Gold, the stock market and the yield curve

October 16, 2017

The yield curve is a remarkably useful leading indicator of major economic and financial-market events. For example, its long-term trend can be relied on to shift from flattening to steepening ahead of economic recessions and equity bear markets. Also, usually it will remain in a flattening trend while a monetary-inflation-fueled boom is in progress. That’s why I consider the yield curve’s trend to be one of the true fundamental drivers of both the stock market and the gold market. Not surprisingly, when the yield curve’s trend is bullish for the stock market it is bearish for the gold market, and vice versa.

A major steepening of the yield curve will have one of two causes. If the steepening is primarily the result of rising long-term interest rates then the root cause will be rising inflation expectations, whereas if the steepening is primarily the result of falling short-term interest rates then the root cause will be increasing risk aversion linked to declining confidence in the economy and/or financial system. The latter invariably begins to occur during the transition from boom to bust.

A major flattening of the yield curve will have the opposite causes, meaning that it could be the result of either falling inflation expectations or a general increase in economic confidence and the willingness to take risk.

On a related matter, the conventional wisdom is that a steepening yield curve is bullish for the banking system because it results in the expansion of banks’ profit margins. While superficially correct, this ‘wisdom’ ignores the reality that one of the two main reasons for a major steepening of the yield curve is widespread, life-threatening problems within the banking system. For example, the following chart shows that over the past three decades the US yield curve experienced three major steepening trends: the late-1980s to early-1990s, the early-2000s and 2007-2011. All three of these trends were associated with economic recessions, while the first and third got underway when balance-sheet problems started to appear within the banking system and accelerated when it became apparent that most of the large banks were effectively bankrupt.

Here’s an analogy that hopefully helps explain the relationship (under the current monetary system) between major yield-curve trends and the economic/financial backdrop: Saying that a steepening of the yield curve is bullish because it eventually leads to a stronger economy and generally-higher bank profitability is like saying that bear markets are bullish because they eventually lead to bull markets; and saying that a flattening of the yield curve is bearish because it eventually — after many years — is followed by a period of severe economic weakness is like saying that bull markets are bearish because they always precede bear markets.

yieldcurve_161017

Both rising inflation expectations and increasing risk aversion tend to boost the general desire to own gold, whereas gold ownership becomes less desirable when inflation expectations are falling or economic/financial-system confidence is on the rise. Consequently, a steepening yield curve is bullish for gold and a flattening yield curve is bearish for gold.

The US yield curve’s trend has not yet reversed from flattening to steepening, meaning that its present situation is bullish for the stock market and bearish for the gold market. However, the yield curve is just one of seven fundamentals that factor into my gold model and one of five fundamentals that factor into my stock market model.

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Updating gold’s true fundamentals

October 11, 2017

Last week I posted a short piece titled “A silver price-suppression theory gets debunked“, the main purpose of which was to direct readers to a Keith Weiner article disproving that the silver price had been dominated by the “naked” short-selling of futures. My brief post rattled the cage of GATA’s Chris Powell, who made an attempt at a rebuttal early this week and in doing so proved that 1) he doesn’t understand what arbitrage is and how it affects prices, and 2) he doesn’t understand what fundamental and technical analysis are (he seems to believe that any analysis that uses charts to display data is the ‘technical’ variety).

My approach to the gold market involves fundamentals, sentiment and technicals in that order, except when sentiment is extreme in which case it takes priority. To give non-TSI subscribers an idea of what I do, here’s a brief excerpt from the TSI commentary that was published on 8th October:

Last week, two of the seven components of our Gold True Fundamentals Model (GTFM) flipped from bullish to bearish. We are referring to the bond/dollar ratio, which broke below its moving demarcation level, and the real interest rate (the 10-year TIPS yield), which broke above its moving demarcation level. As a result, five of the seven components are now bearish and the GTFM is well into bearish territory. Here’s the updated chart:

The gold market responds more immediately, directly and accurately to changes in the fundamental backdrop than any other major financial market. This means that there is often an easy-to-identify fundamental reason for any sizable multi-week move in the gold price, but it also means that changes in the fundamental backdrop often say more about the past than the future. For example, the fact that the fundamental backdrop was gold-bearish at the end of last week doesn’t imply that there will be additional short-term weakness in the gold price. Instead, it explains the weakness that has already happened.

