[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.

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

Short-term moves can create opportunities to scale in or scale out, but the big picture always should be kept in mind. For the gold mining sector, this means keeping in mind the high probability that a cyclical bull market is underway. This cyclical trend should result in large additional gains by gold mining stocks in nominal terms and relative to most other stocks. With regard to relative performance, the following two weekly charts give some idea as to the amount by which gold mining stocks could outperform other commodity-related stocks over the next 6-12 months.

The first chart shows that gold mining stocks (represented by GDX) doubled-bottomed relative to general mining stocks (represented by XME) between August of last year and February of this year. Significant gains in the GDX/XME ratio have occurred already, but based on the historical record the ratio could double from here prior to making its next major peak. As mentioned in previous TSI commentaries, the cyclicality of this ratio points to the gold sector’s next major relative-strength peak occurring between late-2023 and mid-2024.

The second chart shows that the gold sector reversed upward relative to the oil sector (represented by XLE) during the final quarter of last year. This chart suggests that the new trend involving strength in gold stocks relative to oil stocks is still in its infancy.

In case what we’ve written above and in many previous commentaries is not clear, the focus of most investing/speculating should be on gold and the related assets (silver and the gold/silver mining stocks). This has been the case for the past six months, it is the case now and it likely will be the case for the next six months.

For equity traders, this means that the gold mining sector should be prioritised when planning portfolio additions. However, it doesn’t mean that everything else should be ignored and that your entire portfolio should consist of gold/silver stocks. With regard to “everything else”, we note that the fundamentals for the oil tanker sector remain very bullish, the cannabis sector is starting to shows signs of life, it is important to have exposure to energy (oil, coal, uranium and natural gas) and it would make sense to have some exposure to commodities such as lithium and the REEs.