Good Morning.. A quiet day on Wall St but a very mixed session in Asian markets where we saw Gold race higher again having breached $2000 in the US session. This is the topic of great conversation and it seems that gold is the hedge against everything all of a sudden. I guess with manipulated bond markets that no longer move freely to signal future inflation, they have a point. But at the core of this is Fed policies and a weaker USD. The Fed is probably going to have to do more bond buying as the Treasury issues a Tsunami of debt, which is likely to be added to by a new bail-out programme in the next few days. The numbers are staggering and the Fed will continue to debase the USD buy printing more toy dollars. Gold bugs say beware of inflation but that may be some way off and it would take solid growth and consumer spending to shift all the money sloshing around the financial markets to shift to the broad economy but I guess markets are forward looking. A lot of services PMI data today and last night saw some disappointments from China and Oz. US ADP today as well as we gear up for Claims tomorrow and NFP’s Friday. Could be a choppy week still and I still think this USD is headed lower. I have also recommended adding EURGBP to the portfolio (see below).

Keep the Faith..

Details 05/08/20

Gold blasts through $2000 and the USD resumes its fall: The BoE meeting and buying EURGBP:

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As I type this piece, spot gold is trading at $2023 as it accelerates through the psychological $2000 barrier. It is strange as while gold has been rallying as the USD fell, this time it seems to have led the USD lower. But the two are linked and at the core of this move in both the USD and gold is the Fed. The Fed is clearly going to have to do more bond buying as the issuance coming down the pipe is already huge and that is before a new bail-out programme has been agreed upon and that will likely be a minimum of $1trln. There is not the demand for this kind of issuance and so the Fed will have to place itself as the buyer of last resort and that means the balance sheet will expand even further and printed money will flood the system with make-believe dollars. Whether gold is rising on inflation fears too, is an interesting question with US real rates at -1% though. Below is a monthly chart that resembles a 4hour chart as the move has been so strong.

But forward-forward rates 5years out suggest there are growing fears of what all this liquidity may produce. Of course, to get inflation, we will need to see this wall of money move from the financial markets to the broad economy and for that we need growth and a confident, spending consumer. Right now, all that money is handed to financial markets and the velocity of the money is still falling and so we face a deflationary period as banks are cautious lenders and demand for loans is weak..

But markets are forward looking and the weaker USD triggered a strong bounce in many commodities, sending prices higher. The 35% rally this year has made gold one of the world’s best-performing mainstream assets, reflecting concerns among investors over the implications of money printing, the danger of over-valuations in stocks, rising geo-political risks and the dominance of central banks distorting bond markets; broad uncertainty is pushing many into gold and I do wonder if some asset managers have added a small portion to their portfolio’s now. I said many weeks ago, that if we saw that happen, gold may have a supply issue. The yellow metal (and the silver one) are seeing some significant inflows and investors stashed a net $7.4bn of cash into gold-backed ETFs last month, according to data from the World Gold Council — adding to the record $40bn they invested in the first half of the year. That is more than just a few speculative entities taking part in this in my view.

The problem for investors is that bonds have lost some of their status as a safe bet against inflation due to the manipulation and dominance of the central banks and the Fed seems to be following Japan’s template. YCC would exacerbate this and turn more towards gold as bond markets lose their ability to move freely and forecast future inflation. Gold is back where it was many years ago as an inflation hedge. Lets just hope the Fed does not decide to intervene and stop gold moving freely as it is one of the last free markets out there. I hear a lot of twaddle about gold investors and bond investors can’t both be right but why not? Bonds are not the indicator they used to be due to central bank dominance. But risks remain and gold and silver have a nasty habit of having some serious reversals too, especially if the USD rallies. But for now, I remain a USD bear and this EUR may take out the highs above 1.1900 again soon as sentiment against the USD remains weak and the Fed is going nowhere with policy for the foreseeable future. According to the clever people at BoA, Gold is still under-owned by global investors relative to global stocks, with less than 3 per cent of their assets in the precious metal. In 1980, allocations were as high as 6.2 per cent, the bank’s analysts said. A move back to that rate would see gold a lot higher and it is growing in popularity. When you factor in inflation, the all-time high of gold is about $2,500 (when Soviet tanks rolled into Afghanistan in 1979).

