[This blog post is an excerpt for a commentary published at speculative-investor.com on 19th November 2023]

There was a government-spending-fuelled burst of economic activity in the US during the third quarter of this year that led to a high GDP growth number being reported for the quarter, but signs of weakness are now appearing in coincident economic indicators.

The most important of the aforementioned signs is the rise in Continuous Claims for Unemployment Insurance. With reference to the following weekly chart, Continuous Claims bottomed in September-2022, moved higher into April of this year, dropped back to a higher low during September and has just confirmed an upward trend by moving above its April-2023 high. This is consistent with our view that a US recession will begin before the end of this year, although based on the historical record the recession start date won’t become official until the second half of next year.

Another sign is the decline in the year-over-year (YOY) growth rate of Industrial Production (IP) to negative 0.70%, the lowest level since February-2021. The YOY growth rate of IP in October-2023 is similar to where it was in the month before the start of the 2001 recession and is well below where it was at the start of the 2007-2009 recession. Below is a chart of this coincident economic indicator.

It probably will be many months before the US coincident economic data become consistently weak. In the meantime, we expect to see — and should see, if our current outlook is correct — a gradual increase in the proportion of economic statistics that are worse than generally expected. We also expect to see a gradual shift away from the “soft landing” narrative (the belief that the US economy will make it through the monetary tightening without a recession) towards the recession narrative.

A few weeks ago (refer to the 30th October Weekly Update) we noted early signs that the financial world was starting to move away from the soft landing scenario. One of the indicators that we are tracking to check that this shift remains in progress is the January-2025 Fed Funds Futures (FFF) contract, a daily chart of which is displayed below. Note that the line on this chart moves in the opposite direction to interest rate expectations.

The substantial downward move on this chart from early-May through to mid-October reflects a major increase in the popularity of the soft landing scenario, while the relatively small upward move over the past few weeks is tentative evidence that a shift towards general belief in a less innocuous economic outcome has begun.

At this time, the soft landing narrative remains dominant. That’s why the SPX has rebounded to within 2% of its high for the year and the January-2025 FFF contract has retraced only a small part of its May-October decline. However, we expect that belief in a soft landing will dissipate over the next six months, leading to a substantial decline in the stock market and a substantial rise in the US$ gold price.

[This blog post is a brief excerpt from a recent commentary published at speculative-investor.com]

Why has the junior end of the gold mining world performed so poorly over the past two years. In particular, why has it performed so poorly over the past 12 months in parallel with a relatively strong gold market?

Understanding why begins with understanding that in the absence of a mining operation that can be used to PROFITABLY extract it from the ground, gold in the ground has option value only. The option could be valued by the market at almost zero or a lot depending on many factors, the most important variable being the public’s desire to speculate. Furthermore, a gold mining operation that generates losses year after year also has option value only, with the public’s desire to speculate again being the most important determinant of the option’s market value.

In other words, with the relatively illiquid stocks it comes down to the general public’s desire to speculate.

Hedge funds usually will focus on gold mining ETFs or the larger-cap gold stocks because they need the liquidity. Wealthy professional investors such as Eric Sprott typically will take positions via private placements with the aim of eventually exiting via a liquidity event such as a takeover. It’s the general public that determines performance at the bottom of the food chain and over the past two years the public has become progressively less interested in speculating. Hence, the market values of stocks with option value only have become a lot cheaper.

Although during the course of this year we have suggested directing most new buying in the gold sector towards profitable producers, we are still interested in gold stocks that have option value only. These are the stocks that will generate by far the largest returns after the general public starts getting interested in the sector. However, sparking that interest probably will require a minimum of all-time highs in the US$ gold price and gold mining indices such as the HUI breaking above their H1-2023 highs, which probably won’t happen until the first half of next year. In fact, based on the historical record, sparking the general public’s interest in speculative gold mining stocks could require the broad stock market to begin discounting the combination of a recovery from recession and much easier monetary conditions, which possibly won’t happen until the first half of 2025.

Until then, most (not all) new buying in the gold sector should be directed towards profitable producers, that is, towards the stocks of real businesses. But, only when they are oversold or consolidating. Don’t get excited and buy them after they have just gone up a lot.

[This blog post is an excerpt from a commentary published at speculative-investor.com on 29th October 2023]

Thanks largely to rapid government spending, inventory building by the private sector and about $500B coming out of the Fed’s Reverse Repo (RRP) Facility, US ‘real’ GDP grew at an annualised rate of almost 5% in Q3-2023. The GDP number included strong quarterly growth in Real Gross Private Domestic Investment (RGPDI), which could be explained in part by investment incentivised by the Federal government’s misnamed “Inflation Reduction Act”. What are the implications for the financial markets of this economic activity surge?

With one important exception, all of the implications are in the past. It has been known for a few months that the GDP growth number for Q3 would be high, meaning that a high number was factored into market prices well before last week’s news. To the financial markets, what matters now is what’s likely to happen to economic activity over the quarters ahead.

We suspect that the GDP growth number that gets reported for the final quarter of this year will look fine, partly because money is coming out of the RRP Facility at a rapid rate (about $450B came out over just the past four weeks) and partly because the US federal government will continue spending as if there were no tomorrow. However, it’s likely that much weaker numbers will be reported during the first half of 2024 due to the lagged effects of monetary tightening, the exhaustion of the RRP liquidity channel, the effects on the US economy of recession in Europe, and reduced consumer spending in response to declining asset prices (stocks and real estate).

