New Year, New Targets

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For nothing more than an arbitrary statistic, as of Fridays close gold prices in US dollars are already up 2.3% on the year. That follows an approximately 4.5% gain in the month of December. The market technicians will remark of the strengthening seasonality picture this time of year also. Gold in January has averaged 3.4% gains over the past 10 years and for the last 5 years has gained every January between 3-8%. Examining fundamentals, several major market moving headlines over the past month can be turned into a bullish story for gold.

 

The gold market has momentum. The market moving forces of a weak USD dollar and the positive global growth story resulting from the anticipation of the US and China inking a Phase 1 trade deal has ensued a risk on trade. Additionally, events at the end of last week adding to heightened tensions between the United States and Iran have renewed gold’s geo-political safe-haven bid. It also can’t be forgotten that a strong base for the precious metals was provided by the theme of central bank easing in 2019 where we witnessed a 10 year high in terms of the percentage of central banks cutting interest rates.

 

Looking at the central bank picture, minutes out of the latest FOMC meeting released last week also revealed a heightened level of caution. Officials at the US Fed seemed focused on risks to the US and global economy. Current discussion is whether heading into another election cycle there is the possibility for a rate cut from the Fed. Nonetheless, a consensus seems to be building that the Fed would opt to let inflation run a little higher before being quick to raise interest rates.

 

In a gold market like this, where every headline seems to appear bullish, it might be wise to exercise some caution. A pull back following a geopolitical (war-type) spike should not be a surprise as investors can sometimes be a little overzealous or too cautious entering the safe-haven hedge. There seem as many historical examples of where a geopolitical induced rally has been short-lived verses being sustained. Ultimately it seems the dollar should be the area of focus right now with the Bloomberg US dollar index down 2% in December for its biggest monthly decline of the past 2 years. This potentially could be a headwind to gold.

 

Still, as the vulnerability of the risk assets showed back in July/Aug when the S&P500 fell 5% in a couple days, gold and the USD can trade higher together, which I think is possible when the next negative trade development comes. In addition to this, with equity markets trading at record highs following a banner year, the higher gold prices with the higher equity markets is exhibiting this degree of caution in the markets.

 

With a quick note to the physical market, the retail reaction to the events Thursday evening was a heightened level of buying/selling from customers as they continue to be ever more price conscious and reactive to large market movements. This isn’t necessarily an anomalous phenomenon as increased volatility traditionally sees higher volume in financial markets. On the one hand we’re back at our record 52 week high in USD and within 2.4% of record highs in Canadian dollars, so clients are both happy to be selling near record highs, but also buyers looking for diversification are active as we continue near record prices.

 

Clear as Mud

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As North American equity markets generally made their way higher in 2019 (with hiccups in May and August), it was against headwinds of caution and uncertainty. Geopolitical market risks were elevated with many examples making headlines throughout the year. Front and center were the Brexit delays and negotiations, and a lingering UK election (for the third time in five years). Tense ongoing trade negotiations between the US and China consistently sat in focus. This past week, however, provided a little more certainty for investors. It also leaves a lingering question of, what’s next?

In a busy week, we look to finally see the finish line for the CUSMA, which is the trade deal to replace NAFTA. As to US trade with China, there is an agreement in principle being cheered by the US President that avoids the costly tariffs that were set to directly impact American consumers. And across the Atlantic, it looks like the UK Tories were delivered their mandate to put an end to Brexit. In summary, some of the headline risks to the year have moved on to the next chapter.

Spend any time watching business news on CNBC or Bloomberg, the way to avoid any questions on the outlook for the markets is the link to uncertainty or unknowns. As we move forward, a modicum of that market uncertainty was definitively removed this week. With the UK election a textbook market reaction ensued. The Tories received their strongest show of support since the 1980’s, and the weakest result for Labour since World War II. Friday, the British Pound Sterling was as much as two and a half percent higher against the US dollar, with similar gains against the euro.

This move in the currency markets put the pound at its highest level against the US dollar in 19 months and its highest against the euro since the Brexit referendum back in 2016. In a quick digression, it was then we recall the pound fell 8 percent against the US dollar for the biggest one day move in a major currency since the end of Bretton Woods.

