The Week Ahead in Gold

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The gold market hit a 6-year high in recent trade and appears poised for further upside. The metal may be vulnerable, however, to a corrective pullback before seeing a fresh leg higher in price. The market currently has several tailwinds working in its favor, and the trading week could bring with it fresh news that could propel the market beyond its recent highs.

The ongoing U.S./China trade war is having a measurable effect on the economies of both countries. Since talks broke down several weeks ago, there has been little, if any, dialog between the two nations on trade. U.S. President Trump is set to meet with Chinese Leader Xi Jinping later this week at the G20 meeting in Japan, and markets appear to be pinning their hopes on some productive talks being had. Progress towards a long-term agreement could have far-reaching implications for global markets and could fuel a major shift in investor sentiment. If the two leaders are unable to find any common ground, the ongoing dispute could pressure stocks while keeping gold and other perceived safe haven assets on the offensive.

Current U.S./Iran tensions are also playing a role in recent market action. Over the weekend, the U.S. reportedly announced that it had launched cyber-attacks against Iranian assets tied to the Revolutionary Guard. This action comes on the heels of a reported military strike that was called off at the last minute by President Trump. The U.S. is also set to impose major new sanctions against Iran this week that could potentially stir the pot even further. If Iran is not willing to come to the bargaining table, the potential for military conflict will hang over markets and likely keep a floor under gold prices.

A slumping dollar index may also be an area of focus this week, as the greenback recently traded at a 3-month low. The dollar is likely feeling the effects of an increasingly dovish Fed as markets price in a July rate cut and the strong potential for additional cuts later this year. In addition to the Fed’s about-face, the dollar may also be under pressure as the effects of recent tax cuts and government spending fade.

The gold market currently has a combination of economic and geopolitical factors working for it that could keep the market moving substantially higher. The increasing risk of a global recession, the potential for lower rates, a weakening dollar and numerous geopolitical risks may keep the yellow metal well-bid, and a run higher of another $100 per-ounce or more in the weeks ahead seems to be an increasing possibility.

Current market fundamentals could be considered highly bullish for gold, and the market’s technical posture is now also pointing to further upside. The market is now in an accelerating month-long uptrend on the daily chart, and the bulls may look to test a solid area of resistance around $1450 in short order. A breach above this level on closing basis could set the stage for a push towards previous all-time highs over $1900 per-ounce in the months ahead.

Summer Shift

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Central bank policy decisions and the direction for interest rates have once again captured the focus of economists and financial market analyst’s midway through 2019. The ongoing trade dispute between the United States and China, which has entangled Canada through the extradition hearings of a CFO of a major Chinese technology firm, has continued to increase business uncertainty and has the potential to further weigh on economic growth.

The result has been scaled back GDP forecasts for the Canadian and US economies, and an expectation for a return to accommodative policy from the US Federal Reserve with the Bank of Canada destined to follow their approach. The challenge with the heightened level of anticipation of seeing interest rate cuts from the two central banks is the great level of unpredictability around the destined outcome for US-China trade terms. With that said, the US Fed has softened their stance through 2019.

The question is, why?

US Federal Reserve Chair Jerome Powell may have had one of his career-defining moments in early June when he stated the Fed will act “appropriately to sustain the expansion.” Half a year earlier there was overwhelming evidence of friction between the way this apolitical official conducted his job and the president that appointed him, but the feds stubbornness to a path of steady and higher interest rates seems to be coming to an end. Whether this was a result of political pressures from the oval office or foreseeing lingering economic uncertainty from an unresolved trade dispute is unknown.

What will be difficult to foresee, however, will be whether the Fed is proactive or reactive in its policy approach to a global slowdown or recession that many seem to be predicting. Different US economic indicators in recent months have shown signs of manufacturing slowing, or the labour market stalling in the US (despite being near full employment) but forecasting the duration of this trade war between the worlds top 2 superpowers is a ‘known-unknown.’

Signs of a prolonged dispute have investors fully pricing in odds of the US Fed cutting interest rates in July. Any negative impact felt by the US economy will be reverberated north of the border, and that will especially be the case should tariffs continue to increase and policies become much more punitive and protectionist. The Bank of Canada’s reaction to a rate cut from the Fed may not be immediate, but it will be highly likely for them to follow.  

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The Week Ahead in Gold

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Is the next great financial crisis already in the making? That may be the question many investors are now asking, and recent economic and geopolitical developments seemingly suggest that the next major recession could hit as soon as next year.

The U.S. Fed is widely expected to clear the way for a July rate cut at its meeting later this week. A rate cut by the central bank would be the first in more than a decade and could set the stage for additional cuts in the months ahead.

