[This blog post is an excerpt from a commentary published last week at www.speculative-investor.com]

In a world where the official currencies make poor measuring sticks due to their relentless and variable depreciation, looking at the relative performances of different investments is the best way to determine which ones are in bull markets. Furthermore, because they are effectively at opposite ends of an investment seesaw, with one doing best when confidence in money, central banking and government is rising and the other doing best when confidence in money, central banking and government is falling, this is a concept that works especially well for gold bullion and the S&P500 Index (SPX).

There will be times when both gold and the SPX are rising in US$ terms, but it should be possible to tell the one that is in a genuine bull market because it will be the one that is relatively strong. More specifically, if the SPX/gold ratio is in a multi-year upward trend then the SPX is in a bull market and gold is not, whereas if the SPX/gold ratio is in a multi-year downward trend then gold is in a bull market and the SPX is not. There naturally will be periods of a year or longer when it will be impossible to determine whether a multi-year trend has reversed or is consolidating (we are now in the midst of such a period), but there is a moving-average crossover that can be used to confirm a reversal in timely fashion.

For at least a decade, we have been monitoring the SPX/gold ratio (or the gold/SPX ratio) relative to its 200-week MA to ascertain whether gold or the SPX is in a long-term bull market*. The idea is that when the SPX/gold ratio is above its 200-week moving average, it means that the SPX is in a bull market and gold is not. And when the ratio is below this moving average, it means that gold is in a bull market and the SPX is not.

The following weekly chart shows that since 1980 the SPX/gold ratio relative to its 200-week MA (the blue line) has generated only two false signals. Both of these false signals occurred as a result of stock market crashes — the October-1987 crash and the March-2020 crash. The chart also shows that since peaking in late-2021, the SPX/gold ratio has dropped back to its 200-week MA but is yet to make a sustained break to the downside.

The next weekly chart zooms in on the SPX/gold ratio’s more recent performance. This chart makes it clear that over the past 12 months the ratio has been oscillating around its bull-bear demarcation level.

It’s likely that an SPX bear market, and therefore a gold bull market, began in late-2021, but there remains some doubt. The remaining doubt would be eliminated by the SPX/gold ratio breaking below its March-2023 low.

Further to comments we made in the latest Weekly Update, the only plausible alternative to the bear-market-rebound scenario for the US stock market is that a bear market has not yet started. This is clearer when looking at the SPX in gold terms than when looking at the SPX in nominal dollar terms. What we mean is that the moderate pullback in the SPX/gold ratio to its 200-week MA clearly was not a complete bear market; it was either the start of a bear market or it was a bull-market correction.

Our view is that a multi-year equity bear market is in progress. However, if the SPX/gold ratio fails to break below its March-2023 low within the next few months and instead makes its way upward, then what transpired during 2022 was an intermediate-term stock market correction within a bull market.

*A January-2019 blog post discussing the concept can be found HERE.

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

Leading indicators of the US economy continue to signal imminent recession, but coincident indicators are mixed and some lagging indicators, most notably employment, are still showing strength. Therefore, it isn’t clear whether or not a recession has commenced. Also, high-profile parts of the stock market are muddying the water by trading as if a “soft landing” (no recession, but a large-enough inflation decline to cause the Fed to reverse course) were the most likely economic outcome over the next several months.

Turning to our favourite two leading indicators, first up we have a chart showing that the ISM Manufacturing New Orders Index (NOI) made its cycle low to date in January-2023 and returned to its cycle low in May-2023. As noted in previous TSI commentaries, at no time since 1970 has the ISM Manufacturing NOI been as low as it is today without the US economy being either in recession or about to enter recession.

Next up is the yield curve, which remains inverted to an extreme. The extreme inversion tells us that monetary conditions have become tight enough to virtually guarantee an official recession, but the signal that a recession is imminent is a reversal of the yield curve from flattening/inverting to steepening.

A yield curve reversal from flattening/inverting to steepening has not happened, yet. It’s possible that the rebound in the 10-year T-Note yield minus the 2-year T-Note yield (the 10y-2y spread) from its March-2023 low is the start of a reversal, but the 10-year T-Note yield minus the 3-month T-Note yield (the 10y-3m spread), an equally important measure of the yield curve, just hit a new inversion extreme for the cycle. Daily charts of these interest rate spreads are displayed below.

As explained in the past, the yield curve is driven by the monetary inflation rate and tends to lag the monetary inflation rate at major turning points. Of particular relevance at this time, a reversal in the yield curve from flattening/inverting to steepening usually follows a major upward reversal in the monetary inflation rate. This relationship is illustrated by the monthly chart displayed below. The red line on this chart is the 10y-2y spread and the blue line is the growth rate of US True Money Supply (TMS).

