A Few moments

In the iconic movie Wall Street, Bud Fox walks into Gordon Gekko’s office for the first time, glances in the mirror, checks his tie and says, “Life all comes down to a few moments. This is one of them.”

 

There are two realities in trading. First, great trading opportunities don’t come around every day. Second, when those trading opportunities present themselves, you have to act counterintuitively to capture them. Right now, investors are overlooking the fact that there is one market in the world that can trade higher in a wide range of possible presidential, Fed, and economic scenarios. Earning extraordinary returns comes down to making counterintuitive decisions in a few key moments. My friends, right now is one of those moments, and buying gold is the counterintuitive decision.

 

Investors are convinced that the Fed is going to raise rates in December, no matter how bad the economic data looks. In fact, the latest market-implied odds have the probability of a rate hike at 75%. For all of you who love Fed-watching, I hate to burst your bubble, but no matter what the Fed does in December, it’s dovish.

 

When it comes to evaluating markets, I don’t listen to narrative, I evaluate data. Narrative is what sells TV ad space and gets clicks on blogs. But it doesn’t get you paid; in fact, it can be the very thing that leads you and your portfolio to the slaughter.

 

The U.S. economic data has been deteriorating all year long, and over the last couple of weeks it has only gotten worse. This isn’t narrative, this is a fact based on the data, including the first estimate of Q3 GDP. The narrative surrounding the Q3 GDP report was very positive. Given how markets reacted, there are a lot of investors who believe that Q3 growth sealed the deal on a Fed rate hike. The first rule of any data point is that the headline number is meaningless. The devil, if you believe in that sort of thing, is in the details.

 

While everyone was focused on the headline +2.9% quarter-over-quarter growth rate, the real information was buried beneath the surface. My analysis starts with the annual growth rate, because quarter-over-quarter data can be noisy and misleading. The Q3 GDP annual growth rate accelerated slightly from 1.3% in Q2 to 1.5% in Q3, pushed higher by three things: an inventory build, increased Obamacare costs, and unusually high net exports. The exports number stood out because it was the highest in over two years, it accounted for a third of Q3’s growth, and it ramped up even though the U.S. dollar was grinding higher. A strong greenback usually weighs heavily on exports.

 

It turns out that the spike in exports was driven by soybeans, of all things. Wait, what? I didn’t even know the U.S. produced enough soybeans to matter. Historically, U.S. soybean exports peak in the winter months. However, this year there was a lackluster harvest in Argentina and Brazil, which left a huge gap to be filled by U.S. producers. The bottom line is that this is a one-off event, and not a new trend in the U.S. leading the world in soybean exports.

 

If you exclude this soybean export anomaly, the U.S. economy grew by 90 basis points in Q3, which means rather than accelerating by 20 basis points, soybeanless Q3 U.S. growth actually slowed by 40 basis points. This would make Q3 the sixth consecutive quarterly slowdown in GDP growth. Ouch!

 

Believe it or not, the soybean sleight of hand isn’t the worst part of the GDP report. The consumer portion of GDP, which accounts for 70% of GDP growth, fell by 50% from Q2. Fifty percent! And unlike soybeans, this is not an anomaly, because consumer activity has been slowing for well over a year. It’s not just GDP: consumer slowing is showing up in a number of economic reports.

 

If you remove defense spending and aircraft sales from durable goods, you have a good approximation of U.S. household spending. Last week’s durable goods report showed that annual household spending contracted for the sixth time in seven months, and has been negative in 15 of the last 17 months. Oh, and credit card delinquencies have risen for four straight quarters and are at the highest level since 2012.

 

Keep in mind that the consumer is pumping the brakes even before a significant deterioration in the U.S. labor market. The woes of the labor market are going to be on full display this Friday, because October’s non-farm payroll number will be a massacre of Texas Chainsaw proportions.

 

No, I’m not a descendant of Nostradamus, I’m data-dependent. Last October, 298K jobs were created, and there is no way the U.S. economy created that many jobs last month. Unless, of course, the Chinese government does the calculation. This Friday’s jobs number won’t even start with a “2,” which means the annual growth rate is certain to contract. The only question is, by how much?

 

If you’ve read my past commentaries, then you already know that slowing U.S. economic growth is bullish for gold. But I can hear you now: “Landon, have you seen a chart of gold over the last four months?!”

 

I can promise you that if extraordinary returns could be earned by applying simple technical analysis, then there would be more millionaires and less 40-year-old guys living in their momma’s basement.

 

You cannot earn great returns by being Captain Chart Chaser. This game is too difficult. It’s critical to use multiple factors in order to evaluate the quantitative gravity of a market. And no, Elliott waves, astrological signs and “Three Black Crows” Japanese candlestick patterns don’t count.

 

Gold has corrected 8% since peaking in July, but this has been a bullish pullback and not the beginning of bear decline. Does that sound counterintuitive? Good, because remember, great returns are earned when you act counterintuitively in the face of great trading opportunities.

 

I track close to a dozen quantitative factors for each market, two of which are volume and volatility. During gold’s 8% pullback, daily volume has been cut in half and volatility has declined by 65%. I’ve been involved in markets for almost 20 years, and I can tell you with absolute certainty that when markets are in a bearish decline, both volume and volatility explode to the upside.

 

If you think I’m wrong and you’re convinced that being Captain Chart Chaser is the key to success, then look at charts of gold and the S&P 500 from last December.

 

Gold peaked in January 2015 and declined all year, finally bottoming one day after the Fed raised rates for the first time in a decade. Gold rallied 20% over the next 12 weeks, while the S&P lost 1.5% with three times as much volatility.

 

Captain Chart Chaser was the one buying the S&P last December because it was sitting at all-time highs, rather than gold, which was sitting at five-year lows. January and February weren’t fun months for our fair Captain.

 

Behaviorally, gold is flashing all bullish signals. Since the SPDR Gold Shares ETF, GLD, peaked on July 6, investors have yanked almost $2B or 5% of GLD’s total assets. Likewise, in the futures markets, investors have been closing long positions at a record pace and not only that, they’ve been increasing their short bets, too!

 

This is the exact same herd behavior I saw in gold last December. Throughout 2015, investors in GLD yanked $3.5B, and SHORT positions in gold futures stood five standard deviations above their historical average. Gold went on to rally more than 30% in the first seven months of 2016.

 

Last December, the Fed raised rates into slowing data, and what happened? Most financial markets, except gold, cratered instantly, and economic data has continued to slow ever since.

 

If the Fed is dumb enough to raise rates into slowing U.S. data yet again, then what’s the most likely outcome? Remind me, what’s the definition of insanity? A Fed rate hike is dovish because it will force the U.S. into a recession, and the Fed will eventually have to ease policy again to stabilize the economy. This an extremely bullish backdrop for gold.

 

If the Fed becomes data dependent rather than narrative dependent and decides not to raise rates, it’s obviously dovish. No matter what the chart looks like, gold is going to begin a monster rally towards the 2016 highs.

 

Investors paying attention to headlines, listening to narratives, and chasing charts will get crushed. Pay attention to the details, use multiple quantitative factors, and when the time is right, make the counter-intuitive decision to walk into a building that appears to be burning, while everyone else is running out.

 

Life all comes down to a few moments. This is one of them.