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TODAY’S S&P 500 SET-UP – December 17, 2012

As we look at today's setup for the S&P 500, the range is 23 points or 0.39% downside to 1408 and 1.23% upside to 1431. 















  • YIELD CURVE: 1.49 from 1.47
  • VIX closed at 17.0 1 day percent change of 2.66%
  • UST 10YR – more commodity deflation this morning is good for #GrowthStabilizing expectations (consumption), globally. 10yr yield is +2bps this morning to 1.72%, 3bps above my TREND line (was resistance) of 1.69%; #1 way to get people to buy equities for real is get the flows back (they’re in bonds).

MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30am: Empire Manufacturing, Dec., est. -1.0 (prior -5.22)
  • 9am: Total Net TIC Flows, Oct. (prior $4.7b)
  • 9am: Net L-T TIC Flows, Oct., est. $25.0b (prior $3.3b)
  • 11am: Fed’s Stein speaks on dollar funding in Frankfurt
  • 11am: Fed to buy $4.25b-$5.25b notes in 2018-2020 sector
  • 11:30am: U.S. Treasury to sell $32b 3M, $28b 6M bills
  • 1pm: U.S. Treasury to sell $35b 2Y notes
  • 1pm: Fed’s Lacker speaks on economy in Charlotte, N.C.


    • House, Senate in session
    • Federal Retirement Thrift Investment Board meets, 10am
    • Defense Secretary Leon Panetta discusses U.S. policy, 1pm


  • Apple downgraded at Citigroup; drops below $500 pre-mkt
  • Boehner offers Obama tax-rate-boost deal w/ entitlement cuts
  • Google said to end FTC probe with letter promising changes
  • AIG offers to sell as much as $6.5b of AIA shares
  • First Quantum again raises offer for Inmet Mining
  • UBS said to face $1.6b penalty as Libor settlement looms
  • Starwood Capital nears buy of Principal Hayley: Sunday Times
  • China signals tolerance of slower growth after annual mtg
  • Abe’s LDP wins victory over Noda in Japan election rout
  • Novartis therapy wins U.S. backing for Cushing’s Disease
  • Cisco said to hire Barclays to sell Linksys routers unit
  • Jackson’s “Hobbit” tops weekend box office at $84.8m
  • Holiday spending “modest” through Dec. 8: SpendingPulse
  • SAC e-mails show Cohen consulted on Dell trade
  • Akamai Says co-founder Leighton to become CEO effective Jan. 1
  • Spending probably rose, home sales climbed: U.S. eco preview


GOLD – gold just doesn’t like rising rates - never has – and that makes sense as absolute return (up for 12 straight yrs) on gold looks less exciting when risk free rates move higher. Gold remains bearish TRADE and TREND in our model with a big zone of resistance up at $1/oz.

  • Hedge Funds Reduce Bullish Bets by Most in a Month: Commodities
  • Rubber Surges to Seven-Month High as Yen Weakens on Abe Victory
  • JPMorgan Wins SEC Approval for Physically-Backed Copper ETF
  • Gold Drops on U.S. Fiscal Cliff Talks as ETP Holdings at Record
  • Soybeans Jump to Five-Week High as U.S. Crushes Most Since 2010
  • Rebar Extends Gain on Demand Outlook as China Flags Urban Growth
  • Oil Bulls in Biggest Retreat in Seven Months: Energy Markets
  • China Cuts Natural Rubber Import Taxes to Boost Local Supplies
  • Malaysia Sets Zero Export Tax for Crude Palm Oil to Cut Reserves
  • India Cuts Benchmark Import Price of Gold to $550 Per 10 Grams
  • Malaysia Sets Crude Palm Oil Export Tax at Zero for January
  • Natural Gas Prices Need Cold Winter to Get Off Floor: Outlook
  • HKEx May Allow Chinese Cos. as LME Category 1 Members, HKET Says
  • Brent Crude Futures Drop Amid Disagreement in U.S. Budget Talks










JAPAN – the Japanese begged for a bailout bureaucracy and got it with a big LDP win over the weekend and follow through buying in the Nikkei (up another +0.94% to 9828, up +13.5% since mid November!). Probability continues to rise that Japan becomes 1st modern economy to fall on the sword of Keynesian economic policy (burning currency). Economic data is awful.








The Hedgeye Macro Team




The Rest Of Us

This note was originally published at 8am on December 03, 2012 for Hedgeye subscribers.

