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Episode 35

Gold is good, bubbles are bad

Published on: July 02, 2020 • Duration: 19 minutes

This week we look at how bond yields are reflecting the growth outlook whilst equities reflect the flow. This is an environment that favours a break-out to new highs by gold. US real yields have been falling and this has been very supportive over the last few years. The Chatter looks at the resilience of assets to an increase in COVID cases, but that resilience does not extend to the real economy of small businesses. The Whisper looks at the data on the data and how retail investors are engaging with markets.

  • In the last few days, the US five year bond yield briefly touched a new all time low. Markets are grappling with the prospects of lower growth, but stronger U.S. equity markets and a Federal Reserve that is more determined to support risk assets than real growth. Although it's a consensus trade, gold should continue to thrive in this environment. That's The Big Conversation.

    A couple of weeks ago, we looked at how the US bond market may give us the clearest indication of what lies ahead. Obviously in this era of quantitative easing on steroids, where the Fed appears to be prepared to step into the corporate and government bond markets at the slightest trouble, we have to caveat our outlook with the knowledge that the price discovery mechanism is severely distorted. Nonetheless, we have seen U.S. yields rolling over again. The U.S. five year yield in the relatively neutral part of the yield curve briefly made a new all time intraday low on Tuesday, the 30th of June of under twenty seven basis points, having nearly halved from the optimistic spike high yield seen earlier in the month. The U.S. 10 year yield has also broken the uptrend. The two year yield is also back at the lows. And we do need to add another caveat here, this quarter end has been well flagged as a 'sell equity buy bonds' overhang for a lot of the balanced funds that split their allocations between bond and equities. And this is because equities have rallied hard over the last quarter since the beginning of April, whilst bonds and bond yields have flatlined over the same period, showing quite a significant divergence of performance. Asset allocators will not have just been targeting that last trading session of the month. In fact the end of day performance on the 30th of June went against the grain of what was expected. Equities rallied and bonds fell. But the size of the numbers means that they will need to spread the risk out over a number of days, maybe even weeks and months, as they adjust the allocation to their models - with only a small amount of leeway to chase the trends in sentiment that might be driving this differential in asset performance. The equity bond reallocation has been well flagged, we mentioned it earlier on in the month as something to watch through June along with the quarterly expiry. So far, however, there has been very little impact on the equity markets, suggesting that the driver of bond yields is not the rebalancing but the underlying growth and flow dynamics. The Fed has also been a little less active over the last couple of weeks as they reduce some of their emergency measures. In terms of flow there has also been quite a lot of focus on the increased selling volume of U.S. treasuries by foreigners. This should have more impact for the dollar than for bond yields, because even though the size of foreign selling on U.S. treasuries, i.e. the longer term securities, has increased, the US Federal Reserve has obviously been a size buyer in the government bond market. Even here however, the flow has been a bit more two way than the net flows for U.S. Treasury data imply. When we look at the shorter end of the curve, such as the T-Bills, then we are seeing decent inflows into the US, i.e. net buying by foreigners. As a result the overall net flows into T-Bills and treasuries has been rather more neutral with buying and selling largely offsetting each other. The direction of yields remains a key indicator about the future prospects of growth. Previously we've outlined how the initial phase in March of the sell off in risk assets was driven by deleveraging and liquidity fears. The rebound phase since then has seen the performance of U.S. equity markets and in particular a few stocks begin to drive the narrative about economic growth, even though equities have been trading off flows rather than fundamentals for the best part of five years or more. In terms of year to date performance, U.S. equities really stand out and the year today performance are the blue bars on this chart. Their performance is not a reflection of underlying economic growth, but of a concentration of economic acceleration within a few stocks and a central bank that is determined to stand behind US based risk assets. For U.S. equities, second guessing the determination of the Fed to backstop risk is the key to guessing how well equities will perform, though the entry of retail investors should keep a bid in the markets volatility A drop in bond yields from here, however, would suggest that real economic growth remains sluggish. If real growth had picked up in line with equity markets, the Fed would at least allow a limited rise in bond yields. So far most the rebounds that we've been seeing have been within the survey data rather than the real economy data. Global PMI's have bounced back, whilst underlying trade volumes have remained pretty weak. Perhaps one of the few real economy data points that has rebounded is U.S. retail traffic, according to alt-data from Unacast and Safegraph, though these may be tempered by the return of restrictions in many parts of the U.S. as the number of cases continues to rise. And this has also been seen in the UK, with the first localized lockdown being imposed on UK's Leicester. Whilst retail data has been influenced by furlough schemes, and sentiment data doesn't reflect actual volume, we can see that other real economy data which reflect animal spirits are still under duress. If China was one of the first economies to try and normalize, it's not showing up in perhaps the ultimate indicators of those animal spirits, such as the gaming tables of Macau, which would require both travel and close human contact. The May figures were as bad as they were from February through April, and this was before the latest COVID outbreaks or another round of localized shutdowns in China. Macau room bookings for May fell to the lowest level for the year. So should investors still continue to chase the market winners here? The U.S. equity market may have extended beyond the normal retracement levels, but in terms of timeframe, this is still a tricky window. A number of historically major bear markets had a rebound that lasted three to four months after their initial lows before peaking and rolling over. These include the S&P in 1929, japan in 1990, the Nasdaq in 2000, and the S&P in 2008, which is shown here. The current equity rebound in the US is just over three months old. In fact, policymakers are going to need an even bigger bailout to keep risk assets floating near their highs. Furlough schemes are due to roll off in the coming weeks and months. In many places that would crystallize the embedded unemployment that has so far been deferred by support. UK unemployment remains near the lows, which ypu can see in this chart. Even as the UK unemployment claims data has skyrocketed. Additional support will come in the form of additional QE and additional handouts, QE will at least cap bond yields. If policy support is not forthcoming, risk assets are likely to fall and this should boost bonds, though this assumes that the liquidity risk of another deleveraging event across systematic funds such as risk parity is not going to hit the market a second time. If bond yields are falling, but consumer inflation is buoyed by the very support schemes, real yields will again come under pressure, as they have done in making a new low for this move - far more emphatically than the recent move in nominal bond yields. The previous high in the gold price was just prior to the last low in real yields between 2011 and 2012. The gold price continues to track US real yields, the relationship is inverted. When real yields fall, gold rises. On this chart the gold price has been inverted. This suggests that gold should soon be testing the highs. Obviously, there are always concerns the view on gold is one of the most popular and crowded and CFTC speculative positioning is still stretched, but it has come some way off its highs. It real yields are falling gold should continue to advance. And if bond yields are to take another leg lower then real yields should once again fall, providing yet more support for the gold price. For the supercharged play, though this comes with additional risks, we can look at the gold miners. This chart is the NYSE Arca Gold Bugs - they've had a very good run off the lows, but they are still far from the highs posted in 2012 and are testing the first major Fibonacci resistance level around 300. A breakthrough that would target the 62 percent retracement level of 440, around 50 percent above the current levels. Now, just to reemphasize that these are high octane plays. The actual (or historical) 50 day volatility of gold is 13, but for gold miners, it's 45. And if you want to supercharge that further, look at silver and silver miners. So overall the environment remains extremely favorable for gold. If the economy slows down, then real yields will fall and that supports gold prices. If the economy is held up in suspended animation, it will be because central banks are still aggressively pumping the printing presses, undermining the value of currency and supporting the outlook for gold. And gold is not just for a bear market. In fact, one of the key drivers of gold's performance is the very thing that is supported risk assets and pushed U.S. equities well beyond the previous historical rebound over such a short period of time. That is central bank and government stimulus. Bond yields may be flirting with the lows simply because of the quarter-end rebalancing effects - but there is still sufficient slack in the real economy to suggest that growth remains extremely sluggish.... or that central banks and governments will still need an even bigger bailout to keep the rebound intact. And all these would be good for gold.

