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ABSTRACT: Amid continued risk-off sentiment in the markets following an easing of geopolitical tensions, the precious metals sunk even further this week. The attention of investors, however, turns to the likelihood of an increase to the federal funds rate in September. Stock indices in the U.S. slumped on mixed corporate earnings data, while a strong dollar and weak oil prices continued to weigh on the gold price.

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GOVERNMENT & POLICY

News & Notes

Jeb Bush ramps up his rhetoric about gutting the government of its largess, rekindling the sentiment behind his 2003 inauguration speech as governor of Florida.

Donald J. Trump (as the media has long taken to calling the magnate, at his behest) visits the U.S.-Mexico border to bring greater attention to his statements regarding the problems of illegal immigration and border security.

St. Louis Fed President James Bullard, who isn’t a voting member of the FOMC this year, gives a “better than 50-50 chance” that the first federal funds rate hike comes this September. A consensus of FOMC participants put interest rates at 0.50% to 0.75% by year’s end.

The Fed finalizes its new capital requirements for the country’s eight largest banks in an effort to limit depositor exposure to corporate defaults. JPMorgan faces the stiffest increase to its required capital reserves at 4.5% of risk-weighted assets. A few days later, the Fed announces that it is investigating 22 major financial institutions for manipulating trades on the Treasury market.

The ride-sharing service Uber seemingly wins its legal battle in New York City, as Mayor de Blasio abandons attempts to limit the company’s growth for the moment. Though not directly at issue in New York, companies like Uber and Lyft have come under fire from regulatory authorities for their business models that classify all of their employees as independent contractors.

The IMF warns Japan that it is relying too heavily on a weak yen (read: devaluing their currency through inflating the money supply) to reflate its economy; the Fund insists that the country must implement structural reforms such as job market deregulation and opening up the agricultural sector in addition to establishing a more credible fiscal strategy.

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MARKETS

Gold Gets Bashed, Wall St Falls on Quarterly Reports

The precious metals were swept in the tide of the seasonal “summer swoon” in the commodities cycle, following up last week’s losses with a sudden $35-per-ounce loss on Monday. While the impending rate hike from the Fed (and the attendant dollar rally thereafter) has undoubtedly helped keep the metal prices lower, Monday’s dramatic action was suspected to be the result of large sell pressure in China. Trade volumes for the benchmark gold contract on the Shanghai Gold Exchange skyrocketed, with more than three million trades on Monday, compared to an average volume of less than 30,000 in the preceding month.

With inflation still lagging and the worst geopolitical tensions seemingly avoided in Greece and Iran, the gold price has little support (barring a wave of institutional buying). Seemingly giddy at the prospect, the financial news media was dominated by headline after headline on Monday and Tuesday about how gold was “losing its luster,” and other clever quips, with some going as far as suggesting that the metal no longer functioned as an asset. Spot gold slipped below the $1,100/oz mark by shedding 3.14% on Monday, while silver shook off some early strength to fall 1.15% to $14.80/oz. Meantime, oversupply, poor retail demand, and the sluggish gold price have also pulled platinum and palladium lower of late, as the two metals lost 1.31% and 1.47%, respectively, to start the week.

U.S. stock indices closed slightly higher on Monday thanks in large part to bullish earnings reported by Halliburton, Morgan Stanley, and Google. The Nasdaq eked out a new record-high as PayPal, newly spun-off from eBay, saw trading volumes above 50 million in its first day listed on the exchanges. (Only Bank of America saw higher volumes.) The dollar was largely flat at 97.8 on the DXY while 10-year Treasuries rose, sending yields four bp lower to 2.37%. In news off the exchanges, iconic grocery chain A&P filed for Chapter 11 bankruptcy for the second time in just five years, and will sell off nearly all of its stores.

European bonds fell while the continent’s stock indices gained modestly on Monday. The STOXX 600 has seen its best rally since April 2014 after rising by more than 4% last week. The euro held at $1.085, though the yen softened back above 124 per dollar. Japanese markets were closed for the country’s Marine Day holiday. Elsewhere in Asia, Shanghai managed to gain 0.9%, though 22% of the shares listed on mainland exchanges were still frozen from trading.

Although Tuesday saw the precious metals stage a modest recovery in afternoon trading, this proved to be only a brief reprieve. Commodities in general have been battered recently, which is also dragging down the purchasing power of currencies in countries that rely on commodity production, such as the Russian ruble, Brazilian real, and Chilean peso. Between the commodity rout and generally low inflation, global economic growth projections continue to see downward revisions.

Wall St was dragged into the red at midweek thanks to a sell-off in tech shares. Investors were apparently disappointed with Apple’s rather rosy earnings report due to lower-than-expected sales of the new iPhone, sending the company’s shares sharply lower and wiping out $60 billion in shareholder value in a matter of minutes. Proportionally, however, this pullback likely won’t tarnish Apple’s luster going forward. The Nasdaq consequently sank 0.7% lower, while the Dow Jones and S&P 500 lost 0.38% and 0.24%, respectively.