“History rouses man to emulate the deeds of earlier generations.”

-Ludvig von Mises


This weekend I forced myself to watch the Sunday morning US political talk shows. While it was sad to watch, it did inspire some leadership thoughts. One was on class warfare. The only two classes I see developing are The Political Class and The Rest Of Us.


Politics is a big business. And I have never been more proud to be neither a Bush Republican nor an Obama Democrat. On economic matters, both parties are Keynesian now. Unlike the Austrian school (center right), Keynesians are center-left. There is no center.


There’s also the left of center-left (Paul Krugman). And these guys are really amping up the Marxist (way left) rhetoric. If you don’t agree with that, read Krugman’s Sunday piece in the New York Times titled “Class Wars of 2012.” #Scary.


Back to the Global Macro Grind


In his preface to Classical Liberalism and The Austrian School, David Gordon recently wrote that, “Ideas do not, as Marxists imagine, reflect the interests of conflicting economic classes. The free market rests, not on irreparable class conflict, but on fundamental harmony of interests of people who benefit from social cooperation.”


I liked that. It’s progressive and collaborative as opposed to regressive and polarizing. On that score, the latter most definitely applies to our generational debate about the #KeynesianCliff. As far as I can see, the cliff debate has 3 big parts:

  1. DEBT
  3. TAXES

This weekend, the left side of the Political Class was focused on 1 of the 3 (TAXES). Meanwhile, this is what Gene Sperling (Director of Obama’s National Economic Council) is actually asking for (he did the interview with Bloomberg TV this weekend):

  1. “a long-term extension of the legal debt limit”
  2. “some stimulus measures to support the economy”
  3. “a tax rate increase for the wealthy”

Got it on point #3 guys – you want to tax us. But what about points 1 and 2? Did some Democrats vote for social issues (that most Independents and socially liberal Republicans agree with), or did they vote for raising the US Debt and Spending levels? Or both?


The Political Class can obfuscate and demagogue all they want about this, but I am pretty sure that The Rest Of Us want to see an arrest of government debt and spending increases, not another moving of the #DebtCeiling goal posts and “stimulus” spending.


Back to the government’s math. In last week’s peculiar (but less than ironically inflated) pre-Election US GDP report of +2.67%:

  1. GOVERNMENT SPENDING contributed positively to “growth” for the 1st time in 9 quarters!
  2. At +0.67% in GOVERNMENT (G) contribution (versus -0.14%, -0.60%, and -0.43% in the last 3 quarters), spending is back!
  3. INVENTORIES contributed the rest of the positive delta, going from -0.46% in Q212 to +0.77% in Q312

Our GDP forecasting model (it’s a predictive tracking algo) couldn’t front run that. Government Spending (+0.67%) and an out of nowhere Inventory build (+0.77%) = 54% of US GDP “growth” in Q3 whereas the C (Consumption) in C +I + G + (EX-IM) = GDP fell to +0.99%. Consumption is 71% of the economy or, put another way, The Rest Of US, too.


All the while, last week global currency investors took USA looking more and more like Italy on debt and spending and sold down the US Dollar for the 2nd consecutive week. Both European and US stocks liked that – they were both up for the 2nd consecutive week at +0.5% and +0.9% for the SP500 and EuroStoxx600 indices, respectively.


Centrally planned stock markets, however, are not the economy. What investors and day traders alike have been trained to do is play the Dollar Debauchery trade that’s in front of them. With the US Dollar under Geithner policy pressure:

  1. CFTC Futures/Options net long contracts jumped +9.8% wk-over-wk (best weekly gain in net long spec since August)
  2. Gold and Silver net long contracts jumped +13% and 12%, respectively (wk-over-wk)
  3. Wheat contracts spiked +35% wk-over-wk

But, if you don’t think rising government DEBT and SPENDING is causal to blowing up the credibility of a country’s currency, you probably think I am just telling you stories this morning.


Sadly, the growing number of class warfare demagogues out there who are emulating the “deeds of earlier generations” are starting to story-tell like Karl Marx did too.


Our immediate-term Risk Ranges (support and resistance) for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1710-1727, $110.07-111.58, $3.54-3.65, $79.81-80.36, $1.29-1.31, 1.58-1.67%, and 1406-1424, respectively.


