I’ll Be Right and Here’s Why –The Seasonality of Gold and Bonds
I’ve written in the past that the seasonality of bonds, gold and agricultural commodities begins sometime between November and February each year. It seems odd to me that investors prefer to buy these assets at this time each year, rather than some other time. So, I asked around my financial network and the answer I got was the same: this is the time of the year those asset classes may enter a bull market. But nobody could tell me why. As it so happens, the answer was staring me in the face!
Last November I wrote that the rise in bond yields had to do with the U.S. Treasury running out of money around the same time as the election. This was set up by the Obama administration to allow the next President, which then President Obama believed would be Hillary, to deal with the budget. That rise in bond yields ignited the narrative that now President Trump would re-inflate the economy and that his policies would create inflation. Investors, believing the big money was behind this move, quickly dumped their bonds and bought stocks.
Based on investor psychology, the move out of defensive assets to risk assets makes perfect sense. Donald Trump’s campaign was based on supply-side economics, or Reaganomics, that suggests economic prosperity is a function of deficit spending, lower taxes and fewer regulations. Under Reagan, this worked because the debt-to-GDP ratio was about 30%, while today it is in excess of 90%.
When the debt-to-GDP ratio of a country exceeds 90%, the stimulative effects of supply-side economics are minimal. But this didn’t stop the Boomers from piling into equities under the belief that we are on the bottom of a 20-year Bull market in stocks like we saw under Reagan. Unfortunately, that will not happen due to our high debt-to-GDP ratio, but that didn’t stop investors from selling their bonds.
Had the public not dumped bonds to buy stocks and a funding bill been passed, I would have been right. When the U.S. Treasury runs low on money the cash level at the Federal Reserve Banks falls. The Federal Reserve maintains twelve regional banks that hold cash to pay the bills for our government. When cash levels fall, interest rates rise to attract capital. The simultaneous event of the U.S. Treasury running out of money and Trump’s victory was a double whammy against bond prices as interest rates rose – due to the inverse relationship between interest rates and bond prices.
The seasonality of bond prices has everything to do with the U.S. Treasury and Congress. Once Congress passes a funding bill that allows the U.S. Treasury to raise cash by selling bonds, the cash balance at the Federal Reserve Banks will rise. When cash balance at the Federal Reserve Banks rises above the level of demand for loans, long-term interest rates fall. This is why, for the past 35 years, nearly every time a large funding bill is passed (compared to a short-term 4-week funding bill), interest rates fall. Once you understand how long-term interest rates can rise or fall due to the cash balance at the Federal Reserve Banks, suddenly the bigger picture comes into focus.
President Reagan and most of the Presidents that followed, all increased the deficit. As deficits increase along with the overall amount of government debt, the U.S. Treasury needs to borrow an increasing amount of money each year to pay our bills. Every time the U.S. Treasury issues a large number of bonds to pay our bills, they place an equally large amount of cash into the Federal Reserve Banks. As the cash level in the reserve banks rises with each successive funding bill, interest rates fall to new all-time lows; meaning that as long as our government continues to run larger deficits, interest rates will continue to fall. Only when we have a balanced budget or a surplus, as happened during President Clinton’s term, can interest rates rise. The 35-year bond Bull market that most economists and analysts have been saying will end, probably won’t anytime soon. At least not until our government gets its spending under control.
If I am correct, then the best time to buy U.S. Treasuries should be right after any substantial funding bill is passed. To confirm this narrative, I pulled the Treasury deposit data for the Federal Reserve Banks and compared it to the 10-year Treasury yield. Sure enough, the correlation was accurate. This means, once a funding bill is passed, long-term interest rates should fall. Coincidentally, funding bills are typically passed sometime between November and February, which explains the seasonality of when bond prices begin to rally.
Most of my long-time readers know I am very bullish on U.S. Treasuries because we are headed into a recession. I have also been on record stating that the chart pattern in bonds is also bullish, where nearly everyone else is bearish on bonds. Other “experts” believe that expected inflation is what is driving yields higher, but I think they are wrong. The reason I think they are wrong is that the Federal Reserve is actively contracting the money supply in our country.