In the next chapter of uncertainties, we have the UK pending divorce and trade negotiations with the European Union over the next 11 months. Also, in focus could be a forthcoming trade deal with the United States in a global environment that sees a continued trend of deglobalization associated with declining global trade volumes. The other obvious uncertainty of course is the next phase of negotiations to take place between the United States and China.

With regards to the United States and China, shortly following the announcement of Phase 1 of a deal are reports of skepticism and calls for details of which trade barriers will be removed. The overzealous reaction in the risk and commodity markets was pared back as it seems the details that have come forward are clear as mud.

There is the angle that this past week may give the equity markets a strong footing into the year-end, but skepticism also lingers for what lies ahead.

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Crisis Era Jobs Data

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According to Statistic Canada’s monthly job report, Canada saw the biggest monthly drop in employment in November since the financial crisis. This staggering headline should have been somewhat anticipated given the recent disparity between employment growth tracked by StatsCan’s two different surveys; albeit, the shortened timespan over which this moderation occurred creates a shock. Job growth in Canada over the past year is now averaging approximately 26 thousand positions and growing at 1.6%, which is more in line with the broader performance of the Canadian economy.

Beyond the sticker shock, the most noticeable afterthought of today’s job numbers is that the Bank of Canada didn’t have this data when they chose to keep interest rates on hold this past Wednesday. As expected, going into the announcement, the Canadian central bank left rates unchanged for the ninth consecutive meeting.

Today’s data is further indication that the economy is softening into next year. And another headline Friday competing with the disastrous job numbers was that Stephen Poloz will not stand for reappointment as the Bank of Canada Governor. His term is up June 2, 2020. This too, although not a surprise, as no governor since Gerald Bouey in the 1970’s and 1980’s stood for two consecutive terms leaves further uncertainty around policy direction in the new year.

Forecasts have been consistent that the Bank of Canada would eventually need to keep pace with the rest of the Western World central bankers and follow their leads into cutting interest rates. For several reasons, Canada was able to hold off (for the time being), as the Canadian economy saw what may be viewed as anomalous strength through the third quarter. Business investment picking up was a positive indicator, but ultimately other macro indicators, and particularly ones linked to trade are seeing past strengths viewed as one-offs.

All bets are (or perhaps were) on for the Bank adjusting course in the beginning of next year, but what has been overlooked is whether Governor Poloz will position himself as a lame-duck. This would be in lieu of actively adjusting policy rates. This does not render him impractical in a scenario where he may need to be reactive, but in a ‘status quo’ economy and given his track record over the past near 7 years, the most probable outcome is a central bank shifting to the sidelines.

What we have witnessed with Stephen Poloz is a Governor that may often over-speak but has exercised more caution and restraint when it came to adjusting policy and rates.  Absent from economic conditions seriously deteriorating into 2020, it would seem more likely in the conservative realm of the central bankers that they hold the course. For this, there are examples in modern history where the incumbent does not look to prescribe the policy of their successor.

This does not necessarily alter our views for the direction of the Canadian dollar, which we still see trending lower into the new year. That said, it is also unlikely the economy falls out of bed, which for this reason enforces the status quo scenario. Canada’s job numbers were disastrous, but given the overshoot of the prior months, it’s more likely that we are witnessing a return to mediocrity.

Short Canada

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Post-election, the bears are coming out of hibernation. It’s in stark contrast from the story being told during the third quarter. As the rest of the world cut interest rates to adapt to a slowing global economy, the Bank of Canada was able to stand pat. In the discussion, points were raised about their ability to do so as interest rates were at an already accommodative level. Moreover, as the Canadian central bank’s policy rate has typically closely followed the US Federal Reserve, the resounding question was if they won’t cut rates now, then when? To some, it seemed clear they were just buying time.

Consensus forecasts are for the Bank of Canada to lower interest rates in the beginning of next year. In terms of a softening Canadian economy, recent data could certainly support this action, but also to the contrary, third quarter GDP data from Statistics Canada justifies this Goldilocks’s economy (not too hot, not too cold).

