China and Commodities Crunched

Gold Market Update: China and Commodities Crunched!

Gold prices have fallen by over 1% this week, re-testing the USD $1240oz level, whilst silver has also declined, trading closer to USD $16oz, as renewed selling pressure hit the entire commodities complex this week.

Escalating trade tensions have been the primary driver, with the Bloomberg Commodity Index of 25 raw materials (including things like copper and oil) dropping by nearly 3% in one day earlier this week, with the index now back to levels seen in December, and down almost 9% from its peak in May.

The decline in commodities, which portends a potential slowdown in economic growth, can be seen clearly in the chart below, which tracks the commodity index over the past few months. 

Wednesday the 11thwas the peak day for selling pressure, with no sector of the commodities complex able to hold up. Agricultural products were impacted, whilst oil fell over 5%, and copper was down 4%.

These moves are also being reflected in currency markets, as the US dollar continues its almost relentless rally, and emerging market currencies tumble, as you can see in the chart below.

So far, developed country stock markets have held up relatively well, though stock market investors in countries like China haven’t been so lucky, with significant declines.

For the month of June, the Hang Seng China Enterprises Index was off 7.6%, whilst the Shanghai Composite was off 8%, with both indices now officially in bear market territory, with declines since January of over 20%.

The importance of dollar strength to the rout in emerging market currencies, stock markets, and commodities can be seen clearly in the following chart, which plots the DXY US Dollar index (inverted) as a red line, as well as the number of units outstanding for the IShares MSCI Emerging Market ETF.

As you can see, dollar strength has been a primary driver of the emerging market sell-off, with this excellent update from Aitken Investment Management (where the chart comes from too) pointing out that the outflow from the IShares MSCI Emerging Market ETF over the last 8 weeks is greater than total outflows seen in all of 2015.

As another visualisation of how extreme some of the market movements have been in recent weeks, the following chart, which plots the USDCNH FX rate, with the Chinese Yuan now in free fall, with its 50DMA falling through its 200DMA, a technical “death cross” that we haven’t seen for over 2 years.

That silver, a quasi-industrial metal, would be caught up in this sell off is entirely understandable, though it will have frustrated precious metal bulls that gold’s ‘safe haven’ status wasn’t enough to support the yellow metal.

Indeed, after testing the USD $1260oz level earlier in the week, the yellow metal pulled back alongside broader commodity markets (see chart below of the last three trading days), though it is holding important support levels for now.

Yield Curve Flattening

It’s not only the swift pullback in commodity prices that have investors and market participants worried about a slowdown in global growth. The US yield curve continues to flatten, with the spread between US 2 year and US 10 year government bonds now below 30 basis points.

The following chart, which plots the yield curve going all the way back to the mid 1980s, highlights why market participants are worried about the flattening, as it tends to portend the onset of a US recession.

Indeed a research report from the San Francisco Fed suggesting yield curve inversion has correctly signalled every US recession since the mid 1950s, whilst only giving off one ‘false-positive’, whereby the curve inverted, but the US economy avoided recession.

Less anyone think this means the US is about to enter a recession, it is also worth stressing that an inversion of the yield curve can happen anywhere from 6 months to 2 years ahead of the economy formally entering a decline in output.

As such, whilst we may already be in the midst ofa slowdown in the growth of economic output, it may take until 2021 for the economy to enter a recession, if history repeats. The likelihood of a US recession being at least a year or two away makes sense when one considers the fiscal stimulus being deployed in the US, the potential for businesses to meaningfully increase their capital expenditure, and the likelihood that the Fed will ease back on its hiking cycle should markets and/or the economy begin to stutter.

For gold investors, the flattening of the yield curve is a positive sign, as a slowdown in growth and especially a recession will likely be bullish, though its not and of itself a guarantee of higher prices, especially in the short-term. 
 
 
Until next time,
Jordan Eliseo
Chief Economist
ABC Bullion

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