Inflation can come in two forms: from an increase in the money supply or from an increase in demand. However, an increase in the money supply doesn’t always lead to inflation. If the growth rate of the money supply is 5% and the growth rate of goods grows by 5%, then the rate of inflation will be 0%. If the growth rate of goods exceeds the growth rate of the money supply, that is deflationary, which is exactly what we are seeing in our economy today.
Due to automation, computers, the Internet, and artificial intelligence, corporations can quickly increase output without a significant increase in cost. Or simply, in an advanced economy like ours, the growth rate of goods is very high. This is why despite printing nearly $4 trillion in new money, we have barely experienced inflation. The growth rate of goods has been high enough to offset any inflationary forces.
A declining money supply isn’t always deflationary. If the growth rate of the money supply declines by 5% and the growth rate of goods declines by 5%, then there is no inflation. If the growth rate of the money supply declines, like it is now, and the growth rate of goods increases, then it is deflationary!
When you factor rising short-term interest rates in a highly indebted economy like ours, real, or inflation-adjusted, disposable incomes fall as consumers face higher interest payments on their revolving debts and higher consumer prices. As the Federal Reserve tightens our money supply, due to our debt levels alone, the economy should deflate. As deflation takes hold, interest rates should fall.
Rising short-term interest rates aren’t the only factor driving down real disposable incomes. As I outlined in last week’s charts, a weakening U.S. Dollar means that real, average, hourly earnings should also fall. When people have less money to spend in the economy, their demand for borrowing falls, which will also bring long-term interest rates down. Not everyone agrees with my view, which is why speculators are heavily shorting 2-, 5-, and 10-year Treasury bonds.
The other reason Treasury yields are rising is that speculators are shorting U.S. Treasuries in hopes that yields will continue to rise. The narrative is this rise in yields is due to an increase, or expected increase, in lending demand, but that isn’t the case either. Commercial and industrial loan demand is only running at a 1-1.5% increase on a year-over-year basis, which is not a sign of strong lending demand. In the late stage of the business cycle, where we are now, the lending growth rate is more likely to turn negative than it is to increase. But speculators aren’t long-term investors; they seek to profit from short-term trends. Chasing a short-term rise in yields will lead to a rapid decline in yields once a funding bill is passed.
Unlike stocks, Treasury yields tend to move nearly vertical from one consolidation pattern to the next. This rapid move in yields is a function of forcing out those who are invested opposite the prevailing trend. Once a funding bill is passed, investors will buy Treasury bonds to participate in the upside price movement. As more investors buy Treasuries, those who have been shorting Treasuries will be quickly “stopped out”; meaning speculators who placed stop-losses on their investments will be forced out of their trades. As those speculators are flushed out, they will also turn bullish to ride the ensuing wave. When a large number of investors turn bullish, prices rapidly rise. This is why I believe bond prices will rapidly rise after a funding bill is passed. Based on historic price returns, upward movements out of these consolidation patterns that follow the passage of a large funding bill can cause Treasury bonds to rise 20-40% in value.
As Treasury yields fall and bond prices rise, gold and agricultural commodities tend to start rallying. Gold and agricultural commodities outperform during periods of falling yields, or deflation, which will occur as the Federal Reserve continues to tighten the money supply, until we enter a recession. Gold and agricultural commodities don’t always turn bullish after a large funding bill is passed, but this time they appear to be poised for a huge increase in price.
According to classical chartist Peter Brandt, a 40-year commodities trading expert, agricultural commodities are poised to make a huge move higher in price. Peter has shown that approximately every 10 years, or the average time between business cycles, that agricultural commodity prices boom. Ten years ago, during the Great Financial Crisis, agricultural commodities nearly doubled in value in a 12-month period.
Based on Brandt’s research, we are on the eve of one of those massive moves higher in price. From my own research, agricultural commodities love any period where consumer prices are rising as the economy is deflating, which should happen as short-term interest rates rise and the money supply contracts. While agricultural commodities may be set for a huge move up, gold is likely to experience an even larger move higher.
