2016 Forecast! The Two Markets to Watch

It’s that time of year again, every pundit, blogger, bank and money manager is filling the media with forecasts for 2016. Do you want to know where the S&P is going to end the year?  How about if 2016 will be the year that OIL finally catches a sustainable bid? There is no limit to number of people willing to throw out their crystal ball forecasts for public consumption.

There is only one problem with all of these forecasts. There is absolutely no way any of these forecasts can be used to manage your portfolio.

There are too many issues with forecasting to cover them all here. Suffice to say, there are an infinite number of factors that influence economic, political and market-related developments. This means that there is a ton of randomness present at all times and its impossible to bifurcate causation and correlation. If we can’t accurately forecast weather out further than 3-5 days with all of the technology available to us, what makes us think that anyone can forecast something as complex as the global economy and global financial markets out even 3 months, much less an entire calendar year from now? The short answer is they can’t.

Take Goldman Sachs for example. At the end of 2014, GS forecasted that the yield on 10-year US Treasuries would end 2015 at 3.0%. Shockingly, they turned out to be wrong. Last week they put out their forecast for where the 10-year would end 2016. What do you think they are predicting? That’s right, 3.0%. Say what you will about big banks but the truth is that they have essentially unlimited resources and unlimited intellectual capital. If they can’t forecast any better than that, why in the world would the rest of us waste time and energy on that pursuit?

I’ve long said that one of the key skills required to gain a sustainable edge over other market participants is to better understand the present. You are far better off to understand the current realities and their implications as opposed to trying to forecast the future. Everyone sees what happens everyday but very few people take the time to step back and evaluate what everyday events say about the investment climate and respond accordingly.

To help you towards that end, I’m going to discuss two markets that are showing strong signs of directionality and have strong catalysts, right now.

I'm a contrarian. And that means I love to see a market where the price action is diverging from what I would expect to see given the prevailing economic or policy conditions, coupled with investor positioning that's extreme and leaning in the wrong direction because they are focused on the wrong information.

The gold market currently has both of these characteristics in spades!

Gold should have been decimated with the Fed’s decision to raise rates but what we’ve seen instead is gold has traded sideways for the last 2 months and is still trading above it’s 2010 lows. This price action is extremely constructive from a bullish perspective but hasn’t received a lot of attention.

Gold has been quietly building a solid base between $1,100 and $1,000, which tells me that the market is skeptical of the Fed’s ability to follow through on its rate hike plan and that global growth concerns are undiminished.

The speculative positioning is both extremely bearish and seemingly ignoring the most recent price action.  The “smart money,” mostly hedge funds, have been adding to their short exposure for months now and have never been more short as a group than they are right now. Commercial speculators, corporations attempting to hedge away the risk of an adverse move in gold, have all but eliminated their short positions, which are at their lowest level in 14 years!  This on its own is an extremely bullish indicator. Coupled with the “smart money” positioning and you have a powder keg that can ignite a massive rally in gold.

I would use SPDR Gold Trust ETF (NYSE: GLD) because it is heavily traded and unlike futures contracts, it can be traded inside of both taxable accounts as well as retirement accounts like IRAs.

GLD could trade as low as $96-100 before it begins a sustained move higher. Once the rally begins there are three critical overhead prices to monitor. The first is the range between $104.50 and 105.50. If GLD can close above that area, traders will start to take notice and some of those wrong-footed speculators will begin to cover their SHORT positions. A GLD close above $110.00 is a confirmation signal that the bullish theme is gaining steam. If GLD subsequently closes above $114.00, load the hopper because there is clear sky for GLD all the way to $130.00.

Another market that is setting up to be a great opportunity in 2016 is long-dated US Treasuries.

Investors are currently mispricing what effect slowing global growth will have on the Fed’s planned 2016 hikes and as a consequence the ultimate impact on US Treasuries. Position yourself to profit when the market finally figures out the realities.

Despite Yellen’s attempts to convince markets that US growth is fine and that the risk of global growth bleeding over into the US is limited, the markets aren’t buying it. I know this because 10 and 30-year US yields have been making lower highs for 2 straight months and both are trading below decade old downtrend lines. Likewise, the 3.5% rally in the 30-year bond since the beginning of November is telling us that investors are concerned about the trajectory of global growth. 

Just last week the head of the IMF confirmed this concern. Lagarde flat out stated that global economic growth next year will be disappointing and that even the intermediate term outlook has deteriorated. She went one step further saying the combination of higher rates in the US and further slowdown in China are increasing the risk of an economic collapse. I love Treasuries with an economic backdrop like that one.

Despite the fact that some markets and leaders are speaking clearly, the “smart money” speculators are short Treasuries all along the curve and sentiment across the board is extremely bearish. These speculators have been increasing short exposure in the 30-year bond for the last 2 years and are more short than they’ve been in the last 5 years. The contrarian in me loves this type of extreme positioning because when this group of speculators, mostly hedge funds, figure out they're wrong, the stampede for the door will cause a massive short squeeze, propelling long bonds higher.

Use the iShares 20+ Year Treasury Bond ETF (NYSE: TLT) because it’s one of the most actively traded ETFs providing ample liquidity. Don’t be alarmed if TLT trades down to the $114-118 area. In fact, that would be the ideal place to initiate new LONG positions. A close above the $123.00 area for 3 consecutive days is the 'all clear' signal for further TLT strength.

I can’t tell you where GLD or TLT will end 2016, and I wouldn’t insult your intelligence trying to do so. But what I can forecast will be true in 2016 is that the best opportunities in financial markets come when the public’s perception of an event diverges from the actual probabilities. The divergences occurring in both gold and Treasuries is creating a great opportunity for investors who are on the right side of the trade in 2016.