An increasingly hawkish Fed had been a major risk for financial markets in recent months, but the central bank has now done a major about-face and turned increasingly dovish. The problem is, any action taken by the central bank may not be enough to stop the next financial crisis.

Among the key risks faced by global markets is the ongoing U.S./China trade war. Thus far, neither side has been willing to blink and hopes for some progress being made at the upcoming G20 meeting appear to be fading fast. If the situation escalates further, both nations could impose additional tariffs or take even more drastic measures. Imagine, for a moment, that China decides to close its markets to U.S.-based multinationals like Apple.

Such a scenario would be enough to send shockwaves throughout the global financial system and there would be little, if anything, that central banks could do to right the ship.

The war on trade isn’t the only problem. Oil poses another potential risk that could have a ripple effect on global markets. The U.S. has taken a hardline stance with Iran, and rhetoric between the two nations has grown increasingly tense. Last week, two oil tankers were attacked in the Strait of Hormuz, a key shipping lane that is one of the globe’s most strategically important choke points. Any shocks to the oil market could see prices increase rapidly by $7 to $10 per-barrel.

The combination of increasing tariffs and higher energy costs could potentially have a significant impact on disposable income. As consumer spending sees a sharp decline, companies would also likely begin to cut back on hiring, investment and expansion plans. This could set off a chain reaction that could force the global economy into recession despite any further action from the Fed or other central banks.

Clearly, some investors appear to be getting the message. The risks to the economy are on the rise, and now may be the ideal time to add diversity and to cut down on equity market exposure. Money managers have been increasing their bullish positioning in gold for the third straight week, and the market has seen an increasingly bullish technical posture.

The market is vulnerable to a pullback at this point, however, and some back-and-fill trade may even be a good thing before the market attempts to push higher. Against the current economic and geopolitical backdrop, gold appears poised to continue its recent ascent. The only major potential roadblock at this point could be if the Fed does not meet increasingly dovish expectations. Even if that is the case, prices are not likely to fall far, and investors may be happy to scoop up the metal on any significant dips.

Two Bullish Calls

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There were two notable bullish calls for the yellow metal this past week. One was from hedge fund manager, Paul Tudor Jones, and the other from DoubleLine Capital founder, Jeffrey Gundlach, who is regarded by some as the ‘bond king’ for his past forecasts.

Their investment outlooks for gold were related and echoing other large-scale investors over the past couple months. In Jones case, it’s based on the belief of the possibility the US could be headed for recession. In Gundlach’s case, after accurately forecasting the volatility in fixed income markets over the last couple months, he now sees a lower priced US dollar by year-end. The lower dollar will be the result of a US recession, interest rate cuts from the US Federal Reserve, and a towering US fiscal deficit.

These calls coincide with markets this week moving on investor expectations the US Federal Reserve will cut interest rates 3 times by year’s end. What’s head-shaking is how quickly this shift has taken place from the US Federal Reserve’s hawkish bias that was much more present into the beginning of 2019. At the close of markets Friday, investors were pricing in 68% odds of a rate cut at the Fed’s July meeting, and then two subsequent cuts by the end of the year.

What gives me pause during weeks like this, coinciding with a regain in confidence in the recent turmoil in equity markets, is asking the question, what’s changed?

Fed Chair Jerome Powell may have had his Mario Draghi moment a couple weeks back, when in a similar scenario back in 2012, European Central Bank President Draghi pledged to do “whatever it takes” to save the euro. What followed was President Trump’s threat of additional tariffs on $300 bln worth of Chinese imports to the United States. Alas, the US President may have succeeded in his wish that the US central bank, that’s supposed to remain apolitical, may be shifting to his corner in this escalating trade war.

Towards the end of the week, China’s economy showed continuing signs of softening. Manufacturing data for industrial output experience the slowest growth in 17 years as their export sector now shows clear signs of the impact and damage of US tariffs. Still, stimulus measures announced by the People’s Bank of China signal the Chinese government stands ready to dig in their heels. There is no shift in sentiment yet that tensions will ease between the world’s two superpowers, and thus the calls for a demand for safe-haven assets like gold.

Jones had a simple way of justifying his market outlook. To paraphrase, the cooperation and policies towards globalization and increases in global trade that fueled economic growth for the past 75 years are coming to an end. His forecast is for gold to take out $1400 US/oz and then not to wait too long to see $1700 US/oz. In some regards, it resembles a fearmongering depiction of the world, but it seems this scenario is becoming a little more prevalent again.

The Week Ahead in Gold

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The last week saw gold and stocks rallying together and that positive correlation could have some room to run still. Stock investors are now seemingly cheering on bad economic news as any misses in key data points could bolster the case for lower rates.

