Drivers for Gold Price Movements and Equity Rallies

by Victor Sperandeo with the Curmudgeon

Disclosure: The views expressed herein are those of Victor Sperandeo, who is a long term investor in gold. Victor recently bought 260 pounds of silver dollars. He is not looking at the intermediate term view of Gold and Silver [which is down (70.6%) from the all-time highs].

Introduction:

Gold futures on Friday extended their losing streak to a seventh straight session, settling at their lowest level in more than three months with a weekly decline of 4.7%. Gold dropped like a rock after a better-than-anticipated jobs report made a December Fed interest-rate rise look more likely.

Gold seems to puzzle many market investors and traders. They often ask why the gold price unexpectedly rises and falls, often with little or no catalyst. Also, who or what entities are affecting the gold market?

The primary factors affecting the Gold market (and most commodities) are: China, the U.S. dollar, the trend of interest rates, inflation, economic growth, and equities. Let’s examine each one of those factors.

Discussion:

1. China-

Strength of China's economy is critical, because it is the world's largest user and buyer of gold and other commodities. One should heavily weight China's "economy" to commodities, and especially gold, more so than its stock market.

Currently, long term commodity trends, including gold, are disconnected from China's equity market (see 5. below for more on this). The Shanghai Composite is up 17.0% from 9/28/15 when the IMF flip flopped on considering giving China reserve currency status.

IMF Reserve status for the Yuan is a “fait accompli” gift. The official announcement should be any week in November. I have stressed this as being the critical reason for rallies around the world in equities. A WSJ editorial on November 3, 2015 "Converting the Yuan" confirmed my view:

“As the yuan becomes more widely accepted, foreign governments and private institutions will accumulate yuan-denominated assets. And as money comes in on the capital account, it will need to go out on the current account to pay for imports."

It's been estimated that the Yuan will get a 14% IMF reserve allocation. Since the 9/28/15 FT article “China’s renminbi creeps closer to global reserve status,” the equity market discounting process has been profound. It is apparent in the rallies in the U.S. (S&P 500 +11.6%) and China (+17%) stock markets. The official IMF announcement will be at least a short term high in my view. So depending on when it will become effective, the markets will adjust equity purchases to the flow of funds into equities in China.

This has a small effect on gold as China's economy will be little effected by the appreciation in equities (think of it as a new type of QE). The official estimate for China's GDP of 6.5%, which is down from 6.8%. No professional believes this number. It is said to be 2-3% by insiders. The bear market for China's economy is intact, and therefore gold will continue to be under pressure.

2. The Dollar -

The greenback is now at new intermediate highs dating back to 4/16/15. The rally began from INTERMEDIATE LOWS ON 10/15/15, while Gold's INTERMEDIATE HIGHS WERE ON THE SAME DAY. Also, Bonds made an INTERMEDIATE CLOSING HIGH ON 10/14/15. GOLD AND BONDS are in downtrends and the dollar is in an uptrend because the Fed claims the economy is strong (?).

After her Congressional testimony on 11/4/15, the newspapers were full of headlines like this one from the NY Times: "December Interest Rate Increase Is a Live Possibility, Janet Yellen Says.” That was before the (ultra-hyped) October U.S. Payroll report of + 271,000 new jobs and a 5% unemployment report, which now provides the Fed with the COVER they need to raise rates 25bps on 12/16/15. Ironically, the Fed Funds rate was reduced to zero 7 years ago on 12/16/08. Of course, this is the current market perception and can change based on new economic reports from now till the December FOMC meeting.

3. Trend of Interest Rates and Monetary Policy -

U.S. interest rates are now headed higher (subject to change) and obviously this is a negative for Gold (and the economy). Interest rates for most of the world are heading lower and Gold appreciates in those currencies. However, gold and other commodities are trending lower in dollar terms. The Bloomberg Commodity Index touched a new 5 year low on Friday. The DJP traded at $23.44 and closed at 23.58 (-21.16%). The S&P GSCI ETN is down (-25.69%) due to its heavy energy weighting.

Here's my outlook for global interest rates:

The U.S. will likely raise rates only once¹ before the 2016 election. That’s all folks!
The UK will keep rates the same (at 0.50%) and projects only a 1% rate by the end of 2018!
That's high relative to the EU which has negative rates in some countries.
Japan left policy unchanged at 0-10 bps.

Note 1. The U.S. Fed Funds rate is 0-25bps currently and will be increased to 25bps-50bps at a future FOMC meeting.

4. Inflation and GDP Growth-

Both are weak to stagnant at 0.1% to 2.0% virtually worldwide. This is largely due to the use of Keynesian monetary policies and deficit borrowing mixed with government spending to stimulate consumer spending. Austerity in the European Union is not working. Yet governments demand they work by doing more, not switching policy? This 'stagnation is causing hoarding of cash and historically low velocity of money, and therefore very low "headline inflation," which is bearish for gold and commodities.

5. Equity Markets -

The opposite of a downtrend in commodities and gold is occurring with rising equities, with some at new all-time highs (NASDAQ and NASDAQ 100). This is an additional reason gold and generally all commodities are trending towards new lows. It's classic and typical as those asset classes are (usually) non-correlated to each other.

Conclusions:

I strongly believe the economic policies of most of the world are not sustainable, and will change to recession, depression, and chaos. That will eventually cause hyperinflation, but it is impossible to time.

The European economies continue to be weak. I believe the EU will break up and end as a single entity at some point in time. Japan with a "stated" 2.30 to 1 debt to GDP ratio is in worse shape than the U.S., which is declining rapidly. Global equities and the business cycle are near the top of their recovery highs.

Thereby, gold is acting normally and it is a time to not be too concerned with the down trend. Why?

Perhaps a quote from my first book "Trader Vic -Methods of a Wall Street Master" (written in 1988-90, published in 1991 by John Wiley & Sons) should be considered. From page 34- Finding Order In Market Chaos:

"The stock market is a collection of individual human beings, and human beings are fallible. With almost every stock trade, one person is right and another is wrong. While the averages do in fact represent the net effect, or a “collective wisdom" of market participants judgements about the future, history shows time and again that millions of people can be as wrong as one, and the stock market is no exception. The nature of the market simply allows participants to ADJUST AND CORRECT THEIR ERRORS RAPIDLY. Any method that claims that the markets are infallible is flawed at the roots."

The key phrase is “adjust and correct their errors rapidly," which unlike elections answers why volatility is almost always a downside phenomenon. It is the same for all markets, and when markets transition from down to up. This should be firmly kept in mind after a five year decline in commodities and gold.

Till next time…

The Curmudgeon
ajwdct@sbumail.com

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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