Everything That Buys Bonds Isn't Gold

I’ve been under the weather for the last two weeks as of this writing, contracting things from strep throat, to a common cold, to a finger infection, to pink eye, and now something with my tonsils. It’s been the less fun part of the school year to date, especially seeing how none of my friends have come up with any of the symptoms I’ve dealt with. The grass is always greener on the other side, as they say. The same can’t be said for gold, however.

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The big story on the Street from Tuesday came from the battering of Gold, as the price of this commodity fell by about $40 amidst a storm of news that didn’t bode well for the metal. This drop, the biggest in three years, was fueled in large part by hawkish comments from two Federal Reserve regional bank presidents; Loretta Mester of the Cleveland branch, and Jeffery Lacker of the Richmond branch. These comments fall in line with what we’ve seen other higher-ranking Fed officials say in recent weeks, that the economy is more-or-less primed for an interest rate hike. Reports also surface during the day Tuesday that the European Central Bank will aim to back off from its aggressive quantitative easing program, as the world of QE-eligible bonds becomes ever more scarce. This scarcity is in part due to investors unwilling to let go of bonds they already have, and central banks already owning a significant chunk of the sovereign bond market.
The Bank of Japan announced a ‘refocus’ of its QE program at its last meeting, which seemed to adjust their primary goal to maintaining the yield curve, in a sign of surrender that the effectiveness of quantitative easing is on the decline.

The combination of hawkish Fed presidents and signals that central banks may be less willing and/or less able to effectively utilize QE sent the dollar on a tear, with the Dollar Index Spot (DXY) jumping from 95.695 on October 3rd at the close to 96.169 on October 4th at the close. DXY is currently down slightly as I type this around noontime Wednesday, but the effects on gold remain.

As a mere college student, trying to learn as much as I can as things unfold, looking back on gold’s drop reveals that there were signals and reasons to be short gold. In addition to the stream of hawkish comments from Fed members in the last several weeks, technical analysis presented a big signal that gold was due to drop.

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We saw a flag back in Q1 and Q2 as gold steadily marched upward, and this flag broke off in late May on a downward breakout point. Gold rapidly gained value yet again in late June after Britain’s Leave vote in the referendum concerning membership in the European Union, as investors sought haven assets amidst the shock to the system (you’ll recall JPY also dropped below 100 yen to the dollar immediately after the referendum’s results were announced). From there, gold entered a Descending Triangle, which came to an abrupt end when the metal dropped $40 in its breakout point on Tuesday. Should gold follow the ‘typical’ path in the wake of a Descending Triangle, suppressed prices should continue over the next few weeks.
From there, I see two possible routes for Gold:

1) The Federal Reserve opts to hike benchmark interest rates in its November 1-2 meeting, favoring a relatively strong economy against uncertainty surrounding the presidential election. Gold suffers another drop as USD strengthens. Equities may also take a hit, save for financials, as I don’t believe the markets have fully priced in the potential for a November rate hike.

2) The Federal Reserve does not hike interest rates in its November meeting, citing uncertainty over the election, but strongly suggesting a December rate hike if data continues to support it (of course…). Gold jumps on a combination of election uncertainty and a weaker dollar, but is subject to a correction downward after the election, particularly if Clinton wins, as the markets appear to be heavily pricing in right now.

To summarize, Gold’s pullback was to be expected from a number of viewpoints, including via technical analysis and the continuation of hawkish Federal Reserve members. Other factors could have been used to identify a pullback, but as a college student without regular access to a Bloomberg, those two will have to suffice. Suppressed gold prices compared to the last 4 months are anticipated to persist into November, when a fork in the road comes up as a consequence of the next Federal Reserve meeting.
I’m hoping each night I go to sleep that I’ll wake up and not be sick and/or not feel sick, because the grass is certainly greener when the body feels healthy. And while the grass may get greener for me when I get my full health back, gold’s shine looks to stay a little dulled for the short and medium terms.

Andrew

Trust and the Banking Sector

In my current semester, I have two communications-based classes. The other day, in one of these classes, the professor had us form a circle and take a few minutes to define exactly what trust is, and how trust can be gained or lost. There is no correct definition of trust, of course, as everyone interprets it differently. You may only trust someone after they lay down their life for you, or you may trust them as soon as you first shake hands.

Recounting that class period now, I can't help but think how ravaged the trust between investors and the banking sector has become, but also how ravaged the trust between big banks and the government has become.

Take, for instance, J.P. Morgan Chase (JPM).

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Over the last six months or so, JPM has been through its fair share of ridges and valleys. Perhaps the most pronounced of these oscillations was the Brexit-induced volatility in late June, when the value of J.P. Morgan's stock dropped to just over $57 in intraday trading. Today, we're back up to $67.49 a share as of Friday's close, over three dollars higher than the close immediately prior to the Brexit referendum.

