US Strategy Weekly: Oil, the Dollar, Gold, and Treasury Bonds

Equities have demonstrated some impressive price momentum in recent weeks, and this inspired us to look at a range of markets to see what might either support or counter this advance. Unfortunately, what we found triggered more questions than answers.

Oil, the Dollar, Gold, and Treasury Bonds

We began by looking at the WTI crude oil future (CLc1 – $80.71) which peaked on June 8, 2022 at a price of $122.11. Much of the weakness in oil was attributed to the shutdowns being implemented in China due to a string of outbreaks of a Covid variant. This was logical since China’s actions implied factory shutdowns, less global economic activity, and less demand for oil. Plus, it was not only China that was a concern since there were growing fears of recessions in Europe and the US.

On September 27, 2022 the dollar (.DXY – $102.39) peaked at a price of $114.11. This was counter to the fact that the Fed was in tightening mode, but it was logical because most energy trades are done in dollars and a weakening global economy, and a lower price of oil would reduce global demand for dollars. However, we found it intriguing that the gold future (GCc1 – $1907.20) troughed on the very same day, September 27, 2022, at a price of $1626.70. This has different implications for the dollar. Gold, which had historically traded in line with inflation, was not an outperformer like most commodities and in fact, it continues to trade below its August 6, 2020 peak of $2051.50. The corresponding high in the dollar and the low in gold implies a possible switch by global investors from the dollar to gold as a safe-haven global currency. This suggests a lack of faith in the US dollar. But in fact, the underlying strength in gold and weakness in the dollar may be directly tied to China. Beijing rarely telegraphs its purchases of gold, yet it recently announced it had purchased 32 tons of gold in November and 30 tons in December. China’s stockpiling of gold resembles that of Russia before its invasion of Ukraine. Before invading Ukraine, Russia de-dollarized its economy and stockpiled gold and Chinese yuan. Some geopolitical analysts theorize that China may be building its gold coffers in preparation for an attack on Taiwan. Should this theory become reality, it would be a major negative for global stability and equities, in our view.

Lastly, and on October 21, 2022, the 10-year Treasury yield index (.TNX – $35.35) peaked at $42.13 or the equivalent of a 4.2% yield in the 10-year bond. It has been declining ever since. A decline in long-duration Treasury bonds yields can have many explanations, but when investors are fearful of an economic slowdown, demand for Treasuries typically increases and yields fall. Global investors will shift to US Treasuries as a safe-haven investment in times of economic weakness or geopolitical uncertainty. This could explain the decline in long-term interest rates.

In sum, the weakness in oil, the dollar and long-term interest rates could make sense in times of impending economic weakness. The rise in gold and fall in the dollar could have ominous implications for Taiwan and geopolitics. In general, this threat could trigger an even greater shift toward gold for stability. Nevertheless, none of this explains or supports the advance in US equities from the October 12, 2022 S&P 500 low of 3577.03.    

Still Jumping the Gun

Headline CPI fell from 7.1% YOY to 6.5% YOY in December, which led to a rally in the equity market. However, this decline in inflation was concentrated in energy, the energy-derivative category, transportation, and apparel. All items less food and energy had a smaller decline from 6% to 5.7% YOY as prices continued to rise at a faster pace in housing, owners’ equivalent rent and services. See page 3. There were items to celebrate in the inflation report. Areas of the economy like new and used cars, transportation (public and private), lodging away from home and household furnishings and operations are experiencing major decelerations in price gains. On the other hand, food at home and all areas of the service sector continue to show stubbornly strong price rises. See page 4.

We remain concerned. Whenever inflation has exceeded a standard deviation above the norm (3.4%), a recession, or string of recessions, has ensued. We do not believe this time will be different. Plus, the Fed has indicated that its goal is to beat inflation and return to a real fed funds rate. Today the real fed funds rate is negative 210 basis points to CPI and negative 170 basis points to November’s PCE index. In short, all signals point to more Fed hikes in 2023. See page 5.

Consumer sentiment improves

Consumer sentiment has improved in recent months as seen by the headline Conference Board Consumer Confidence index rising nearly 7 points to 108.3. The University of Michigan released preliminary results for January which showed an increase from 59.7 to 64.6 in the overall survey, a jump from 59.4 to 68.6 in the present situations and an increase from 59.9 to 62.0 in the expectations survey. Both surveys are clearly improving and rebounding from recent recession levels. See page 6.

But we remain concerned about the consumer. The savings rate was 2.4% in November and has been below 3% for five of the last six months. Readings below 3% were last seen in April 2008 (2.9%), November 2007 (2.8%), and seven of nine consecutive months between February 2005 and October 2005. The record low savings rate of 2.1% was recorded in July 2005. Another indication that consumers are stretched is the rise in credit. As of November, total consumer credit grew 8% YOY, but since August 2022 revolving credit has been steadily expanding at a pace of 15% YOY or more. This is worrisome; however, one consolation is that revolving credit remains below levels seen prior to the 2008 recession. Nevertheless, real consumer credit is just modestly below its 2020 peak and is a sign that consumers are financially strained. See page 7. 

Technicals are Looking UP

The current rally has broadened to include most of the popular indices which are now trading above their 200-day moving averages. The one exception is the Nasdaq Composite. However, January’s advance is reminiscent of the August 2022 rally which also resulted in tests or breaks of the 200-day moving averages but became a failed rally. Nonetheless, the current rally could have staying power and it is significant that this rally is materializing in January, a month that can be predictive of the year’s performance. See page 9.

The 25-day up/down volume oscillator is currently neutral with a reading of 2.44 but is close to recording an overbought reading. An overbought reading that persists for at least five to ten consecutive trading sessions would be significant and a sign of a positive shift in the cycle. See page 10. Also interesting is that the 10-day average of daily new highs is 103 and new lows are 39. This combination is now positive since new highs are above the 100 benchmark and new lows are below 100. New highs have not consistently outnumbered new lows since April 2022. The advance/decline line is currently 33,545 net advancing issues from its 11/8/21 high – still negative yet a big improvement in the last two weeks. See page 11. We remain cautious but are carefully monitoring technical indicators, particularly the 25-day volume oscillator, for potential good news.

Gail Dudack

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