It’s not just that we are in the very late stages of the business cycle that will have the economy lapsing into a recession and cause gold to rise. The stock market is being propped up by record-high levels of leverage and speculation that will unwind as it did during the prior two recessions. Our government is facing tens of trillions of dollars of unfunded entitlement liabilities that may force them to devalue the dollar, as our government has done several times in the past. The American consumer has been underwriting our economy with credit which will eventually come to an end. Based on the economic data, that end date is not far in the future. It is those risks that have driven the major players into defensive assets because they know once the next economic downturn starts, there will be a huge flood of money taken out of risk assets into defensive assets.
That is why the big money and central banks have been buying gold for the past four years, which is evident in the four-year-long consolidation pattern that has formed. As investors, this tells us those buyers believe there is going to be a huge demand for gold in the coming years. By buying up all the supply of gold, the big money is hoping that the forthcoming demand will cause gold prices to skyrocket. The narrative behind such a large move in the metals market makes perfect sense, especially considering that once a funding bill is passed, the stage will be set for a breakout in gold.
Based on Austrian Economic Theory, the more money a government or central bank prints to solve their financial problems, the bigger the ensuing economic crash. Since central bankers have been papering over their financial problems for the past 17 years, the ensuing crash is destined to be bigger than the Great Financial Crisis.
Throughout history, there is one asset that reigns supreme during every economic collapse – gold. Clearly, those behind this four-year buying program are expecting demand and prices to go up. Historically, the upside price movement can easily be 100% or more, which is well worth a four-year wait.
As it turns out, the seasonality with gold, Treasuries, and commodities kicks off with a funding bill. With Congress in a stalemate over the budget, it doesn’t appear there will be an immediate solution. That should send yields higher and gold lower over the short term, which would just push gold down towards my target buy point. Seasonality is a powerful force; one that should bring bond yields down and kick off a big rally in gold.
This update was written last weekend. On Tuesday I received a copy of a new newsletter that is being published by a well-respected macro investment manager. The last two pages of his report, while very technical, were dedicated to this topic. His views are the same as mine, I thought was interesting!
Q&A with Steve – Your Questions Answered
- Can you explain what “coiling” means, as related to gold?
A coil is a form of a chart pattern that takes the appearance of a wound-up garden hose. Coils can be short but often can run a year or more. When a trader sees a coil forming they get very excited because it is an indication that one or more of the big money investors (big money = billions of investment dollars) are buying up as many shares as possible because they anticipate a large move in price. What the big money does is buy at a predetermined bottom, then they let prices rise. Excited investors jump in, and then the big money forces them out by selling. As investors sell, the big money buys. Gold has been in a long coiling pattern for four years and the associated mining stocks have been in a coiling pattern for nearly two years. What that tells us is that when prices move beyond the upper limit (the price points where the big money has previously sold) that prices are going to rise very quickly. Catching the upward price movement out of a coiling pattern can lead to high returns without a minimal amount of downside risk.
- Do “coiling” patterns always lead to a strong move up in price?
No – I’ve been following a Vanguard REIT ETF (symbol: VNQ) that has been in a coiling pattern for the past year. In January it broke out of the coil and prices fell.
- How do you know gold and the mining stocks will move up?
There is no way to know until the chart structure is completed and prices move up or down out of the pattern. There are indicators that can increase the probability of projecting which direction prices will move. For example, in the Vaneck Vectors Gold Mining ETF (symbol: GDX), there has been a consistent price bottom around $21 per share, which suggests that is the bottom end of the price movement. Another indicator is volume, and the longer the coil lasts, the lower the volume. Volume is an indication of the number of trades or interest in a security. To buy all the available shares, the big money needs the small investors to lose interest. The best way to do that is to make the coil last an unusually long time, which will cause most retail investors to move on to other investments that are rising.
- Why don’t you trade in the middle of the coil?
That’s very risky. Those who invest or trade around chart patterns suggest that the best way to reduce the downside risk of a trade is to wait until the pattern completes or until it is nearly complete.
- Does the length of the coil have any meaning?
Yes – the longer the coil the larger the price move will be coming out of the coil. This is a function of how many shares the big money is trying to buy or sell. If they see strong upside potential, then they will seek to buy up as many shares as possible without much concern of how long it will take to acquire those shares.