There were two standout areas of concern as Canadian exports have edged lower over the past year, apart from the anomalous double-digit print in the second quarter. Household consumption growth is minimal and business investment had been lackluster, but it too saw a revival in the most recent three-month thanks to a revitalized residential housing market. What we’re witnessing is mixed economic data with a downward bias.

Canadian employment data is also flashing signs of caution. Into the election, the strong results of Statistics Canada’s Labour Force Survey were refuted by notable Bay Street economists. The issues raised were over both job quality and concentration in the public sector. The time-lagging Survey of Employment, Payroll, and Hours highlights a diverging trend in the oft volatile Labour Force Survey, which tends to steal headlines. In the latter survey, job losses were reported in retail and construction in September. It takes us full circle to what was the standout areas in the Canadian economy that now may be nearing an inflection point.

It raises the question to whether the burst of hiring and spending from Canadian businesses is sustainable in a lackluster economy. As we suggested in past newsletters, Canadian businesses will be hard pressed to escape the global headwinds of deglobalization from trade tensions and geopolitical unrest.

This was reinforced by notable comments this week from the CEO of Quebec’s Pension fund, Michael Sabia. Sabia, who will be stepping down in February following a decade of near double digit returns under his leadership, suggests a fragmented global economy with different regions of influence. Also notable from Sabia’s tenure was increasing the funds allocation to international markets, which is another key takeaway.

To what extent the prognostications of a fragmented global economy come true, the notion of a slowdown in Canada is coming to fruition. Since the inversion of Canadian and US government bond yields mid-Summer, investors have been on recession watch. Absent of a market shock, highly levered Canadian households will see continued moderation of consumer led growth. Calling or predicting the next downturn is its own challenge, but momentum is clearly slowing.

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Least Dirty Shirt

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As we make our way into the end of the year, I’m always very intrigued to read the market outlooks for the year ahead. It seems to be a time when economists and analysts make grandiose predictions for the twelve-month period yet are challenged with only having the ability to look through a myopic lens. The humour in it is, that it has some extra special significance other than creating a yardstick to compare previous periods’ gains or loses.

In addition to this though, the forecasts and predictions seem quickly forgotten. That said, one area of interest is away from the numbers and instead on the investment themes or undertones to the markets that some of these forecasts elaborate. As an active investor, this is where I often find some value. It can also suggest where the ‘herd mentality’ or most mainstream opinions in the markets are, for what they’re worth.

I was struck by a more prolific perspective though over the past couple weeks from Bridgewater Associates, Ray Dalio. From someone that co-founded the biggest hedge fund in the world, his views on the economy have been rather prescient as he has found an ability to succinctly and logically explain, in his perspective, these uncertain economic times.

Dalio suggests that the economic malaise and slowdown is of greater significance than what happens during a boom and bust cycle, and that is a bigger picture debt crisis. He refers to Monetary Policy 1 through 3 which involves lowering interest rates, to quantitative easing and expanding the central banks’ balance sheets to purchase longer dated debt and securities, and there by eventually monetizing federal deficits by printing money. None of the mentioned ‘solutions’ will actually reverse a slowing economy challenged by debt and underfunded liabilities from healthcare to pensions.

This has also been an angle of skepticism of the economic cycle that saw us escape from the Great Recession. The factors that led to the financial panic such as overextended households and governments carrying too much debt hasn’t seen much if any improvement. For those that continued to warn or speak to this issue, a kicking the can down the road approach from policy makers bought time. None the less, this year has seen reports from financial bodies including the IMF and World Bank that the composition of corporate debt has worsened. Further, the global economy now carries more debt than any point in history, and total debt is growing faster than output. Beyond the question of whether a trend like this is even sustainable is one conclusion from Dalio that it will not ever be paid back.

During the financial crisis, conventional wisdom made it hard to explain why some asset prices went higher in a period of dire outlooks and elevated uncertainty. Investors looked for safety in commodity currencies or US treasuries, despite what many perceived as inflation risk created by quantitative easing (or Dalio’s Monetary Policy 2). My favourite analogy though likened the havens of capital to the least dirty shirt. It wasn’t that the Canadian economy was scot free per se, but what mattered was how it was measured. Coming full circle on Dalio’s view and as he suggests a ‘paradigm shift,’ begs the question, which asset or asset class may be the least dirty?