Overall, this chart looks pretty okay to me, and the stats on paper concur. JPM is up nearly 13% in the last six months, and its price-to-earnings ratio is at a comfortable 12.07.
Technical analysis indicators aren't as warm to the idea of placing a Buy sticker on JPM, with the stock's Relative Strength Index at ~70 at Friday's close, right into Overbought territory. Bollinger Bands show JPM grinding along the top band in the last few days, even closing above the upper band three of the last five trading days. It's not insensitive to believe a correction is coming.

But, this is where things get tricky. J.P Morgan's stock could very plausibly stick around these higher levels. We could see repeated intraday breaches of that upper Bollinger Band down the road, and the RSI could easily inch higher. This is the land of broken trust between investors and big banks, big banks and the government, and the government and the investors.

This handy chart I drew up at 3:40 in the morning illustrates how the lack of trust between the three sectors is leading the banking sector to moves irrational moves.

The government, as well as the Federal Reserve, clearly has a problem with investors these days. Time and time again we've heard Fed chairwoman Yellen and other high-ranking officials comment on how the financial markets seem too complacent, purportedly setting the foundation for a benchmark interest rate hike later on in the year. This happened once before, in June, but rate hike chances were eliminated when the United Kingdom voted to leave the EU. Now it's September, and last month at Jackson Hole, Yellen again began painting some more hawkish tones onto her speech, with a handful of other Fed people being more direct and clearly indicating they are ready to raise the benchmark interest rate.
This was all fine and dandy until the ISM Manufacturing PMI number came out this past Thursday. Expectations were for a value somewhere around 52, so there was some egg on some face when the value was released as a 49.4, the lowest in seven months and now into Contraction territory. Almost immediately, the air became thick with the concern that this would be another case of the Fed building up the case for, but not actually being able to hike interest rates. However, calm prevailed until the August jobs report this past Friday, which missed by 29,000 (180k expected, 151k actual) and held the unemployment rate steady at 4.9%. Surprisingly, though, the three benchmark US equities indexes all ended in the black that day. Why? Who knows. All we know is that we're going back around the circle we were in back in June, but this time investors don't seem to be listening all too hard. Equities remain near 52-week, as well as all-time highs, something that will be interpreted by the Fed as complacency but what is really a lack of trust.

Investors aren't too keen on investing in the banking sector. If you managed to figure out the round-about that the Fed has been going around re: hiking interest rates since this past June, congratulations, you can appreciate why there's a general hesitancy to firmly invest in the banking sector.
Profits remain low across the board due to historically-low interest rates, and big-name banks like Deutsche Bank are cutting jobs to compensate for the fall in profits. This has led many banks' shares lower; our JPM example again plays in here, with the bank's share value up a measly 2.21% year-to-date.
For many investors, this is a solid buy sign. The economic recovery continues slowly chugging along, and the overall banking sector is valued pretty okay compared to pretty-overbought defensives. But we aren't seeing a massive rush to the banking sector, and the blame for that is placed squarely on the Fed for inconsistent messages (not solely to their fault), breaking the chain of trust between investors and banks in financial markets.

It's pretty accurate to say that the banking sector doesn't exactly look at the government and Fed with a wink and a smile. The inconsistent Fed messaging has poisoned the trust link here, too, with banks not entirely sure which directions to take internally as the Fed scrambles to find its direction. There's little help coming from hesitant investors, and the government doesn't appear to be about to lay down an Abe-level fiscal stimulus package, leaving it up to the Fed to stimulate the economy and make banks highly-valued again. Of course, the Fed isn't currently doing this, so the banking sector is more or less dead in the water until either investors start wading back into the waters again, or the Fed finally hikes rates like it says it will. Until the latter happens, however, you'll be hard-pressed to find a willingness to trust.



I almost invested in a bank ETF the other day. I started remembering the hawkish Fed speak, anticipated the Manufacturing PMI would be positive, and there weren't any signs to be remarkably pessimistic on non-farm payrolls. Fast-forward to today and we're in another world of uncertainty, albeit not as uncertain as we were immediately post-Brexit (i.e. the yen isn't in the double-digits again). I didn't invest in that ETF, and do not plan to before the FOMC's September meeting, because I have a low amount of trust that the Fed will be able to confidently carry through with their not-so-subtle indications of an impending benchmark rate increase. I also have a low amount of trust in that any rate hike would really help banks- the most recent economic data from last week likely bars any interest rate increases from the current level beyond 50 bps until 2017, and in order for banking sector profits to swell, we'll need more than that.

Trust is hard to gain but easy to lose, and we've got a lot of trust to gain back.

Andrew