of the Earth is foolish. The probabilities that either US Stocks, US Bonds, Non-US Stocks, Gold, and REITs will be the most optimal portfolio allocation is changing every single day. That does not mean you should change your portfolio every single day, but you are doing yourself an enormous disservice to not question from time to time, “Is my portfolio ready for the next year?”

US Stocks were the most optimal asset allocation in the past 5 years. Interestingly enough, this was the first 5 year period that that was the case in the past 5 of such periods. If they win only 1 in every 5 5-year periods (based on the last 25 years), and starting points are important, do you feel good about being over allocated to US Stocks when they are currently the best?

And I know that for the most part the conventional wisdom money manager will tell you to ride that portfolio, but they have jobs to protect. Going against the herd is difficult for them. Therefore, a paid fiduciary is only working in your best interest to the extent that they will continue to make money from you. If others fiduciaries are about to lose, they will lose with them.

The main surprise from this analysis should be that US Stocks were only the primary asset allocation in 1/5 of the last 5 5-year look back periods. From purely a historical perspective, you should realize that the optimal way to earn 10% a year is usually with your primary allocation being to US bonds. I bet most of you reading this are seeing the statistics in front of you and are still unwilling to see the reality because you have been told for your whole life to invest in stocks. It is never too late to wake up.

I also know that most people have essentially a 0% allocation towards gold because they or their money managers can’t understand an asset that doesn’t pay a yield. Newsflash. Not only is gold pretty, but it is an integral part of much of our technology and thus has demand. That’s the easy part to understand. The important part is that it is the only true money that exists and from time to time it basically re-accounts the whole monetary system and at those times, it is a must own asset. Aside from it being a must own once asset every 40 years or so, make sure you didn’t miss that a small allocation towards gold is usually a necessary piece to creating an optimal portfolio.

In terms of “re-accounting” the system, imagine a world where there are $100 and one ounce of gold. Gold should be valued at $100. Remember, although we are not on an official gold standard, gold has a funny way of maintaining that role, which I will display below. If the government decides to print $100 more dollars, then there will be $200 in the system. The intrinsic value of gold should then be $200. The times to buy gold are when there are more dollars than gold ounces multiplied by the current price.

In Wealth Cycles by Mike Maloney, he shows a graphic that displays a pattern of government money creation, gold lagging in price, and then gold catching up to its intrinsic value. The green line is basically all the dollars that exist, and the gold line is all the ounces of gold that the US Treasury holds multiplied by the gold price. From 1944 to 1971, gold lagged in this relationship under the Bretton Woods system. This system pegged all currencies to the dollar and $35 to one ounce of gold. Well, as all governments eventually do, the US spent recklessly and eventually holders of dollars began to doubt that if everyone redeemed their dollars for gold at the same time that there would be enough gold. This is visible below. Gold was $35 from 1944 to 1971, so in order for the yellow line to go down the US Treasury must have been hemorrhaging gold from doubtful dollar holders.

In 1971, Nixon decided that dollars would no longer be redeemable for gold. This essentially allowed gold to float freely, and the result was that the gold price rose to re-account for all of the past spending.

This graphic from Santiago Capital is of similar nature. It shows the gold price necessary to re-account for various different countries and their gold holdings.

Over the past year, the fundamentals, geopolitical risks, and liquidity factors have all deteriorated, yet we are still near all time highs. This is the definition of irrational exuberance. If you still have a heavy allocation towards stocks, then this may be your last chance.

Sell high, buy low. Sell stocks, buy gold.

Let me leave you with this. A historically normal mean reversion of the Dow to Gold Ratio would be a move from 20 to 8. With the Dow near 25,000 and Gold near $1,300 and holding the opposite asset constant, either gold would need to rise above $3,000, or the Dow would need to fall under 11,000.

The current chart though is eerily similar to that of the 1966 peak, 1974 trough, and the 1976 retracement, before the eventual 1980 trough where the Dow was roughly the price of an ounce of gold. If that scenario unfolded and holding the opposite asset constant, then the Dow would need to go down about 95% or gold would need to go up about 18 times.

In conclusion, do you feel lucky?

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.