The big economic data focused on the housing market this week. May home prices rose by 0.4%, while the pace of home sales reached an 8-and-½-year high after existing home sales jumped 3.2% in June. Sales of newly constructed homes, however, sank to a seven-month low after falling 6.8% in June. This surprised some observers, contradicting recent strength in housing starts data; new houses may be popping up, but they’re going unsold. Stock indices in Asia and Europe were both in the red while 10-year Treasury yields held steady at 2.32%.

Wednesday saw more evidence of gold traders capitulating—no longer aggressively supporting higher prices by buying and holding long contracts—as gold and silver each fell further, though platinum and palladium were unchanged. The COMEX gold price (the “paper gold” price) retreated for 10 consecutive days, the worst such streak for the metal since 1996. The benchmark Gold Miners’ index, which tracks shares of major gold mining companies, fell to its lowest level since 2001, back when gold was a mere $300/oz. Gold miners have been forced to ramp up production amid the weak price environment in order to increase their revenues and service their debts with higher volumes at the depressed prices.

The tumbling gold price has kick-started physical retail demand, however: the U.S. Mint has sold 130,000 troy ounces of American Gold Eagle coins thus far in July, already the most in any month since April 2013 when the bear market in gold officially began. Analysts at Morgan Stanley see a worst-case scenario where spot gold falls as far as $800/oz, though it says its median expectation for the year-end gold price is still $1,050/oz. The last time gold closed the year near the $800 level was 2007, just before the bull run that saw spot prices more than double.

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Weekly jobless claims fell by 26,000 to 255,000 new claims on Thursday, notching a new 42-year low for the measure. In spite of this seemingly world-beater employment data, mixed results from the quarterly earnings season yanked shares from the green down to ½ to ⅔ of a percentage point in the negative by the day’s close. On the bad side of earnings reports, McDonald’s posted its seventh consecutive quarter of falling sales, construction equipment maker Caterpillar slumped, and resource mining conglomerate Freeport-McMoRan saw a drop in its quarterly profits; on the other end, Newmont Mining beat investors’ expectations, General Motors saw profits soar on robust truck sales in North America, and Amazon defied expectations of a quarterly loss with an excellent Q2 performance thanks to growth of its cloud technology business. Shares of Amazon spiked as much as 20%, hitting a new intraday high.

Thursday also saw a momentary corrective bounce for the precious metals as the dollar eased up to 97.18 on the DXY. Copper prices were slated to fall further based on futures contracts, as the red metal has tracked with tumbling gold prices and is simultaneously held down by economic slowdown in China, which accounts for a huge proportion of global copper consumption. Stocks were up in Asia and Europe while the U.S. was mixed, as more troubles for American Express pulled the Dow Industrials down furthest. Consumer comfort measures fell to a five-week low.

Despite the protracted crisis in Greece, the European market has recovered considerably over the last 4 years, particularly in the case of Spain, surprisingly enough: before Greece first ran into its current problems in 2010 and required a bailout, Spain looked to be in far worse shape than its counterpart on the opposite end of the Mediterranean. Now, Spain is actually showing the fastest growth in the region.

Stocks in the U.S. sank on softer earnings data on Friday, with the S&P 500 and Nasdaq losing more than 1% each. China’s factory output experienced a contraction in July, as the gauge of factory activity registered its lowest reading in 15 months. 10-year Treasuries saw some demand, with yields dropping to 2.27%. After opening the day slightly down, the precious metals did recover to add 0.75% by Friday’s close, excepting silver, which ended the day flat. This is the 5th straight losing week for the silver price, while gold lost almost 4.5% over the course of the week. Expect high trading volumes in the metals going forward until prices begin to turn higher: trading volumes for gold have been about double their 100-day moving average, and exchange-traded product holdings of platinum and palladium are actually at 8-month highs.

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M&A News

  • Lockheed Martin is expected to buy the Sikorsky division of United Technologies (maker of military helicopters such as Black Hawks) for as much as $9 billion. This is the biggest acquisition for Lockheed since merging with Martin for $10 billion in 1995 to become the world’s largest defense contractor.
  • Anthem finalizes its $54-billion deal for Cigna, possibly sparking more consolidation in the healthcare sector.
  • Japan’s Nikkei purchases the 127-year-old Financial Times (U.K.) from Pearson Plc for $1.3 billion.
  • Home Depot is expected to acquire Interline Brands for $1.63 billion.
  • Regulators in Europe approve mobile phone maker Nokia’s bid to acquire Alcatel-Lucent SA, citing a robust competitive balance in the region’s wireless technology industry.
  • The FCC is expected to approve AT&T’s acquisition of DirecTV.
  • Software company Schneider Electric SE will take control of Aveva Group Plc.
  • Dutch fertilizer maker OCI NV is in talks to merge with CF Industries Holdings.