The one important exception mentioned above is the potential effect of the just-reported high GDP growth number on the future actions of the Fed. In particular, even if it is likely that the rate of GDP growth will be significantly lower in Q4-2023 and turn negative during H1-2024, the Fed tends to look backward and therefore could be encouraged by last quarter’s strong growth to stay tighter for longer.

It turned out, however, that during the hours following last Thursday’s announcement of the strong GDP growth number the expectations of the Fed Funds Futures (FFF) market shifted in a ‘dovish’ direction. Specifically, according to this market, last Thursday the probability of another Fed rate hike before year-end dropped from around 29% to around 20% and the expected Fed Funds Rate at the end of next year fell from 4.68% to 4.60%.

The market responses to last week’s strong US GDP number and generally good news on the corporate earnings front could be early signs that the financial world is beginning to move away from the “soft landing” scenario (the idea that the US economy will avoid a recession). This is to be expected, in that every recession begins as a soft landing and then turns into something more painful. The timing is usually difficult to pin down, though, because on the way to a recession there invariably are many twists and turns.

[This blog post is an excerpt from a commentary published at www.speculative-investor.com on 25th October 2023]

We aren’t geopolitical experts and do not know how the Israel-Hamas war will unfold*. Nobody does. There are far too many unknowns at this stage for even the geopolitical experts to do anything other than guess. What we are able to do is figure out what the markets are discounting, that is, what the majority of market participants currently believe will happen. Today’s assessments of how the conflict will play out may turn out to be wrong and therefore could necessitate large price adjustments in the future, but when deciding what to do in the markets it is important to know what’s currently priced in. Here’s what we think is priced in right now:

1) The oil market

At the time of the Hamas attack on Israel the oil market was slightly oversold due to a price plunge over the preceding week. Consequently, at least a countertrend rebound was likely regardless of news.

During the three trading days after the war news hit the wires (9th-11th October), the oil price bounced and then pulled back. We wrote in the 11th October Interim Update that this price action suggested an expectation among large oil traders that the conflict would not broaden or that if it did broaden then Saudi Arabia would act to offset any loss of oil from Iran.

The subsequent price action indicates that the oil market has not ‘changed its mind’. We say this because the rebound in the oil price from its pre-war-news low looks more like a countertrend reaction than the start of a move to above the September-2023 high. Also, the extent of the backwardation in the oil futures market has decreased over the past week, which suggests less urgency to stock-up on physical oil.

In summary, the oil market does not believe that the war will have a significant negative effect on global oil supply.

2) The gold market

Prior to the war news hitting the wires the gold market was very oversold in both momentum and sentiment terms and therefore was poised for a rebound. As a result of the war news, the rebound has been much stronger than it otherwise would have been.

The performance of the US$ gold price indicates that large speculators initially were uncertain as to how big the war would become. Would it be confined to Israel versus Hamas in/around Gaza, or would it expand to encompass direct involvement from the US and Iran? Also, how much additional US government spending would result from the war in the Middle East and how would this spending affect the resources directed towards the NATO-Russia war in Ukraine?

At the moment large speculators in the gold market believe that these are open questions, with a substantial expansion of the war being one of the more likely scenarios. That’s a reasonable conclusion because the gold price continues to hover around resistance at US$1980-$2000 — about $180 above where it was three weeks ago.

We’ll know that the perceived level of uncertainty/risk has increased significantly if the gold price breaks above US$2000. By the same token, we’ll know that the perceived level of uncertainty/risk has begun to wane when there is a clear downward reversal in the US$ gold price. Note that a downward reversal in the US$ gold price is likely to precede a turn for the better in the news from the Middle East.

3) The stock market

In the US stock market, the war has prompted a shift away from risk but has been very much a secondary issue. The primary issue is the downward trend in the bond market (the upward trend in long-dated Treasury yields).

4) The currency market

In early-October the Dollar Index (DX) was very overbought and had just begun to ‘correct’. The war news may have reduced the magnitude of the correction, but up until now has not been sufficient to propel the DX above its early-October high.

As far as we can tell, according to the currency market the outbreak of war in the Middle East has increased the attractiveness of the US$ relative to other fiat currencies but also added to concerns about the pace at which the US government is going into debt. Putting it another way, what’s priced into the currency market at the moment is both the uncertainty regarding the outcome of the war and the offsetting consideration that the war is increasing the risk of a US government debt spiral.

Summarising all of the above, the oil market is not concerned about a significant supply disruption, the gold market has priced-in considerable uncertainty/risk and could price-in more of the same before reversing, the US stock market is more concerned about bond yields than about the Middle East, and the currency market thinks that the benefits of holding the US$ in a period of increasing geopolitical instability are being mostly offset by the likelihood that a further increase in geopolitical instability would accelerate the already rapid pace of US government deficit-spending.

*As is always the case these days when major geopolitical events occur, many people quickly become ‘experts’ as a result of the large volume of information that suddenly becomes available over the internet. People who a month ago could not have identified Gaza on a map and knew nothing about the history of Hamas are now ‘experts’ who can confidently explain why the events have occurred and what’s going to happen. The actual experts, on the other hand, know that there are a lot of unknowns and therefore that the outcome is uncertain.