Mixed factors are contributing to the pain being suffered by gold and the miners over the past week. How strong are the bearish fundamentals?
As European economic data sinks like a stone, the EUR/USD has suffered mightily, which has boosted the USD Index. And with more downside poised to materialize for the currency pair, we remain dollar bulls in the months ahead.
However, while stocks suffer and the PMs retreat, is this simply a ‘growth scare’ that morphs into a relief rally, or is something more sinister on the horizon?
Recession Fears Scare Gold
With the PMs declining again on Sep. 7, our GDXJ short position posted another day of profits. Moreover, with gold closing below its 50-day moving average, we think more downside should materialize in the weeks ahead.
For example, the U.S. dollar is one of the main components in our bearish precious metals thesis. And with the EUR/USD accounting for nearly 58% of the USD Index’s movement, Europe’s economic fright fest has pressured the currency pair. Furthermore, we warned this would occur on Jul. 14. We wrote:
Euro optimism contrasts the realities on the ground, and the bulls should suffer mightily in the months ahead.
Please see below:
The green line above tracks the EUR/USD, while the red line above tracks Citigroup’s Eurozone Economic Surprise Index. For context, a positive ‘surprise’ occurs when a data point outperforms economists’ consensus estimate, while a negative surprise is the opposite. And if you analyze the right side of the chart, you can see that the red line has crashed, as Eurozone economic data has come in much weaker than expected.
Therefore, while gold benefits from the euro’s uprising, the ominous fundamentals plaguing the Eurozone should come home to roost and uplift the U.S. dollar.
To that point, S&P Global/HCOB revealed on Sep. 5 that “the Eurozone economy declined at the fastest rate in nearly three years in August.” The report added:
“For the first time in 2023 so far, output fell in both the services and manufacturing sectors. The service sector ended a seven-month run of growth with the steepest contraction since February 2021. Goods production meanwhile dropped for the fifth month running and at another rapid rate, albeit one that eased since July.”
As a result, with Europe racing toward a recession, the fundamental backdrop continues to align with our expectations of a stronger USD Index.
Please see below:
Likewise, we also noted the relationship between the USD Index and European stocks. We added on Jul. 14:
While no one cares right now, investors’ appetite for European risk assets should come under immense pressure over time, and the USD Index should be a primary beneficiary.
Please see below:
To explain, the black line above tracks the monthly movement of the iShares MSCI Eurozone (EZU) ETF, while the red line above tracks the German ZEW Economic Sentiment Index. As you can see, when weak economic sentiment plagues Europe, its stock markets suffer mightily.
Yet, if you analyze the right side of the chart, you can see that the EZU ETF closed at a new 2023 high on Jul. 13, while the ZEW ESI has materially diverged. However, since 2009, the EZU ETF has not been able to prosper when the ZEW ESI crashes, and this time should be no different.
To that point, please turn your attention to the blue line at the bottom, as it tracks the USD Index. If you analyze the vertical gray lines, you can see that when the EZU ETF peaks and begins its descent, the USD Index bottoms and begins its ascent.
Thus, with the prediction proving prescient, the EZU ETF’s downfall has coincided with a USD Index rally.
Please see below:
To explain, the black line above tracks the EZU ETF, while the blue line above tracks the USD Index. If you analyze the horizontal gray line near the left side of the chart, you can see that when the EZU ETF began to stumble on Jul. 14, the USD Index found its footing and the pair went in opposite directions. Consequently, the fundamentals continue to align with our thesis, and the outlooks for gold, mining stocks and silver remain bearish.
More Dollar Fuel
While a Eurozone malaise helps support the greenback, more catalysts could supercharge the dollar’s ascent. For example, the Cboe Volatility Index (VIX) has been heavily depressed in recent months. But, with VIX seasonality highly bullish, a material drawdown of the S&P 500 should result in further profits for our GDXJ ETF short position.
Please see below:
To explain, the black line above tracks the VIX’s average movement during the highest correlation years, while the red line above tracks its movement year-to-date (YTD). If you analyze the middle of the chart, you can see that the VIX typically bottoms in the summer before rising sharply in the fall.
So, if the VIX regains its swagger in the weeks ahead, it should result in more USD Index upside, which is bearish for the PMs.
As another sign of stock market complacency, the S&P 500 has gone 92 days without suffering a daily decline of 1.5% or more. And with the streak near the highs seen over the last ~13 years, a Minsky Moment could be even more painful considering the abnormally bullish behavior.
Please see below:
To explain, the blue line above tracks the number of days it took for the S&P 500 to experience a 1.5% or more daily drawdown. If you analyze the horizontal dotted line, you can see that there aren’t many occurrences where the S&P 500 was more tranquil. As a result, we should see this streak end in the weeks ahead.
Overall, the fundamentals have not deviated from our expectations. High interest rates and a stronger U.S. dollar remain bearish for the PMs, and recession clouds make the backdrop even worse. Moreover, higher oil prices reduce Americans’ disposable incomes, and student loan repayments restart in October. Therefore, recession winds should grow stronger over the next few months.
The Bottom Line
The fundamentals remain aligned with our expectations, as stubborn inflation helped push long-term interest rates higher and keep the Fed hawkish for longer than expected. Yet, with long-term Treasury yields poised to weigh on economic activity, this cycle should conclude with a recession that pushes the PMs to their final lows and the USD Index to a new high.
In conclusion, the PMs declined on Sep. 7, as more pain confronted risk assets. And with the bearish fundamentals far from fixed, more downside should commence in the weeks ahead.
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Alex Demolitor
Precious Metals Strategist