- When do you see an entry point in the mining stocks?
Soon, but I’ve been saying that for nine months now. Based on the volume and the length of the coil, I expect there to be one last move down to flush out those who have bought in the past few months. That will be an excellent entry point, but if prices move up and out of the coil, then we will need to enter sooner.
- What is your return expectation?
If GDX goes back to its most recent high set back in August 2016, that would represent a 25% return. If it returns to its all-time high that was set in September 2011, that would represent a 150% return. If that is the case and this is a resumption of the Bull market in gold miners, then prices should rise above their all-time highs.
- Does your interest in agricultural commodities have anything to do with what’s going on in Venezuela?
Not directly, but Venezuela is experiencing high rates of inflation. Any time there are high rates of inflation, commodity prices soar and supply falls. If you’ve seen any pictures or videos of grocery stores in Venezuela, then you know that most of their shelves are bare. High demand and low supply lead to high agricultural commodity prices. Based on data going back more than 300 years, soaring food prices is a common occurrence in regions experiencing high inflation. I wanted to buy a small piece as a hedge against all this central bank money printing.
Video Topic of the Week – Bubble!
We are now in the biggest stock market bubble in history.
Chart of the Week – Treasury Deposits in Federal Reserve Banks
This week I have several charts on how gold, bonds, oil, the dollar, and volatility are affected by Treasury deposits in Federal Reserve Banks.
Portfolio Shield™ Update
Work progresses on the new strategy that can short the market based on an algorithm. Unfortunately, these tests take 3-5 hours to run, so I’m limited to how much time I can dedicate to them. I am currently testing a split strategy where the time scale for the long positions is different than the short positions. While that doesn’t make much sense, what I’m trying to do is keep the algorithm from recommending a short position too late into the downturn and holding that short position too long during the upswing. It’s much harder than it looks, but I have two sample tests on my desk that look promising.
I’m also working on a completely new algorithm that I think will work much better. I can visualize how it should work, but I will still need to translate that into a mathematical formula. If it were to work, it would adjust between a long and a short position much more fluidly than the current algorithm can.
If this can work, then the new algorithm would be unlike anything else I’ve seen. I believe it could be adapted to securities that rise and fall rapidly as well as securities that don’t. If that worked, then I could dump a wide assortment of securities into the algorithm to develop a portfolio that adjusted to the securities that had a high probability of generating a positive return. Things like this keep me awake at night!
Tracking the Big Money
To validate my narrative, I dug into the charts to see if there were any signs of how the big money was positioned. Another view that I didn’t cover in the main piece of this week’s update is my opinion that the United States will be forced to devalue the dollar. The dollar has been in a topping pattern, which would suggest that the big money wants to reduce their dollar holdings. And for good reason, if the U.S. devalues the dollar, those dollar holdings will be worth less. So, let’s take a look at some comparisons between the dollar, gold and government bonds.
In December 2016 the dollar peaked in value for this cycle. Also in December 2016, gold held its upward forming trendline by setting a “higher low,” 10-year Treasury yields peaked for this cycle at 2.6% (this peak has been slightly broken) and Treasury bonds bottomed.
By September 2017, the dollar had fallen nearly 10% and formed a short-term bottom. Also in September 2018, gold formed a short-term top, 10-year Treasury yields bottomed and Treasury bonds peaked.
In November 2017 the dollar rebounded and formed a short-term top. Following that move, gold was in a mid-point consolidation pattern as were 10-year Treasury yields and bonds.
As of January 2018, the dollar is at a potential bottom, gold is at a potential short-term top, Treasury yields are rising (keep in mind this has to do with the reduction of cash held at Federal Reserve Banks), and Treasury bonds are near their lows.
These correlations are telling us that the big money is rotating their money out of the dollar and into gold and bonds, which offers validations for my opinion.
The Debt Ceiling Allocation
Based on this week’s update and corresponding charts, this gives us a “debt ceiling allocation” should Congress pass a bill to raise the debt ceiling, which will give the U.S. Treasury the ability to raise debt.