    [00:09:29] In many regions, the corona health crisis is getting much worse rather than better. But the ability for risk assets to shrug this off is testament to both the backstops in place from central banks such as the US Federal Reserve, and the greater understanding that people now have of the risks not just of the virus itself, but also the evaluation of the lockdown and its consequences. Back in March, we featured the work of alternative data analysts, MarketPsyche, who outlined how the lows in risk prices usually coincided with a peak in fear, but that the peak in fear usually predated the peak in both virus cases and headlines by a considerable margin. Today we obviously have cases that are rising globally at a fairly steady pace, with some of the larger developing markets bearing the brunt of that increase. But peak fear is behind us. However, it is the U.S. Which is again driving the majority of the headlines. Not only are the cases rising in absolute terms - testing volumes were increasing, but have been largely static for a few days - but the US GDP that is being affected by the rising cases is greater than it was back in April. First, here is a chart of that one week rolling average of new cases in the USA showing a clear break from the previous highs. This second chart shows the potential economic impact. On April the 24th, the four states with the highest number of new cases daily, at 47 percent of the total were New York, Massachusetts, Illinois and New Jersey, who between them account for just over 18 percent of U.S. GDP. Today, the top four states with the highest New Delhi cases at 54 percent of the total are Florida, Texas, California and Arizona and between them, these states account for just over 30 percent of U.S. GDP. The impact, however, will be less severe in terms of the speed and severity, because there is now a familiarity with the potential outcomes. Back in March, we had the uncertainty of the disease, the sudden and shocking collapse in risk assets, which was given additional impetus by the oil price war that caused a collapse in oil prices. To put the March move in the U.S. equity market into perspective, we can compare it to Black Monday of 1987, the dot com bust of 2000, 2002 and the global financial crisis of 2007 to 2008. On an annualized basis the decline in March was ninety eight point five percent, eclipsing the 1987 crash, which was ninety four point five percent. And that one started a couple of months before the historic single day drop of 22 percent of October that year. The dot com bust was only 16 percent, whilst the GFC was 41 percent annualized. This year's selloff was indeed exceptional and its rebound spectacular, but that familiarity has now hardened investors. It will be hard to shock again after that experience. So whilst investors remain wary and skeptical, this will help avoid another surprise. Investors are also now cautious about the outlook. In a recent Reuters poll, only eight percent thought the Fed's outlook for economic growth in the pandemic era was too optimistic. 17 percent thought it was too pessimistic, but 75 percent thought it was just about right. When it came to the economic data over 60 percent thought the May payrolls, which rebounded aggressively from the April's record decline, overstated the job market recovery. It's much harder to shock a skeptic. Investors do still expect the unemployment rate to drop steadily from current levels over the course of the rest of this year, but it is still expected to finish around double where it was pre-Covid. Not surprisingly, investors also expect the Fed to soothe the economy with more and more balance sheet expansion, with another three trillion U.S. dollars expected to be added by year end to take the total Fed balance sheet to ten trillion dollars. As we know, the Fed had committed to buying government and corporate bonds. And this will help soothe the equity market, although there are signs that U.S. BBB rated equities are significantly underperforming their own debt. A very similar situation to European banks, where share prices remain close to the all time lows, whilst the debt is also supported by the European Central Bank. So far, the Fed has been buying the bonds of some of the largest holders of corporate debt as would be expected, names such as AT&T and Boeing. In terms of sectors, they've largely kept their buying in line with each sector's weight within the index. Consumer cyclicals, for instance, accounted for 15 percent of the total bought and represents just over 16 percent of the index. For consumer cyclicals the numbers were twenty point seven seven percent and twenty point two nine percent. But what will further reassure investors is the Fed has not really started buying at all. They still have considerable dry powder in a marked contrast to March when no programs were in place. In terms of direct lending, the Fed has done almost nothing so far, in corporate bonds, it has barely managed one percent of its total firepower. In all the other categories it has done significantly less. This shows the confidence trick that central bankers love to use, especially since the ECB's Draghi said they would do whatever it takes back in 2012. The backstop is there, but most of these backstops remain a potential boost to liquidity and not a backstop to solvency. Whislt it would be incredibly hard to shock the market again right now, because of the magnitude of the moves we've seen so far and the size of the implied backstop, the real risk in the economy is that companies have now adjusted to working with fewer staff. Also, because of the lingering effects of COVID that continues to flare up in both Asia and Europe, people will remain reluctant to return to old spending patterns. This will alter cash flows and undermine many low margin business models. The unemployment rate will again be tested by the ending of furlough schemes, although governments may want to keep them going for a few more additional months. But if unemployment rates remain elevated, we can still expect the next phase, that of insolvency, to push through the real economy.

