Gold and Golds
March 17, 2019 – Weekly note
I don’t know much the gold/silver ratio. Perhaps some of the extraordinary strength in palladium caused gold/silver to rally in sympathy. In any case, the chart below is interesting, as the ratio is pressing new highs just under 85, even as stocks have seen a spirited rebound from December’s swoon. The chart shows the gold/silver ratio overlaid with SPX since 2000. In general, it appears as if the ratio strengthens with the onset of financial stress, using SPX as a proxy. Mid-2008 is a stark example. The site monetary-metals.com has more information about gold/silver and also has a chart which shows that the 6-month Gold forward rate has dropped from nearly 2.5% to below 2.1% in the past three months.
Now consider the gold-pack on the Eurodollar strip, which is the fifth year forward. As of Friday, it was the average price of the four contracts EDH23, EDM23, EDU23 and EDZ23. (On Monday it will be the four contracts starting EDM23). These forward contracts should be affected by inflation expectations and term premium. Of course, at the time represented by these contracts, we won’t even be certain how much libor-based trading will occur as the market’s benchmark rate is to be changed. What is interesting on the curve however, is that the gold pack has just squeaked over the high set on January 3, the day of maximum turmoil related to stocks, a day which sent rates and near euro$ calendar spreads hurtling lower. On that day, the gold pack settled 97.50125, which was up 14.5. On Friday it settled 97.5025 (+4.0). The strongest part of the curve on Jan 3 was the red pack (2nd year forward) which was up 18.375 at 97.67875. On Friday the red pack settled 97.570, more than 10 bps lower.
Below is a chart of EDM23, representative of the gold pack. Stocks have bounced. But back dollars aren’t buying into the idea of an economic resurgence and associated inflation.
It’s also worth taking a look at a longer term chart of what is now the lowest one-year calendar spread on the curve, EDZ19/EDZ20. On Jan 3 the most negative spread settlement was June19/June20 at -28. Dec/Dec had settled -22.0, and on Friday had the lowest settlement since then at -21.0. The chart below is a constant maturity 3rd to 7th quarterly, the slot into which Dec/Dec will roll next week as EDH19 expires. This chart starts in the year 2000. The lower panel is the spread, with negative values in red. The lowest print is -47.5 in late 2006, after the hiking cycle ended, but before the first ease occurred which was Sept 18, 2007. The spread is saying the Fed is ‘tight’. Stocks are concluding that accommodation will continue.
Going into the FOMC meeting this week, there has been quite a bit of discussion relating to a change in the Fed’s policy framework. The idea of letting inflation run over the 2% target to make up for previous shortfalls is finding footing, and the role of controlling inflation expectations in terms of monetary policy has also been favorably mentioned by Powell.
The problem is that, as usual, some pockets of the market are calling out the Fed. That’s why the dots, which will surely be revised lower this week, are somewhat irrelevant. The market is leaning towards an ease this year in spite of the rebound in equity prices. The gold-pack is dismissing the thought of higher inflation. Other market indicators of inflation, like the ten-yr inflation-indexed breakeven and the 5y5y forward inflation swap have rebounded off the lows set in early January, but have fallen quite a bit short of reclaiming the highs of last autumn. The chart below shows that the ten year breakeven (in yellow) was almost 2.2% in October, fell to 1.7% at year end and is now 1.95%. The 5y5y inflation swap (white) was nearly 2.5% and is now 2.28%. And the 18th quarterly euro$ in amber, now EDM23, was 3.25% in October, but is currently 2.49%, equaling the low in early Jan, as mentioned above. Down 75 bps!
With the change in policy and tone by the Fed, it now finds itself at the mercy of markets. The SPX break in Q4 is being viewed by interest rate markets as a serious episode that will take a longer time to heal. With a Fed on hold it’s back to TINA for stocks.
A couple of other things worth mention. Moody’s has a data set known as CQI, which stands for bond Covenant Quality Indicator. Here’s the headline last week from the Moody’s site for North America: ‘Heavy Ba concentration and weak protections push CQI to record worst’. From the article, “Our Covenant Quality Indicator has worsened by 10% in 2019, reflecting both an abnormally high concentration of Ba-rated bonds and very weak packages in lower rated bonds.”
Second, while the upward sloping yield trendline off the low in 2016 had been broken in December for the ten year treasury, the ten year inflation-indexed note just broke the trend last week. From a ‘real’ yield high of nearly 1.2% in Q4, on Friday it closed at just 64.5 bps. Not exactly a sign of productivity led growth prospects.
| 3/08/2019 | 03/15/2019 | ||
| UST 2Y | 245.5 | 244.0 | -1.5 |
| UST 5Y | 242.0 | 239.5 | -2.5 |
| UST 10Y | 262.1 | 258.9 | -3.2 |
| UST 30Y | 301.5 | 301.5 | 0.0 |
| GERM 2Y | -55.0 | -54.1 | 0.9 |
| GERM 10Y | 6.2 | 8.4 | 2.2 |
| JPN 30Y | 57.0 | 57.5 | 0.5 |
| EURO$ Z9/Z0 | -19.5 | -21.0 | -1.5 |
| EURO$ Z0/Z1 | -3.0 | -3.5 | -0.5 |
| EUR | 112.36 | 113.26 | 0.90 |
| CRUDE (1st cont) | 56.07 | 58.52 | 2.45 |
| SPX | 2743.07 | 2822.48 | 79.41 |
| VIX | 16.05 | 12.88 | -3.17 |
