Metals Thoughts: Summer break
Tuesday, May 10, 2016
With summer rapidly approaching, it seems an appropriate time to hit pause on our weekly focus. Let's take a look at our broader, medium-term macro outlook and establish where upside and downside risks to our base case exist. Here's my version of a summer long-form beach read.
We have said for the last month that gold seems incredibly overbought and due for a big selloff once the momentum subsided, yet it has found support each time off the prior lows and some new (mostly futures) buying came in as dollar weakness pervades (XAU/DXY correlation almost -90 percent). I had been assuming this year would be similar to each of the last four, where first-quarter growth is anemic, but then tightening discussions re-emerge and the USD strengthens along with domestic growth, and gold gets sold back lower.
While I still believe we will see some semblance of improved sentiment in the macro space as the year goes on, we continue to disappoint for anyone thinking we will return to normal, whatever that means. Basically the degree of hope in upside surprises seems to be waning.
Put simply, the basic paradigm doesn't seem to be changing, and this year there doesn't seem to be anything to make investors think it truly has. Without a major catalyst — geopolitics always seems like a decent candidate, though psychologically overvalued — there doesn't seem to be a reason to get most punters off the couch to make major portfolio changes.
If that persists, we may not get the big correction in metals we have been looking for unless some major spec futures length comes off in a hurry. Given the aforementioned correlation/co-dependence with the dollar then, we are probably looking at broader macro for the next major move.
We define the base case as such (and number them so you can quickly refer back if I'm wrong later or you disagree now):
- Consumers are deleveraging, especially in the U.S., but broadly all over the developed world. Household leverage and consumer spending as percent of income are both lower.
- China is muddling through a major economic and governance transition. More urbanization and consumption focus, and less corruption and central planning. It takes a long time.
- Employment is strong but running out of room for continued upside without wage inflation — the key one to watch for change.
- Little to no productivity growth and almost zero price inflation — low risk of change here.
- Corporate earnings are mediocre due to all of the above, and multiples are near cyclic highs — other one that can change without external catalyst.
- Global ZIRP/NIRP are not going anywhere. Fed can hike once or maybe twice this year and core outlook remains.
- Somewhere between The Great Financial Crisis (!) and the asymmetric recovery, the vast majority have lost faith in "the system" and take less risk.
Until one of the above changes in a major way or several make a shift in trend together, we have little reason to think much will change from the current state of affairs. There is some concern that a lack of earnings growth (some define us as being in the fourth quarter of an earnings recession) could finally take the heat off our high-ish equity multiples.
To be clear, the current state of affairs isn't altogether terrible for global macro. It's just that many investors seem to be pining for what could be instead of what is, and the other contingent is looking for some mega-meltdown (see our last tenet). Neither side has any clear evidence they have been disproven yet, and cognitive dissonance will probably make sure that remains for some time.
It will, though, ultimately change, and it's entirely possible that 12 months out we have some garden-variety 2-3-quarter mild recession and some Chicken Little panicking in markets only to realize we are fighting the last war again. That may reset the table a bit, but who knows, in the interim Donald Trump could try to strong-arm an increasingly itchy Kim Jong Un. Then we all get to relearn that safety from nuclear attack means getting under a desk.
My only short-term comment is that futures positioning for both gold and silver (in both specs and managed money) has crossed the "all-time" threshold. That's terrifying considering the last time we made new highs in positioning, the world was falling apart, physical was flying off the shelves, the ETFs were doing nothing but grow and spot gold was $1,830.
It did not precede further gains.
Some of the signals (EFP, GoFo, lack of physical demand and call skew) have moderated in the last week, but there may be some real pain ahead as open interest has only grown. Our failure to break and hold $1,300 and then hold the $1,270 double support points for lower, but we might have to remain patient as we have for the last several weeks before the CTAs start the profit-taking waterfall. $1,248 50 DMA next real support.
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