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


The Rest Of Us - Chart of the Day


The Rest Of Us - Virtual Portfolio


The Economic Data calendar for the week of the 17th of December through the 21st is full of critical releases and events. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.



the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

Weekly European Monitor: Noisy Berlusconi as Grexit Fades

Takeaway: Europe mostly melts higher as government intervention continues.

-- For specific questions on anything Europe, please contact me at to set up a call.


Asset Class Performance:

  • Equities:  The STOXX Europe 600 closed down -0.4% week-over-week vs +1.2% last week. Bottom performers:  Cyprus -3.2%; Slovakia -0.9%; Ireland -0.6%; Switzerland -0.3%; Norway -0.3%.  Top performers:  Portugal +3.5%; Poland +3.0%; Spain +2.2%; Greece +1.9%; Austria +1.8%; Russia (MICEX) +1.7%; Luxembourg +1.6%; Romania +1.5%; Czech Republic +1.5%.  [Other: Germany +1.0%; France +1.0%; UK +0.1%].
  • FX:  The EUR/USD is up +1.81% week-over-week vs -0.45% last week.  W/W Divergences:  PLN/EUR +0.96%; CHF/EUR -0.01%; DKK/EUR -0.06%; CZK/EUR -0.13%; HUF/EUR -0.17%; NOK/EUR -0.86%; GBP/EUR -1.01%; SEK/EUR -1.75%.
  • Fixed Income:  The 10YR yield for sovereigns across the periphery were down week-on-week. Greece declined -154bps to 12.92% and Portugal fell -47bps to 7.09%, and Spain lost -8bps to 5.38%. Germany gain +6bps to 1.36% and Italy rose +5bps to 4.58%.

Weekly European Monitor: Noisy Berlusconi as Grexit Fades - 22. yields



EUR/USD: Our TRADE range is $1.29 – 1.31 with a TREND resistance of $1.31.

  • Our call - the EUR/USD will trade within our quantitative levels and reflect much of the daily headline risk (from Spain, Greece, and Italy in particular), however ECB President Mario Draghi’s September announcement that “the ECB is ready to do whatever it takes to preserve the euro” and the resolve of Eurocrats to maintain the Union will prevent levels falling anywhere near parity.
  • We expect a long road towards a fiscal union as states will be reluctant to give their sovereignty up to an external entity, which should strengthen the lid on the EUR/USD at $1.31.
  • The cross could weaken alongside the ECB showing some willingness to cut the benchmark interest rate: Draghi cited that there was wide discussion [about a rate cut] but the prevailing consensus was to leave rates unchanged when the council met on Thursday.

Weekly European Monitor: Noisy Berlusconi as Grexit Fades - 22. eur usd


Weekly European Monitor: Noisy Berlusconi as Grexit Fades - 22. cftc



Noisy Berlusconi as Grexit Fades:


This week European peripheral equity and credit markets melted higher, taking share from the core. In today’s Early Look we hit on how collectively global data and real-time prices “are signaling a shift from #SlowingGrowth to #StabilizingGrowth.” This is a switch to a marginally more bullish market tone, however the question remains whether governments can stay out of the way of economic stability.


Unfortunately, what we continue to see from Eurocrats is a suspension of economic reality; and bond and equity players have largely cheered on the workings of Draghi, Merkel, and van Rompuy since the early Fall. The latest hope rally is that Draghi will release the OMT to the likes of Spain or Italy, should either country request it.


As we touched on in last week’s note, we continue to call out that growth will remain weak throughout the Eurozone for a protracted period and that estimate revisions are just now coming closer to this reality. Remember, last week the ECB revised Eurozone growth for 2012 and 2013 growth to the ranges of -0.6% and -0.4% and -0.9% and +0.3%, respectively. This week Germany’s  IFO Institute cut Germany’s 2013 GDP forecast to +0.7% from +1.3% previously, while the Bundesbank last week revised Germany’s 2013 GDP projections to +0.4% versus  +1.6% predicted in June.


Yet one signal of data improvement came this week from German PMI Services, which came in at 52.1 in December versus 49.7 in November, showing expansion (above 50) and improvement over two straight months.  However, Eurozone and French Manufacturing and Services PMIs registered below 50 (contraction) and saw little improvement month-over-month.


On the dealings of Eurocrats this week there were two main fronts: 1. Eurozone Finance Ministers set in motion a common bank supervisor by agreeing to terms to allow the ECB to begin direct supervision of up to 200 lenders by March 2014. (The deal still needs to be signed off on by European Parliament  and ratified by National Parliaments).  2. Greece received its disbursement of a €34.4B tranche of bailout funding.