Allocation: Short equities; long Treasuries; short oil; long dollar; and long gold.
Weekly Broad Market / Economy Commentary
The big issue of the week is the weakening U.S. Dollar. Donald Trump campaigned that he wanted a weaker dollar and his administration has seen a rapid decline in its value starting the month before he took office. This weakness is largely a function of liquidity, or the lack thereof, as indicated by the amount of Treasury deposits held at Federal Reserve Banks, which has rapidly declined since the election.
Without a funding bill that would increase the debt ceiling, the U.S. Treasury can’t issue new long-term debt. Instead, they have been issuing short-term debt to pay bills, which is adding liquidity to the markets. The rise in the stock market has everything to do with liquidity because we have never seen stocks move as much as this regardless if the news is good or bad. Liquidity drives markets and when this liquidity spigot is removed, it should have a noticeable effect on asset prices.
The Trump administration is saying that a weak dollar will help exports and create jobs. Provided there is demand for U.S. goods and services, this is true. But as I showed in the charts last week (or the week before) that a weaker dollar leads to lower inflation-adjusted wages. While a weaker dollar might create more jobs, workers will quickly find their paychecks don’t go as far as they used to.
The real reason I believe the Trump administration is pursuing a weaker dollar is our debt. Federal tax receipts have been at a recessionary level for the past two years, which is highly unusual. In past reflationary attempts, tax receipts have risen, which is what should happen. But they haven’t.
Another way to fix the problem is to weaken the dollar, which is a tactic that has been utilized several times in the history of our country. Devaluing the dollar is a quick way to create inflation, which leads to higher tax receipts. Higher tax receipts can reduce the deficit which would allow the current administration to pursue increases in infrastructure spending without breaking the bank.
The quickest way to devalue the dollar would be to increase the price of gold, which has been done by past Presidents. That could be interesting with gold sitting on the cusp of a Bull market rally.
Of course, the moment I write this, President Trump in an interview says he wants a strong dollar…
The problem with a weaker dollar is inflation. While the Federal Reserve wants inflation, they don’t want too much. While the real economy isn’t showing too many signs of inflation, the stock market is. It is entirely possible the new Powell-led Fed will seek to raise interest rates faster than anyone expects. If the dollar starts to gain strength as the Fed increases its tightening, it will act as a gigantic liquidity drain to an economy that is already draining.
This is what happens towards the end of every business cycle: the Fed over-tightens and sends the economy spiraling down.
Bonus (29 min):
- M2 Money Stock YoY% vs Recessions
- Commercial & Industrial Loans
- Consumer Loans
- Federal Reserve Balance Sheet
- UoM: Consumer Sentiment
- Total Savings Deposits at all Depository Institutions
- U.S. Dollar vs Tax Receipts
- U.S. Dollar vs Corporate Profits
- Savings Rate vs GDP Growth
- Treasury Deposits at Federal Reserve Banks vs 10-Year Treasury Yields
- Stock Prices vs GAAP Reported Earnings
- S&P 500 Price-to-Sales Ratio
- Richmond Fed Manufacturing Survey
- Goldman Sachs Risk Appetite
- Citi Economic Surprise Index
- Markit Flash PMIs
- U.S. Pension Funds Rebalancing
- Goldman Sachs Equity Valuations
- Goldman Sachs Financial Conditions
- Home Sales
- Stock-to-Bond Ratio
- Shiller Cyclically Adjusted P/E Ratio
- Credit Card Delinquencies
- S&P 500 vs U.S. Dollar
- S&P 500 (SPY) Chart
- 5-Year Treasury Yield (FVX) Technical Analysis
- 10-Year Treasury Yield (TNX) Technical Analysis
- Gold Futures (GCZ7) Technical Analysis
- Vaneck Vectors Gold Miners (GDX) Technical Analysis
- Global X Silver Miners (SIL) Technical Analysis
- iShares 7-10 Year Treasury Bond (IEF) Technical Analysis
- PowerShares DB Agriculture (DBA) Technical Analysis
- U.S. Dollar Index (DXY) Technical Analysis
- General Electric (GE) Technical Analysis