Metals Thoughts: Light at the end of the tunnel
Tuesday, March 07, 2017
Gold prices are off about $25 in the last week and silver off an impressive $1.50. Our gold longer term models based on rates and currencies still shows some further weakness to come, but I think that with the Fed March hike now priced in and some support from moving averages, it’s more of a mixed bag. See Table 1 for some analysis on when we might break this low vol period.
- A turn in equity markets could have investors seeking havens, of which there are few more attractive than gold at these levels (neg correlation).
- 50 dma and 100 dma almost converging for support at 1212-1210 area, which should be stout support.
- 1216 was the mid-February low tick and will also lend a hand or at least some words of positive affirmation.
- Longer-term: if the Fed is behind the curve on rate hikes, asset prices, rates and metals can all head higher vs. negative real short rates.
- Simpler long-term: investors aren’t rotating out of assets and into long bonds until they think hike cycle is nearing completion.
- A turn in equity markets could have investors solidify gains, de-risk and go to cash or short duration bonds while waiting for more attractive opportunities amidst higher expected rates (pos correlation).
- Gold positioning in last week’s CFTC report reached new 3-month highs for net longs.
- The DXY continues to strengthen and looks to test the 102 resistance. December highs were just under 104 for comparison. That would be a strong tide for gold to resist should we break through.
- Real yields are gaining ground for the first time since November. Real yields, not nominal are our most important input to metal prices.
- 10-year nominal yields looking to test the 2.6 percent Dec. highs
- Even with the sell-off, silver is a very crowded long by almost any metric with very little follow-through in industrial or investor physical demand.
- At the start of the year, long USD was an extremely crowded trade and we have seen the excess mostly scrubbed out and are back to October levels.
- Platinum is a bit of a crowded long as well and seems to be going through some major changes with the reversal of popularity in diesel engines for passenger vehicles, particularly in Europe.
We’ve been doing some work here at analyzing prior recent low-volatility regimes and their duration/outcomes. While our current doldrums date back to early August 2016 (216 days) and have now passed the average duration of our observation set (195 days), one important indicator has not yet triggered, which is the spread between 1-month and 1-year vols (2nd column from right).
The average level of one year vols (3rd column from right), however, is actually below the ending average level for prior cycles (15.6 percent), so a move in 1 month could have a healthy result in resetting the options market. In the last two weeks alone we have seen the long end of the vol curve get sold fairly hard, off 1 percent since Feb. 24 from 16.3 to 15.3 percent.
With macro conditions being a bit precarious, we could be nearing the light in the tunnel. "No leaf clover," anyone? Whatever it is, we don’t expect the catalyst to be driven by the white house so much as by the Fed, though we may be using that as a convenient excuse to turn down the noise.
Crude oil positioning. Everyone seems to be bullish crude right now for a variety of reasons (Bakken shale depletions being the most recent) and yet OPEC exports are trending higher. Last week actually saw a slight reduction in what I’m sure was a disappointing long for many, especially with some reasonably expensive contango to pay for futures rolls.
We are merely tourists in the energy space, but crowded longs with little momentum and some persistent put skew with depressed vol levels (selling calls against long outrights?) make us nervous.
Thursday's ECB decision and Friday's NFP fill an otherwise very slow multi-week period for data and I think next week’s Fed is basically a known quantity at this point, so we don’t expect much in the way of fireworks.
If Fed were up in the air, this would be a massive NFP, but I think it would take a serious outlier to shift expectations at this point and after Kashkari’s speech yesterday, we are into the enforced quiet period from FOMC members.
We think we are range bound between the moving averages of 1210 and 1262 and unless the paradigm changes, I’m not sure what pushes us beyond that. Since we are at the lower bounds, would expect some mean reversion.
Have a great week everyone. The ACC hoops tournament began midday today. Go Deacs.
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