While the latter was widely expected and solidifies our call that a Greek exit (Grexit) or expulsion from the Eurozone is an extremely unlikely event in the medium term, this latest bailout gives Greece good cover going into 2013. On a Banking Union, our call now as before is that while the actions may be a step in the right direction, the key to shoring up the risk loop between banks and sovereigns is setting in place a Fiscal Union in addition to a Banking Union.  Of note is that the 200 banks expected to fall under the ECB’s Banking Union is a far cry from the ECB’s original hope of all 6,000 in the region.



Boisterous Berlusconi

Finally, Berlusconi made broad headlines for a second straight week. The week started with PM Monti announcing his intention to resign once Parliament passes the 2013 budget law (expected to pass before Christmas with early elections likely following on February 17th or 24th) and Berlusconi saying he will take another run at it. Then in mid-week Berlusconi said that he would consider stepping down as a candidate for PM if Monti agreed to run in the upcoming elections as the head of a broad centre-right coalition.


What’s clear is that Berlusconi and his PDL are trailing badly in the opinion polls. Per Luigi Bersani of the Democratic Party (PD) is the current front-runner and despite Berlusconi’s comeback barks he realizes that he personally has no shot to be PM. Further, because a coalition government will have to be formed, Berlusconi may be thinking that the continuity of a Monti victory could bode well for the country’s health.  While Berlusconi’s positioning and utterance may not be clear, expect the risk spotlight to turn up as elections are pushed forward and for Berlusconi's political gravitas to be less than it was in the past.   



The European Week Ahead:

Sunday: Dec. UK releases Dec. Rightmove House Prices


Monday: Oct. Eurozone Trade Balance; 3Q Eurozone Labour Costs; Oct. Italy Trade Balance


Tuesday: Nov. UK PPI Input, PPI Output, CPI, RPI; Oct. UK ONS House Price; Oct. Italy Current Account


Wednesday: Oct. Eurozone Current Account, Construction Output; Dec. Germany IFO Business Climate, Current Assessment, and Expectations; UK BoE Minutes; Dec. UK CBI Reported Sales; Oct. Italy Industrial Orders and Sales


Thursday: ECB Governing and General Council Meeting; Dec. Eurozone Consumer Confidence – Advance; Nov. Germany Producer Prices; Dec. UK GfK Consumer Confidence Survey; Nov. UK Retail Sales; Nov. Spain Budget Balance; Oct. Spain Total Housing Permits; Oct. Italy Retail Sales; Oct. Greece Current Account


Friday: Jan. Germany GfK Consumer Confidence Survey; Nov. Germany Import Price Index; Nov. UK Public Finances, Public Sector Net Borrowing; Oct. UK Index of Services; 3Q UK GDP – Final, Current Account, Total Business Investment – Final; Dec. France Own-Company Production Outlook, Production Outlook Indicator, Business Confidence Indicator; Nov. Spain Producer Prices; Oct. Spain Trade Balance; Dec. Italy Consumer Confidence Indicator; Nov. Italy Hourly Wages



Data Dump:


Eurozone ZEW Economic Sentiment 7.6 DEC vs -2.6 NOV

Eurozone Industrial Production -3.6% OCT Y/Y vs -2.8% September   [-1.4% OCT M/M vs -2.3% SEPT]