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Cautious Optimism

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Last Friday, Bank of Montreal likened the events to take place on the economic calendar this week to essentially every major world sports event taking place within a 24-hour time period. From GDP prints in the United States and Canada to Brexit deadlines to central bank meetings, there was the potential for some market moving events. However, as expectations seemed to be fairly matched to prior telegraphed policy guidance, there were no major market gyrations.

The US Fed, as per usual, took center stage this week as they culminated what is expected to be their third and final interest rate cut in their ‘mid cycle policy adjustment’. As Fed Chair Jerome Powell made clear, it will be international disturbances that could prompt them to act again. But their return to neutrality was certainly reinforced by the economic data out this week. US GDP prints for the third quarter were stable and slightly above expectations. Job market growth reported Friday was again better than expected with revisions to the upside for the prior two months. It remains that the US economy is benefiting from the unfaltering of the American consumer.

In Canada, in aggregate it wasn’t that different a story. The Bank of Canada has held pat as the Western World’s central banks have shifted policy rates to a more accommodative level. The minor move lower in the Canadian dollar was in reaction to perhaps a dovish undertone that eventually the Canadian central bank will have to act, but likely not until the new year. Noticeably, in the last quarter has been the strength in the Canadian dollar as the strongest performing currency in the G10. The major factor had been interest rate differentials between the US and Canada, but as we’ve seen in the past, this can only go so far until strength in the loonie comes at the cost of Canadian exports and productivity weighing on growth.

Perhaps the missed headline in the past week has been the strength of the US equity markets as Brexit uncertainty and trade tensions have subdued. The story, however, goes a little deeper. As investor focus has been squared on when the next recession may occur, the US corporate sector reinforced the notion of some underlying strength in the US economy.

Data from Factset showed that of 342 companies in the S&P500 companies to report earnings thus far, about three quarters have beaten their estimates for earnings growth, reinforcing the idea that the market consensus may have gotten a little too bearish. In addition, big names like Johnson and Johnson and Intel have all raised their outlooks for the year ahead. As Apple in the past had been a general bellwether for equity markets, they too had strong earnings carrying their stock to new record highs.

The message seems very clear. Over the past couple of months there have been warnings from the IMF and World Bank and caution exhibited by policy makers and central bankers over the vulnerability to economic growth and financial markets. Former Bank of England Governor Mervyn King proclaimed, “economists and policymakers are sleepwalking towards the next crisis.” Still as the markets trade on record highs, we can think back as recently as the beginning of August when the S&P declined 6% in as many days.  For now, protection is imperative, especially as the trend for US stocks is higher.

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The Week Ahead in Gold

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The gold market is off to a good start to kick off the new trading week as prices are up over $8 per-ounce in early action. Strong safe haven demand and technical buying are featured and could potentially lead to further gains in price in the coming sessions.

 

Last week, the U.S. Federal Reserve cut the Fed Funds rate by 25-basis points in a move that was widely expected. The central bank did not, however, paint a very clear picture of further easing. The reaction to the cut was muted, and the Fed may have to take a far-more dovish tone in order to keep stock investors appeased. A lack of progress on trade and other geopolitical risks could potentially force the Fed to become more aggressive in the months ahead.

 

There is mounting evidence that the global slowdown could be accelerating. Recent eurozone manufacturing data was downbeat to say the least and has fueled an increase in risk aversion. Activity in Germany’s key manufacturing sector sank in September to the lowest level in more than a decade. The nation’s manufacturing purchasing managers’ index declined to a reading of 41.4, well into contraction territory and far below analyst estimates of 44. The country’s composite PMI, which includes both the manufacturing and services sectors, declined to a seven-year low.

 

As the economic engine of the eurozone, such weakness coming out of Germany is a major cause for concern. Ongoing anxiety over trade, Brexit and other economic and geopolitical issues are all taking a toll, and the ECB will likely be forced to implement further measures in order to prevent the region’s economy from slowing further.