Just what do US bond markets tell us now and as I said, they have lost a lot of their signalling power? US Treasury yields closed at new lows on Tuesday and may be partly due the belief that the Fed will be forced back into buying and maybe some interest to hedge against seemingly high equity markets. The divergence between what bond and gold investors see coming and equity investors has never been greater but again can they both be right? For now it seems yes but the question is what can tip equities over and right now there is a complacency that the Fed will not allow a significant move down and if we take Powell at his word, they are probably right. So in a way, we have the Fed distorting not only bond markets but equities too and so both can move in tandem in this weird and topsy-turvy world in which we now exist in. There’s an extreme level of divisiveness and it is turning the world, not to mention the financial markets, into a casino where no one really has a handle of the odds of either the game or what is ultimately at stake. Risk premia are eroded for high risk assets and no one cares, they keep buying! Right now we face a phase of deflation but can we be sure that this massive global money printing will not have an impact or a nasty side-effect attached to it at some point in the future?

The inflation vs. deflation debate remains one of the more hotly contested ideas in the marketplace today. The inflation hawks argue precious metals are a one-way street higher while cash is trash, and bonds are worthless. The deflationary crowd continues to play with the multi-decade trend arguing that interest rates are not done falling, and more gains are left with nominal Treasury bonds. But one of the dangers to equities is a much slower recovery as I am not sure how much more governments can spend on propping up their economies going forwards and a slower recovery means weaker earnings. As a result of the weakening economy and high levels of public and private debt, banks are likely to maintain their reluctance in extending high quantities of new loans. Similarly, the capacity for borrowers to demand new loans for productive investment will remain low and the consumer still seems reluctant to get back to the lifestyle they once had over fears of the virus and job insecurity.

I note with some interest some disappointing services PMI data out last night from China. Services came in at 54.1 after 58.0 expected and we saw weak services in Oz and Japan (Japan still some way from recovering above 50). I think a lot of global data is going to start levelling out after the natural surge after unlocking economies. Of course, it is unemployment data and consumer behaviour that is at the core of all this and is why the rest of this week is so important. Also this week, we get the BoE meeting and I will be very surprised if the BoE is still signalling a V-shaped recovery and I will be interested to hear of ongoing talks regarding negative rates.

Line chart of UK GDP (2005 = 100) showing The MPC’s forecast in May was for a ‘V’-shaped recovery

I think they can forget that chart above now and I would think with regional lockdowns, as virus cases rise and unemployment looks likely to continue rising, they will be rather more dovish when it updates its quarterly projections on Thursday. This meeting is ridiculously early at 7am London time and so I will cover part of it today. No one is looking for a cut but I think the market is going to be looking for some forward guidance from the Bank. If the BoE’s new projections show a slower recovery, it will be taken by markets as a signal that policymakers may consider a further expansion of the asset purchase programme later in the year or even consider negative rates which are starting to get priced in 2021.

In the UK we have millions of workers furloughed and the big question is how many will still have a company or a job to go back to and even if they do return to work, how many will hold their jobs if we see draconian cost cutting measure as companies struggle to stay alive. Unemployment is in danger of rising rather fast in my view into the end of this year and the BoE needs to set policy for the future; not today. But they have already done a lot and the government is spending like crazy but how much more can both do? The government is putting plasters on a gaping wound and they just hope that we get through this soon as they cannot go on forever funding firms and the unemployed. The BoE has rates more or less at zero and to be honest, probably realise that more QE will not help the broad economy. But the BoE also knows that a lot of Treasury issuance is coming and need to be prepared to buy if demand falters, which it probably will. On top of all this, we still have Brexit hanging over us like a dark cloud and talks have been pushed back to the 11th hour in October. If we end up with no deal then firms will not have any time to adjust. I am wondering if EURGBP is headed back up and I am prepared to dip a toe in here and buy at .9030 with a tight stop down near 8950.

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Strategy:

Macro:.

Short USDJPY @ 105.25.. Stop at 106.75

Long EURAUD @ 1.6250 Raising stop to 1.6400.

Long EUR @ 1.1762 looking to add at 1.1705. Stop at 1.1530.

Long EURGBP @ .9030.. Stop at .8950ish.

Brought to you by Maurice Pomery, Strategic Alpha Limited.

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