That being said, an understanding of the true fundamental drivers of the gold price can be used to assess the future prospects for the gold price. For example, five of the seven components of the GTFM are either directly or indirectly influenced by the bond market, with T-Bond strength generally acting to shift these components in the gold-bullish direction and T-Bond weakness generally acting to shift these components in the gold-bearish direction. Therefore, a strong expectation regarding the future direction of the T-Bond price can feed into an assessment of gold’s risk/reward.

For example, it was partly the expectation of T-Bond weakness, potentially exacerbated by the Fed taking its first genuine step along the monetary tightening path, that three weeks ago caused us to become sufficiently concerned about gold’s short-term risk/reward to suggest buying some put-option insurance. This was despite the GTFM being well into gold-bullish territory at the time.

It is now the expectation of a T-Bond rebound that causes us to view gold’s short-term risk/reward as being skewed towards reward, despite the GTFM being well into gold-bearish territory.

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Blatant statistical bias: Gun ownership vs. gun deaths

October 9, 2017

This post has nothing to do with the US Second Amendment or my opinion on whether gun ownership should be legal. It’s about the presentation of gun-related death statistics in a way that supports a political position rather than provides relevant information.

The following chart from a recent post at ritholtz.com compares the number of gun-related deaths to the number of guns per 100 people across many countries. It naturally shows that the country with by far the highest rate of gun ownership (the US) has by far the highest rate of gun-related deaths.

The above chart would be presented for only one reason: to persuade people that the US needs stricter gun control. However, the chart does not make the case for stricter gun control in even a small way. This is because the charted comparison is meaningless.

Obviously, the greater the availability of guns the higher the proportion of gun-related deaths. A country with zero guns will have zero gun-related deaths and a country in which everyone owns a gun will have a significant number of gun-related deaths. This is not evidence that the first country is safer than the second country.

Also, not all gun-related deaths are equal. There is, for example, a huge difference between someone using a gun to take his own life and someone using a gun to take someone else’s life. Lumping all gun-related deaths together is therefore disingenuous. It is part of a deliberate effort to mislead.

The relevant comparison isn’t the gun ownership rate and the gun-related death rate, it’s the gun ownership rate and the total homicide rate or the violent crime rate. Evidence that a higher rate of gun ownership led to a higher rate of homicide and/or a higher rate of violent crime would not prove that stricter gun control was desirable, but at least it would be relevant to the debate.

The following charts from a 2014 article at crimeresearch.org contain relevant information. These charts compare homicide rates and gun ownership rates across countries. They show that the US has a much higher gun ownership rate than average and a slightly higher homicide rate than comparable countries. The slightly higher homicide rate could be due to the higher rate of gun ownership, but it could also be due to other factors.

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OECD and Small Arms Survey

As mentioned at the start, this post has nothing to do with my opinion on whether the US should have stricter gun control laws. It’s about how statistics are abused to influence opinions and promote agendas.

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A silver price-suppression theory gets debunked

October 6, 2017

Embracing the belief that a bank or a cartel of banks has suppressed the prices of gold and silver for decades via the short-selling of futures contracts is like adopting a child. It’s a lifetime commitment through thick and thin, meaning that once this belief takes hold there is no amount of evidence or logic that can dislodge it.

Entering a debate with someone who is incapable of being swayed by evidence that invalidates their position is a waste of time and energy, so these days I devote no TSI commentary space and minimal blog space to debunking the manipulation-centric gold and silver articles that regularly appear. However, Keith Weiner has taken on the challenge in a recent post.

Keith’s article is brilliant. In essence, it proves that the silver market has NOT been dominated by the “naked” short-selling of futures. His arguments might not be as interesting as many of the manipulation stories, but they have the advantage of being based on facts and logic.

Don’t get me wrong; for as long as I can remember it has been apparent to me that gold, silver and all the other important financial markets are manipulated. However, it is also apparent to me that the price manipulation happens in both directions and never overrides the fundamentals for long. Of course, to see that this is the case you first have to know what the true fundamentals are.

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