 

The U.S./China trade war also continues to fuel safe haven buying. Stocks saw early gains slip away to end the trading week as news spread that Chinese negotiators would not be meeting with farms in Montana and Nebraska as planned. High-level meetings are still set to take place early next month in Washington, however. A lack of progress at those meetings could fuel heightened volatility and a more significant downturn in stocks.

 

Tensions in the Middle East also remain elevated following the recent attack on Saudi oil facilities. The U.S. has ordered further sanctions against the central bank of Iran and has also ordered more troops to the region to strengthen Saudi Arabia’s air and missile defenses.

 

The fundamental and technical landscape for gold looks very positive. The ongoing trade war, Brexit, Middle East tensions, unrest in Hong Kong and the accelerating global economic slowdown may all keep the metal well-supported. From a technical perspective, the uptrend is intact, and prices could be gearing up for a challenge of recent highs. Thus far, willing buyers have stepped in to buy the dip to $1500 or less, and that trend may continue until proven otherwise. With so many major issues at stake, it is difficult to see a scenario in which the yellow metal sees a more significant decline.

The Week Ahead in Gold

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Another major geopolitical issue can now be added to the list of bullish catalysts that could potentially send gold sharply higher. Over the weekend, the largest Saudi production facility was attacked, igniting fears of a major conflict in the Middle East. The attack reportedly removed 5 million barrels per day from the market which is over half of total Saudi production. The cut in production is the largest ever and sent oil prices soaring. Brent crude leapt by 20 percent on the news while WTI crude also saw a significant double-digit jump.

 

The U.S. believes that Iran was behind the attack, although the country has denied any involvement. President Trump was quick to respond, suggesting that the U.S. could potentially take military action once the perpetrator was known. He also said that he would authorize the release of oil from the Strategic Petroleum Reserve if necessary to keep the market well-supplied.

 

No official timeline has been given yet for restoration of production to previous levels. Some reports have suggested that about one-third of production could be restored as early as Monday.

 

The attack on Saudi oil facilities represents an attack on the global economy. If the damage cannot be repaired quickly, there are concerns that oil prices could spike to $75 or even $100 per barrel. A sharply higher oil price could potentially be the straw that broke the camel’s back as the global economy is already fighting a significant slowdown. Not only could higher oil prices put the economy into recession, but they could also cause central banks to rethink their currency policy stances if higher costs are paid by the public as inflation accelerates.

 

As markets continue to monitor the situation in Saudi Arabia, any further attacks or military action taken by the U.S. or its allies could stoke significant risk aversion. If crude prices continue to rise, that too may cause market unrest and increasing volatility.

 

The major economic news of the week will be the FOMC meeting. The Fed is widely expected to cut the Fed Funds rate by another 25-basis points at the conclusion of the meeting. As another rate cut has already been “baked into the cake,” markets will likely focus their attention on the central bank’s commentary, looking for any clues about its plans going forward. The notion of additional cuts has been a major influence on the recent rally in gold, and any hawkish commentary from the Fed has the potential to fuel some profit taking and even a significant pullback.

 

The three-month uptrend on the daily chart is still intact. The bulls are having some trouble defending the $1500 region thus far, however, and a test of technical support around the $1485 level could be seen soon if the market fails to put together a sustainable rally.

 

Given the current economic and geopolitical backdrop, prices may not have to fall far before finding more willing buyers. The combination of a slowing global economy, central bank easing and numerous geopolitical risks may keep any dips in the market shallow and viewed as an opportunity to buy on sale.

Recession Risk

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All the economic and market chatter through the final summer months seemed focused on whether a recession is looming, and whether it will be a result of policy missteps (potentially led there by one global superpower and their bombastic president). It seems somewhat pedantic waiting for a shoe to drop as we’ve seen global economic indicators signal factories and manufacturers output cutting back and other signs that often precede recession. Still, the ace in the hole has been, and (for now) continues to be the strength in the US labour market.

For many, this had been the conundrum over the summer months. In aggregate, the US economy (and here in Canada) continue to look relatively strong. We can also cite indicators that show reason for concern, and those seemed to be concentrated around the business sector and their spending and investment plans, but job market activity has yet to exhibit signs of weakness.