Eurozone Sentix Investor Confidence -16.8 DEC (exp. -16.9) vs -18.8 NOV

Eurozone CPI 2.2% NOV Y/Y vs 2.2% OCT

EU27 New Car Registrations -10.3% NOV Y/Y vs -4.8% OCT

Eurozone PMI Manufacturing 46.3 DEC Prelim vs 46.2 NOV

Eurozone PMI Services 47.8 DEC Prelim vs 46.7 NOV


Germany PMI Manufacturing 46.3 DEC Prelim vs 46.8 NOV

Germany PMI Services 52.1 DEC Prelim vs 49.7 NOV

Germany CPI 1.9% NOV Final Y/Y vs 2.0% initial

Germany ZEW Current Sentiment 5.7 DEC (exp. 6.0) vs 5.4 NOV

Germany ZEW Economic Sentiment 6.9 DEC (exp. -11.5) vs -15.7 NOV

Germany Exports 0.3% OCT M/M (exp. -0.3%) vs -2.4% September

Germany Imports 2.5% OCT M/M (exp. 0.4%) vs -1.4% SEPT


UK ILO Unemployment Rate 7.8% OCT vs 7.8% SEPT

UK Jobless Claims Change -3K NOV vs 6K OCT


France PMI Manufacturing 44.6 DEC Prelim vs 44.5 NOV

France PMI Services 46.0 DEC Prelim vs 45.8 NOV

France CPI 1.6% NOV Y/Y vs 2.1% in OCT

France Non-Farm Payrolls -0.3% in Q3 Q/Q

France Bank of France Business Sentiment 91 NOV vs 92 OCT

France Industrial Production -3.6% OCT Y/Y (exp. -2.3%) vs -2.5% September

France Manufacturing Production -4.0% OCT Y/Y (exp. -2.4%) vs -2.6% SEPT


Italy Q3 GDP Final -0.2% Q/Q (unch)   [-2.4% Y/Y (unch)]

Italy CPI 2.6% NOV Final Y/Y [unch vs initial]

Italy Industrial Production -6.2% OCT Y/Y (exp. -4.3%) vs -5.0% September


Spain CPI 3.0% NOV Final Y/Y [unch vs initial]

Spain House Prices for Total Homes -15.2% in Q3 Y/Y vs -14.4% in Q2

Spain Labor Costs -0.1% in Q3 Y/Y vs -0.3% in Q2


Portugal Construction Works Index 55 OCT vs 52 SEPT

Portugal CPI 1.9% NOV Y/Y vs 2.1% OCT


Sweden Industrial Production -4.4% OCT Y/Y (exp. -5.2%) vs -5.0% SEPT

Sweden Unemployment Rate 8.1% NOV vs 7.7% OCT

Sweden CPI -0.1% NOV Y/Y vs 0.4% OCT


Denmark CPI 2.2% NOV Y/Y [inline] vs 2.3% OCT

Finland Industrial Production -0.7% OCT Y/Y vs -2.7% SEPT

Finland CPI 2.2% NOV Y/Y vs 2.6% OCT

Norway CPI 1.1% NOV Y/Y vs 1.1% OCT


Ireland CPI 1.6% NOV Y/Y vs 2.1% OCT


Switzerland Credit Suisse ZEW Survey of Expectations -15.5 DEC vs -27.9 NOV

Switzerland Producer and Import Prices 1.2% NOV Y/Y vs 0.4% OCT   [0.0% NOV M/M vs -0.1% OCT]

Switzerland 3M Libor Target Rate UNCH at 0.00%

Austria CPI 2.8% NOV Y/Y vs 2.8% OCT


Greece Industrial Production 2.0% OCT Y/Y vs -7.3% SEPT
Greece CPI 0.4% NOV Y/Y vs 0.9% OCT

Greece Unemployment Rate 24.8% in Q3 vs 23.6% in Q2


Russia Q3 GDP Preliminary 2.9% Y/Y vs 4.0% in Q2

Russia Light Vehicle and Car Sales 0% NOV Y/Y vs 5% OCT


Czech Republic Unemployment Rate 8.7% NOV vs 8.5% OCT

Czech Republic Industrial Output 4.1% OCT Y/Y vs -6.8% September

Czech Republic CPI 2.7% NOV Y/Y vs 3.4% OCT


Slovenia Industrial Production 2.0% OCT Y/Y vs -0.2% September

Slovakia CPI 3.4% NOV Y/Y vs 3.8% OCT

Romania Consumer Prices 4.6% NOV Y/Y vs 5.0% OCT

Romania Industrial Output -0.1% OCT Y/Y vs -0.1% SEPT

Hungary Consumer Prices 5.2% NOV Y/Y vs 6.0% OCT

Hungary Industrial Production -3.8% OCT Final Y/Y [unch]


Estonia Q3 GDP Final 1.6% Q/Q vs 1.7% initial   [3.5% Y/Y vs 3.4% initial]

Estonia Unemployment Rate 6.0% NOV vs 5.8% OCT


Turkey Q3 GDP 1.6% Y/Y vs 3.0% in Q2   [0.2% Q/Q vs 1.7% in Q2]

Turkey Industrial Production -0.9% OCT Y/Y vs 6.2% SEPT



Interest Rate Decisions:


(12/10) Russia Refinancing Rate UNCH at 8.25%

(12/10) Russia Overnight Deposit Rate HIKED 25bps to 4.50%

(12/10) Russia Overnight Auction-Based Repo UNCH at 5.50%



Matthew Hedrick

Senior Analyst

Rotten Apple

Last year, Apple (AAPL) was THE stock to own. Everyone from portfolio managers to grandparents were loading up on the stock as it continued to make new highs week-after-week. Then, in September of 2012, Apple peaked at $702.10 a share and has since begun a descent of epic proportion as people realize that the stock is overvalued and tech continues to get killed. Since September, AAPL has fallen -27.62% to $508.21 and ended up closing today at $509.82 a share. We're looking to buy soon, but only when our signals indicate the time is right; there's a process for everything and you need to stick to it.


