Commodities | Jun 11 2019
Richard (Rick) Mills
Ahead of the Herd
As a general rule, the most successful man in life is the man who has the best information.
The season for gold
Gold was riding high last Monday on bad news regarding the US economy, causing stocks to fall and Wall Street traders to pile into bullion.
US markets were choppy on the first trading day after June 1, when the United States increased the tariff on $200 billion of Chinese imports from 10% to 25%. Shares of the so-called ‘FAANG' stocks slumped, pulling the S&P 500 and the Dow with them, after media reports that the Department of Justice is weighing actions against Google and Apple, and the Federal Trade Commission said it wants to conduct a probe against Facebook for improper use of data.
Roller coaster Dow Jones
Contributing to the jitters was a white paper from China published over the weekend that blamed the US for escalating the trade war (ie. imposing 25% tariffs following an accusation that China backtracked on commitments agreed to earlier):
"The U.S. government accusation of Chinese backtracking is totally groundless. It is common practice for both sides to make new proposals for adjustments to the text and language in ongoing consultations," the white paper read. "In the previous more than 10 rounds of negotiations, the U.S. administration kept changing its demands. It is reckless to accuse China of ‘backtracking' while the talks are still under way."
US President Trump responded that the tariffs on China are working, with Chinese firms leaving the country to avoid paying tariffs, no visible increase in inflation, and the US "taking billions." (the IMF showed that the billions in tariffs are actually being paid by US companies, not Chinese firms as Trump has argued) He also accused China of subsidizing its industries to help them cope with the trade war.
All the uncertainty was enough to propel gold to a two-month high.
As of last Monday, the precious metal was holding at $1,324.38 - a climb of nearly $43 since May 1, when gold finished at $1,281.40.
The price was helped by a 0.1-point drop in the US dollar index. Since May 31 the index has dropped over a full point, from 98.12 to the current 97.06. Gold and the USD normally move in opposite directions.
There are plenty of other reasons to believe we are heading into a summer exploration season backstopped by some very bullish signs for gold. This article gets into the nitty-gritty of each and concludes that now is a very good time to be owning promising junior gold stocks as a wager on rising gold prices and some spectacular drill results.
Forward- looking indicators
The first reason is a set of forward-looking indicators that show the US economy has all but stopped growing from the 3.2% it managed in the first quarter: the PMI, the ISM manufacturing index, and orders for durable goods.
Orders for durable goods are down and the Purchasing Managers Index (PMI) of the countries that count are, frankly, sucking wind; Wolf Street called the US PMI figure, 50.2, "the cleanest of the dirty shirts." Germany, Japan and China were all lower.
The finance publication notes that orders for durable goods like cars and appliances have steadily ticked down since December and have shown no growth for three months in a row. The PMIs for US services and manufacturing in May were the lowest since recessionary 2009.
After the data was released GDP forecasts for the second quarter were slashed from 2.2 to 2% in the best case scenario (Barclays Plc) to 2.25% to 1% in the worst case (JPMorgan Chase).
Pouring more kerosene on the fire was another bad report released on Monday by the Institute for Supply Management. Its manufacturing index read 52.1% in April, weaker than consensus forecasts which expected 53%. Readings above 50% are seen as a sign of economic growth.
Zero Hedge notes that the 52.1% figure was the weakest since October 2016, despite a kick of new export orders and employment. The fact that three of five ISM components - production, inventories and supplier deliveries - declined, is a worrying sign that stagflation is looming, when unemployment and inflation both rise and economic growth falls.
No trade deal
The lack of a trade deal between the US and China, of course, it's what scaring everybody into thinking that we could be in for a long, protracted jag of protectionism.
China's President Xi Jinping said as much when he compared the current conflict to the ‘Long March' of 1935 and urged citizens to prepare for hardship.
Kitco quotes Scotiabank saying "A bigger move in gold" will occur when the market digests a "no trade deal scenario" whereby global growth continues to fall, inflation rates rise, equities weaken and the risk of a recession increases.
"The widening cold war accelerated with a ‘no trade deal' now the base case, after Huawei was blacklisted, tariffs were upped and China continues to retaliating most recently with weaponizing rare earths; we are in a sustained global economic ‘us' vs ‘them' war (see Copper note which goes into more detail) with dire implications for both global growth (now) and inflation (later)," Scotiabank commodity strategist Nicky Shiels wrote in a macro update last week.
The US president isn't helping matters by his erratic, careless messaging that is putting the country at odds with its so-called allies.
On Monday Trump kicked off a state visit to the United Kingdom by calling London's mayor a "stone cold loser" after Mayor Sadiq Khan said Trump is "one of the most egregious examples of a growing global threat" to liberal democracy from the far right.
Trump ended last week by impetuously threatening Mexico with 5% tariffs on June 10, if moves are not made to stem migrants from Central America. CNN Business noted that Mexico is now the United States' largest trading partner and that the tax on imports would affect just about every sector of the American economy including autos, electronics, oil, food products and appliances. [These tariffs have since been suspended indefinitely]
Yield curve inversion
In May the yield curve between 10-year and 3-month Treasury notes re-inverted, after dipping in March into negative territory for the first time since 2007. MarketWatch reported the yield on the 10-year note fell to 2.402%, below the 3-month note's 2.406% yield. An inverted 10-year/ 3-month yield curve is a reliable recession-indicator.
The yield curve is the difference in returns between short-term and long-term bonds. The curve has been inverted since May 23. The yields on long-term Treasury bills are getting worse. They should be much higher than short-term notes because investors demand a higher interest rate for holding bonds long term. On Monday the yield on the 10-year note fell below 2.07% - the lowest in 20 months - while the 30-year bond also slumped, to 2.53%.
Forbes quotes an economist at Moody's Analytics saying that the yield curve inversion spells bad news ahead for the US economy:
Generally, the yield curve inverts when investors are worried about the long-term outlook of the economy, said deRitis. Most economists say an inverted yield doesn't cause a recession but reflects negative sentiment about growth.
Meanwhile in Canada, which takes its cues from the US economy, the yield curve on government bonds inverted the most since 2007, on worries that Trump's threat to impose tariffs on Mexican imports could mean the demise of the new NAFTA agreement. Ten-year bond yields last Friday fell five basis points to 1.51%, and 17 points below the three-month notes.
Trade war with Europe?
The US Federal Reserve pays close attention to the yield curve as it is a measure of investors' confidence in the economy. The Fed had planned to raise interest rates this year on the strength of a growing economy but has since backed off considering the negative outlook for global growth and concerns over the US economy.