As the discussion continues over what extent US President Donald Trump is successful in jawboning the US Federal Reserve and influencing the direction of their policy, he’s made the epiphany that all he had to do was intensify trade negotiations with Chinese officials. Essentially, the twitter tirades and press conferences criticizing Federal Reserve Chair Jerome Powell made for good headlines, but the ongoing unresolved trade dispute may prove more effective in forcing the Fed to cut interest rates.

Additionally, the escalating back-and-forth tariff announcements through August only further prompted financial market volatility and saw a surge in demand for safe-haven assets. US government debt traded back to record levels and the US yield curve has inverted to the worst level since 2007. Similarly, precious metals proved once again the thought-after asset in volatile markets as gold made multi-year record highs and surpassed all-time highs in Canadian dollars.

The ultimate question is, what’s it to us here in Canada?

One US investment bank suggested that although the Canadian economy looks relatively unscathed to this point, as a commodity exporting nation, we will ultimately be impacted by waning global demand. Furthermore, the Bank of Canada will have no choice but to follow the US Fed and cut interest rates. This will then translate to a weaker Canadian dollar. CIBC economists, however, suggested focus really needs to stay with the United States (and not global events) as we’ve yet to see a recession in Canada without there being one in the US.

Bank of America CEO Brian Moynihan recently said in an interview that he’ is not worried about a slowdown as long as the U.S. consumer remains strong. Of all the indicators, it’ll be the US job market that will paint the picture.

Confusion, Contradiction, and Chaos

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The financial press was referring to this week as the most important week for investors in all of 2019. At the center of it was the US Federal Reserve. Particularly, the interest rate announcement this past Wednesday where the US central bank opted to cut interest rates for the first time since 2008. It might go down in history as one of the best telegraphed rate decisions from the US fed, juxtaposed by confusion as to why they were shifting policy.

The month leading into the announcement, the debate ranged on one side from why the Fed would be cutting interest rates in the first place given the strength in consumer spending data and US labour market to overly dovish expectations of a new easing cycle beginning with a 50 basis point cut.

Given the market reaction into the end of the week, however, its not only safe to say that investors expectations for a renewed period of fed accommodation were not met, but also heightened confusion around the lack of clarity in the messaging from the US Fed Chair, Jay Powell.

Previous heads of the US Fed have used their opportunities to speak publicly to deliver a clear consistent message as it relates to their current policy approach. Ben Bernanke is associated with the attention he brought to the Jackson Hole Economic Symposium to preview the feds upcoming aggressive monetary policy in the heart of the financial crisis. Janet Yellen always seemed well scripted; albeit, concise and direct in her press conferences discussing normalizing interest rate policy and remaining data dependent. The current chair lacks that same level of clarity and direction in his messaging as his predecessors.

For this reason, focus may shift to what message he plans to deliver at their annual meeting in Jackson Hole at the end of this month. It is an opportunity for him to clarify the Fed’s stance regarding their outlook over the near term. Unfortunately, it seems he doesn’t have the luxury of everyone waiting patiently for his remarks.

It was very evident the US President was one of the people left most disappointed from the Fed announcement Wednesday. So much so, that when Jay Powell hinted that their outlook may improve because tensions between the US and China have eased, it was contradicted the next day with the announcement of new tariffs on Chinese imports for the beginning of September. Given previous interference from President Trump and attempting to influence the US Fed, it seems logical that this tactical announcement Thursday may have simply been attempting to force the Fed’s hand.

In these choppy investment markets, its sometimes easier to think about a thesis or investment approach and then step aside instead of trying to time every directional change. This next month should be no different. As the takeaway from the Fed Announcement was a lack of clarity, it seems they’ll be using their FOMC members to broadcast their policy approach into the latter half of this year. This could be sealed from a scripted speech from Jay Powell at the end of this month in Jackson Hole. The question, given the feds initial shift earlier this year that was questionably influenced by the sitting US president, is what level of interference he may play over the next month.

We’re still expecting a follow up rate cut; the question is how quickly?

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