Rotten Apple - image001


Takeaway: We update our bearish bias on gold with a contrarian analysis of the fundamental drivers of this asset class.



  • Gold remains a crowded long for a variety of very obvious reasons – one of which could become less supportive, at the margins, on a sustainable basis.
  • In the note below, we thought we’d take a stab at how a core component of the bull case (i.e. central bank diversification) can come unwound over the long-term TAIL. It’s very important to note that we’re not positing this as the only factor driving the market price of gold; nor are we necessarily suggesting that this is a thesis to run out and short gold today with. Rather, we are offering intellectual ammunition to understand what’s likely going on behind the scenes in the event gold continues to make lower-highs over the intermediate-to-long term.
  • Sustained weakness in the JPY and EUR along with a diminished EM central bank purchases of gold (relative to investor expectations) could provide the necessary lubrication for a sustained USD rally and lower-highs in the price of gold over the long term.
  • All told, we think investors should consider reducing their allocation to this asset class. At a bare minimum, it would be prudent for gold bulls to confirm whether or not our TAIL support ($1,669) holds before increasing exposure to gold here. If $1,669 breaks, there’s no true support to the prior closing lows.


Gold is widely loved and probably over-owned – at both the institutional and sovereign level. Having appreciated in value for 12 consecutive years with a CAGR of 16.4%, the bull case on gold is well understood by just about every market participant.


This is true from traditional L/S equity hedge fund managers all the way down to retail investors, as ETF volumes have been the only thing mitigating the precipitous decline in physical gold demand. The latest data from the World Gold Council (3Q12) showed overall demand had declined -11% YoY from the all-time peak in 3Q11, with every category posting a contraction except “ETF & similar”:






It’s not surprising to see demand for physical gold peaked when the price of hit an all-time peak of ~$1,900 early in the quarter.




We’ll hold off on the discussion on gold supply, as we firmly believe PRICE eventually leads supply in most, if not all commodity markets. For example, if the price of gold rips to the upside, gold miners will likely follow the move by instituting aggressive E&P plans. If the gold price were to plummet, many producers will struggle to operate their mines above the cost of capital and will eventually curb production. Anything in between probably equates to a status quo level of supply growth.


Going back to the point we made earlier about the bull case being deeply penetrated, we thought we’d take a stab at how a core component of the bull case (i.e. central bank diversification) can come unwound over the long-term TAIL. It’s very important to note that we’re not positing this as the only factor driving the market price of gold; nor are we necessarily suggesting that this is a thesis to run out and short gold today with. Rather, we are offering intellectual ammunition to understand what’s likely going on behind the scenes in the event gold continues to make lower-highs over the intermediate-to-long term.



Gold has ripped for over a decade as central banks increasingly diversified out of the primary world reserve currency and into other, more credible currencies, as well as other assets like SDRs and Gold.






We hold the view that credibility within the FX market is 100% relative and ever-changing. The management of foreign exchange is a 24-hour-per-day phenomenon that is consistently anchors on incremental data. Below, we focus specifically on the US because gold and other internationally traded commodities are priced in and settled in USD.


For 10+ years, the stream of incremental data has been a general headwind for the credibility of America’s currency, largely in the form of loose fiscal POLICY and dovish monetary POLICY. That confluence of weak POLICY has created an egregious amount of international money supply that has inflated international reserve assets across both the developed world and non-developed world. Initially, the price of gold appreciated w/o much of a shift in global central bank demand. That changed in 2004 when the confluence of the world’s reserve mangers started to accumulate gold at a rate commensurate with the rate of incremental foreign exchange accumulation. Since 2008 (not ironically when QE1 was introduced), however, they’ve been accumulating gold at a faster rate than incremental FX.