Clearly, the monetary inflation rate has not yet reversed upward. This indicates that the monetary conditions for a yield curve reversal are not yet in place.

Note that for the monetary inflation rate to begin trending upward in the near future, a large amount of money probably will have to exit the Fed’s Reverse Repo facility. This could happen in response to the flood of new debt that will be issued by the Treasury within the next couple of months.

In conclusion, it’s possible that a US economic recession has begun, but it’s now more likely that a recession won’t begin until the third quarter of this year.

[This blog post is an excerpt for a commentary published last week at www.speculative-investor.com]

The following chart shows that over the past five years the US$ copper price (the brown line) and the S&P500 Index (the green line) generally trended in the same direction. Why, then, have they moved in opposite directions over the past two months?

The relationship between the copper price and the S&P500 Index (SPX) can be described as one of generally positive correlation with divergent movements at times. The copper price acts as an economic bellwether due to its extensive industrial usage, while the SPX represents general equity market sentiment. They are influenced by similar macroeconomic factors, but short-term performance differences occasionally arise due to shifts in commodity-specific factors, inflation expectations and risk preferences.

The performance difference since early-April, with the copper price moving downward to a new low for the year while the SPX moved upward to a new high for the year, is most likely due to shifting risk preferences within the stock market. To be more specific, the copper price has declined in sympathy with a global manufacturing recession (the US, European and Chinese manufacturing PMIs are all in recession territory) and the high probability of reduced metal demand over the months ahead as the on-going monetary tightening takes its inevitable economic toll, while the SPX has risen on the back of speculation that technology in general and AI in particular will generate good returns almost regardless of what happens to the economy.

One way or the other, it’s likely that the divergence will close within the next three months.

From our perspective, copper is performing exactly the way it should be performing considering the macroeconomic landscape. It is short-term oversold and could rebound at any time (a routine countertrend rebound would take the copper price back to the US$3.80s), but we suspect that it will trade at least 10% below its current price before completing its downward trend. Consequently, we expect that the divergence will close via weakness in the stock market rather than strength in the copper market.

[This blog post is an excerpt from a recent commentary at https://speculative-investor.com/]

Last week there was a big drop in the US federal government’s account at the Fed (the Treasury General Account, or TGA for short). The latest figures show a TGA balance of only US$57B, which probably means that the government will run out of money within the next three weeks unless a deal is done to raise or suspend the Debt Ceiling. Given the lack of fear recently evident in the financial markets, with risk-off assets such as gold doing relatively poorly and signs of aggressive bullish speculation in parts of the stock market, it appears that most market participants expect a deal to be done very soon. While that’s definitely possible, it’s far from a foregone conclusion. Moreover, what comes after a Debt Ceiling deal will not favour the stock market.

What comes after a Debt Ceiling deal will be a flood of new government debt issuance to replenish the TGA and make the payments that were postponed during the preceding months. To be more specific, based on information provided by the Treasury there will be net new debt issuance of more than US$700B during the three months following a deal. This will drain liquidity from the financial markets unless it is accompanied by money leaving the Fed’s Reverse Repo (RRP) program. For instance, if the government were to increase its total debt by $750B after a deal and $500B of the new debt were purchased by MMFs using funds presently held in the RRP program, then the net liquidity drain would only amount to $250B.

Currently, therefore, there are two big unknowns. The first is the timing of a political deal to raise the Debt Ceiling and the second is the proportion of the ensuing flood of new debt that will be offset — in terms of effect on financial market liquidity — by money coming out of RRPs.

With regard to the timing question, there are two main scenarios.

The first is that a deal will be done within the next three weeks, thus avoiding a partial shutdown of the government. As mentioned above, this currently appears to be the general expectation. We suspect that if it comes to pass it will lead to short-lived (1 week maximum) moves to the upside in the stock market and downside in the gold and T-Bond markets, followed by reversals as other issues, including an imminent recession and the coming flood of new government debt, move to centre-stage.

The second scenario is that the political negotiations will drag on until a deal is forced upon the two negotiating parties by extreme weakness in the stock market. Under this scenario, a deal could be 2-3 months away. Even though the TGA balance probably will drop to almost zero within three weeks, this sort of delay in striking a deal is possible because of the corporate tax payments that are due on 15th June and the additional special measures that could become available to the Treasury at the end of June. In addition to substantial stock market weakness and a partial government shutdown, likely ramifications of this scenario include a large rise in the gold price.

What happens with the US government’s Debt Ceiling will have a big influence on the paths taken by the major financial markets over the next three months, but our short-term assessments of risk and reward do not hinge on when/how the Debt Ceiling issue is resolved. Regardless of whether we get the first scenario or the second scenario or something in between, the outlook for the next three months is bearish for the S&P500 Index, bullish for gold and bullish for the T-Bond.