On Friday, the U.S. Department of Labor reported that the country added just 75,000 jobs in May. That figure was far below consensus estimates for a gain of 185,000 jobs while the unemployment rate was steady at 3.6 percent. Revisions were also made to March and April jobs figures that brought the three-month moving average of gains from 245,000 in January to a current reading of 151,000.

The weaker-than-expected non-farm payrolls report followed an ADP jobs report earlier in the week that showed the smallest increase in private sector employment in nine years. According to ADP, the U.S. added just 27,000 private sector jobs for the month.

As the economic data has become increasingly murky, stock investors have turned their hopes to the Fed and the potential for a series of interest rate cuts. Despite the poor labor market data, the Dow Jones gained some 4.7 percent for the week while the S&P 500 added nearly 4.5 percent. The tech-heavy Nasdaq didn’t miss much either, adding nearly 4 percent for the week.

The market appears to have entered a phase in which bad news is good news, and investors feel confident that the Fed will ride to the rescue as markets and the economy sputter.

The ongoing U.S./China trade war and an aging business cycle could keep the U.S. economy under pressure. The longer the war on trade continues, the more that pressure will increase. The Fed seems to recognize the effects that the trade war is having, and it would not be a huge surprise to see the central bank cut rates as soon as this month. Although an initial rate cut of 25 basis points seems like a sure thing at this point, it remains unclear if the Fed will have to be more aggressive.

The combination of weaker stocks, a decelerating economy and lower rates could be a great recipe for higher gold. These issues could all have a significant impact on the dollar index, which has likely kept gold prices in check in recent months. In addition to a slowing economy and lower rates, the U.S. currency may also have to contend with fading tailwinds from tax cuts and government spending. That same fiscal spending has also caused the U.S. deficit to skyrocket, and at some point, the mounting U.S. debt will become an area of focus.

Strong fundamentals and an improving technical posture could see the gold market gather further momentum. Recent data from the CFTC showed that money managers tripled their long exposure to gold in the most recent reporting period, and ongoing concerns over global growth are likely to keep the metal on the offensive.

Late Cycle Characteristics

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The performance of North American equity markets in May illustrated the escalating tensions between the worlds two biggest superpowers. The S&P 500 fell 6.5% for its worst month of the year and the Dow Jones Industrial Average posted its sixth straight weekly loss, which tallies the longest slump for the blue-chip index all the way back to 2011. All this is in part inspired by the free-spirited (or irresponsible) nature of the American president, and the level of unpredictability, to put it aptly, is astonishing. The continued surprises for financial markets are far beyond what could be imagined.

Beyond the headlines, though, I was struck by a couple of stories this week looking at corporate debt. The first was a headline from the world’s largest brewer, Anhueser-Busch InBev, who’s looking to venture further beyond beers sales in order to drive up sales or top line revenue. Essentially, the change in consumption habits by consumers of alcohol have seen declines in beers sales, putting pressure on select markets. Beyond the details of their business, it was a story of a major multinational company that was apart of a major debt financed acquisition in just 2016, and at the beginning of the year sat on over a hundred billion dollars in debt.

The theme or story for AB InBev doesn’t seem all that different from other multinationals that have taken on debt to finance acquisitions or growth. Companies with stalled or troubled top line growth like Kraft-Heinz, Sears, or General Electric come to mind. The notion was a simple one emerging from the financial crisis. A market was saturated and the easiest was to find profit growth was to acquire or merge with your competitor and create synergies and/or massive cost savings. It’s even what’s being proposed between Fiat-Chrysler and French automaker Renault this past week. The troubling part of the story could be when the cost savings don’t materialize.

Moody’s Investor Services came out with a warning this past week on how there could be potential trouble in the corporate credit markets. The lowest level of speculative grade debt represented the largest share of corporate debt issuance in 2018. At 44%, it was double the level it was in 2007, preceding the subprime mortgage crisis and a series of corporate debt defaults. With Moody’s warning was that the environment remained stable today; however, scenarios like slowing earnings growth or higher interest rates could be troubling and create additional financial pressures.

The Chief Investment Officers of PIMCO this week also issued similar warnings for the global credit markets and what they referred to as the riskiest credit markets ever. Like Moody’s, they don’t envision an imminent market triggering event, but they do see liquidity and quality issues in the credit market, and the question is certainly how that relates to the broader markets. Another part of PIMCO’s call was a continued flight to US treasuries because of a lack havens, quality and safety.

No imminent shock suggests a “status quo” environment for the time being, but phrases like a credit market with “late cycle characterises,” like 2005-2006 is a pretty loud warning for investors.

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