The first major run-up in gold (2004-2008) was occurred as DM central banks began favoring gold over incremental foreign exchange, at the margins. The second major leg up in gold prices came as EM central banks began to do the same (2008-present). This is where the real “juice” likely came from, as EM central banks have increasingly held the lion share of international reserve assets.




The latter point is super intuitive, given that EM economies, on balance, have tended to be more manufacturing and export-oriented in nature (think: China). Additionally, EM central banks have likely aggressively accumulated large amounts of foreign exchange (in lieu of gold, at the margins) over the last 10+ years to resist appreciation pressure on their currencies (think: Chinese yuan and Brazilian Finance Minister Guido Mantega’s “Currency War”).


For reference, Switzerland has been doing exactly this (i.e. accumulating foreign exchange at a rate faster than gold) for the better part of 30 years, as the SNB has semi-perpetually combated the specter of a secular loss of competitiveness – which is a real threat given the country’s +42.9% real exchange rate appreciation over that duration. The CHF’s de-facto ceiling vs. the EUR is yet another example of the Swizz central bank being forced to accumulate incremental FX, lest the country suffer the perceived consequences of having a strong currency amid the international “race to zero” in today’s “Beggar Thy Neighbor” global economy.




That brings us to our final point, which is really a question:


Can EM central banks ever really accumulate that much gold – especially relative to consensus expectations that they are poised to be big players in that market in perpetuity?


There seems to be little political will across the developing world to allow for any dramatic currency appreciation – especially with global GROWTH likely tracking in the +2-3% range for the foreseeable future. This means EM central bankers will continue to be forced to daub up large amounts of fiat currency over the long-term, absent a phase change in the global monetary POLICY landscape.


In light of this, it’s important to note that the People’s Bank of China (a key player in the FX reserve accumulation sphere) now views the yuan at/near an “equilibrium level” and they have been using their USD/CNY reference rate as a tool to temper appreciation pressure emanating from the market for several months now. Incremental Polices To Inflate out of DM central banks will force them to accelerate their pace of foreign exchange accumulation if they are going to resist upward pressure on CNY exchange rates from current levels.


What’s new across developed markets is the political will for the Europeans and the Japanese to pursue incrementally aggressive currency devaluation strategies over the intermediate-to-long term. Keep in mind that we haven’t even seen the ECB really go to town w/ unsterilized bond purchases and that the BOJ’s balance sheet is poised to expand to new heights in a variety of experimental manners under the pending LDP regime.


In short, we think Japan faces the risk of a currency crash (peak-to-trough decline > 20%) over the next 12-18 months. Moreover, unless Europe has been magically fixed (are the Greek and Spanish unemployment situations even “fixable”??), the EUR is likely to continue making lower-highs over the long term. In the eyes of the world’s central bankers, the perceived credibility of the JPY and EUR are likely to be materially eroded over the long term, which, on the margin, is positive for other countries’ currencies to the extent they are credible candidates for international reserve management.


In the aforementioned Global Macro scenario, could we see the USD grind higher against a broad basket of currencies over the intermediate-to-long term? Absolutely – especially if US fiscal POLICY starts to get hawkish on the margin (think: Fiscal Cliff). Perhaps that’s why the US Dollar Index is down less than 100bps YoY, despite the Federal Reserve kicking the ZIRP can down the road 3x in the YTD and instituting perpetual QE – twice in the last three months!




If one is bearish on the US Dollar from here, we can’t even begin to fathom what their next catalyst is, given the USD’s resilience in the face of all that…


In the past, strong USD has been really bad for gold (early-to-mid 1980’s and late 1990’s). The most recent period of sustained USD appreciation came on the strength of the Balanced Budget Act of 1997, so it’s critically important to avoid underweighting fiscal POLICY as a factor for the market price of America’s currency. If Congress and the White House can figure out a way to resolve the Fiscal Cliff in a sustainable and effective manner (a really big “if”), we could see the US Dollar Index approach the high 80s/low 90s level over the intermediate term. That would not be good for gold.




Our quantitative risk management levels for Gold are included in the chart below. If $1,669 breaks, there’s no true support to the prior closing lows. That’s something to think about as you ponder, “Who’s the incremental buyer of gold from here?” For some, that question sounds more like, “Who can I offload my gold to if and when I want to head for the exits before the crowd does?”.




Gold remains a crowded long for a variety of very obvious reasons – one of which could become less supportive, at the margins, on a sustainable basis.


Darius Dale

Senior Analyst

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