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GEOPOLITICS & WORLD EVENTS

Greece Begins Bailout Negotiations

Greece reopened its banks, slightly eased its capital controls, and was able to successfully pass both austerity bills required by the country’s European creditors before talks between the two sides on a long-term bailout deal could resume. Since reopening, the Athens Stock Exchange has surged nearly 10%, while Greek bonds continue to recover.

The biggest question that remains is the matter of debt relief, an issue vehemently opposed by the coalition of Northern European countries led by Germany despite level-headed calls by other principal players (France, the IMF, and the U.S. noteworthy among them) for some degree of debt forgiveness. Many in the German camp have definitively ruled out any nominal reduction to the debt burden, leaving only the extension of maturities on the debt instruments as a viable option for easing the immediate debt load for Greece. The moving back of maturities was also suggested by Italian Prime Minister Matteo Renzi as he grasped for some common ground between those in favor and against debt relief.

The situation is made more complicated by the unavoidable politicking that accompanies the negotiations. The rest of Europe has seemingly lowered the boom on the Greek economy, as the new deal calls for the highest levels of fiscal rigor and market deregulation of any member of the eurozone. In the same way that irresponsible government spending burdens an economy with debt, inflexible austerity will likely rob depression-stricken Greece of any opportunity for much-needed growth.

As difficult as it is to accept the logic of PM Tsipras’ populist rhetoric against the bailout deal while still urging that the Greek parliament approve the measures, the Tsipras paradox is no more dissonant and vexing than that of the most hardline austerity hawks in Europe.

Has China’s Love of Gold Waned?

gold_tumbleLast Friday, China reported its official gold reserves for the first time since 2009. (Most countries announce changes to their reserves monthly.) Though the official government number could be understated, most analysts expected far more than the 1,600+ tonnes the central bank claimed to have. The updated figures still place the People’s Republic fifth in global gold reserves, leapfrogging Russia.

Although Russia has actually outpaced the Chinese government in its gold purchases over the last 6 years, as the Russian central bank added another 25 tonnes this June, the amount of gold flowing into mainland China has brought the country into close competition with India as the world’s largest consumer of the yellow metal. Thanks to the acquisition of a number of lucrative South African mines, China also stands are the globe’s #1 gold producer.

The latest Chinese gold reserves would indicate that the country has been adding roughly 100 tonnes of gold to its stockpile each year since the last announcement. Though this is nothing to sneeze at, it doesn’t quite reckon with the thousands of tonnes of gold bullion that have been imported into the country over that time span. The recently operational Shanghai Gold Exchange has rapidly become the world’s largest marketplace for physical bullion, and gold bars also change hands in nearby Hong Kong.

Beyond a strategy of diversifying its forex holdings out of dollars (of which the Chinese hold an enormous amount) and into something that may back its own global currency of the future, the yuan or renminbi, the lower-than-expected gold reserves (if they are to be believed) would have to mean that either a considerable amount of gold is in private hands in China, or that this extra metal has been exported. The latter scenario might lend support to speculation that last week’s flash crash that set off the downward slide for gold prices was the result of large Chinese funds selling their holdings to cover mounting losses in equities.

One would generally commend individual Chinese investors for accumulating gold, especially as an insurance policy in the event of a serious stock market correction—like the one that erased $4 trillion in value from mainland exchanges over the last month. Unfortunately for retail investors in mainland China, the timing of their stock meltdown coincides with a bottoming out of precious metal prices and a gradual slowing of the fastest-growing economy over the last quarter-century.

With the losses now coming from seemingly all angles, many Chinese traders have begun resorting to certain simplistic strategies in derivatives: rather than following Buy-and-Hold patterns that usually characterize a stable stock market, futures traders are exploiting “Open-to-Close” tactics, buying and then quickly selling shares of major state-sponsored firms to take advantage of intraday moves that are almost always supported by government intervention.

With more uncertainty and volatility sure to come, hopefully the most leveraged Chinese investors have held on to their gold for the longer haul.

News & Notes

Large-scale strategic war games are taking place in Australia this week as American, Aussie, and Japanese commandos cooperate together in the exercises. This comes as the Japanese government is attempting to ease constraints on its military activity, a remnant of the country’s post-WWII constitution. It also helps Japan mend relations with Australia, which the imperial government occupied during the war. From the U.S. perspective, the exercises should strengthen the country’s interests in the South Pacific by the symbolic show of might and demonstration of preparedness, as well as the shoring up of ties with key allies. Chinese officers were among observers of the military exercises from 30 different nations; as is the case with many other countries, Australia’s biggest trading partner is China.

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A LOOK AHEAD: Durable goods orders and the Dallas Fed manufacturing survey will carry the day in U.S. markets on Monday. Meantime, Germany’s Ifo Institute releases its Business Climate Index, while the eurozone as a whole announces its M3 measure of the money supply.

 

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