    [00:15:30] In this section, we look at some of the trends or themes that we can glean from the data on the data. So what's data on the data? It's the statistics on the actual data usage by market participants, such as traders, wealth managers or anyone who accesses the data and news feeds. Refinitiv have billions of data points that are used per day. There will be obvious trends and we can expect the most heavily traded stocks, for instance, or major market themes to have the highest number of data hits, both in terms of viewing headlines and accessing price and volume data. For instance, with crude oil recently rallying back, too, and retesting the breakdown levels that were created at the beginning of the oil price war, news about OPEC and crude oil inventories were regularly the top stories in tickers with Brent crude futures some of the most frequently accessed codes. It's this usage of data that can be analyzed for trends. For instance, it can highlight emerging trends that reflect shifts in investment patterns and new themes from which we can profit. In this aggregated and anonymous format we can see where momentum in data usage is beginning to build, helping to spot trends whilst they're still in their infancy. We can also see how existing themes are evolving. One such theme has been the rise of the retail trader. Since March, retail traders have been increasingly active in equity markets and have in many ways become the cheerleaders for the rally, even though there have been many other key and indeed dominant players involved. Retail has clearly been driving an interest in less well-known equity names. We can see this increase in private investor data usage on the platform, not just in the equity space, but also across many asset classes, including commodities and foreign exchange.

    Within the US, we've been seeing an increased ticker usage across some of the retail favorites, such as Hertz and Chesapeake. We've also seen an increase in the use of tickers for other smaller stocks such as Carver Bancorp. Institutional hits on these tickers has generally kept pace with the names that the retail crowd are following - the hits generally matching the move in price. Occasionally we see a name where the hits have lagged the share price. One such name is Urban One, a US community radio station, which in this case saw the rising price and volumes leading the pickup in hits on Refinitiv's Eikon platform. This was one of a number of names where the interest and demand appears to have been building retail momentum via social media. In many cases, retail investors are using these names like penny stocks, looking for short term 4X or 5X return. Many names are below the institutional radar. Retail is a new entrant. They are trading via online brokerages, via handheld devices. Following headlines and tips via social media, building a new network of stock pickers with a very different set of criteria to the existing and pre-Covid trader base. This may be a short lived flash in the pan based around a few mini manias. But it also could be indicating a shift in the wavefront of investing in which the individual investor, many of whom cut their teeth on Bitcoin, are trading using technology and media in a new way. The data on the data suggests that we may need to watch this wave of momentum investing in case it develops into a permanent style of investor base.