We're in the Black and Staying There

The first month of the year is in the books and it was brutal for most money managers and their investors - 81% of mutual funds tracked by Morningstar are underwater and although hedge funds and separate account asset managers haven’t reported yet, I’m going to guess their stats will be similar.

But not TWR.

On our side of the fence, we stuck to the process that’s gotten us to this point and it paid off once again. TWR subscribers came out of January unscathed; up 1.4% for the month.

Not only that, but we got solid confirmation last week that the playbook we’ve been discussing for months, which would propel gold and US Treasuries higher, is playing out just as we thought it would.

Fed Mumblings

The Fed released its minutes from the January meeting last week. The main takeaway is that the Fed acknowledged that US economic activity had slowed and that inflationary pressures and expectations had declined further.

As a result of this statement, the market has decided that it will take an improvement in the economy and market conditions in general for the Fed to hike again at its March meeting.

A number of market participants have taken this one step further and because there is no major catalyst between now and March, they see no way things can improve enough between now and then to justify a rate hike. They’ve taken all of this to mean that the Fed will likely delay its March hike and deliver another dovish message.

I had a different take on the Fed minutes and didn’t see it as dovishly as others. The statement didn’t say that the Fed’s assessment of the global risks has changed but simply that it's trying to determine whether recent developments should change its perspective on rate hikes. Given the language, my interpretation is that recent events have not reached a level that would require a change to the Fed’s trajectory.

This means the odds of a March hike are greater than the 25% chance of hike that the March Fed Funds futures contract is pricing in as of Friday’s close. The bar for the Fed to raise rates in March is not nearly as high as people think.

But this doesn’t sway me from believing that the Fed will be on a course towards more easing by the end of the year. If the Fed statement was really that dovish, I would expect the USD to give up some ground, but it stood firm. The USD was unchanged on the week and is still trading at its highest level since early December, just 60 basis points away from breaking through the 100 level.

Looking For Contradiction

One of the core principles of my process is that I must be independent, unconventional and open-minded because I can’t make extraordinary returns by evaluating markets the same way everyone else does. Open-mindedness is critical to long-term success.

To that end, I’m constantly looking for facts that refute my beliefs. There are currently two markets that are saying I’m wrong and that we're in for multiple rate hikes this year and no easing at all.

Fed Funds futures peg the chance of a July rate increase at 50% and put the chance of higher rates by year-end at 68%.  Two-year Treasuries, which are the most sensitive to shifts in Fed policy of all the Treasury durations, are yielding 83 basis points. That’s down from over 100 basis points late last year but still higher than September, when the market was convinced the Fed was going to increase rates. These markets are not forecasting a return to zero interest rates, not by a long shot.

The Two Markets To Be In Now

However, there are two markets that are in disagreement. Look at a list of the top performing exchange-traded funds (ETFs) this year and you’ll see that most of them are in some way related to gold and long-dated US Treasuries.

These two markets are two of our 8 Focus Markets that we trade each week in TWR.

GLD, which represents gold, is up 5.4% and TLT, which represents long-dated Treasuries is up 5.6%.

The beauty is that these moves are just getting started. I know this because the price action in both securities has only recently started to pick up and the speculative positioning in gold and Treasury futures is still extremely lopsided to the SHORT side.

Just imagine the types of bull moves that will occur when the historically short positioning in both of these markets begins to reverse. There will be an epic short squeeze to start as hedge funds and the like cover their short positions. This will be followed by a constructive and orderly move higher once this same “smart money” begins to build large long positions.

The market will be waiting with bated breath for this week’s release of the monthly US labor numbers. If the numbers are solid then the market will interpret that as an increase in the likelihood that the Fed will hike again in March. If the numbers come is soft, the opposite will be believed and asset will begin to price accordingly.

That said, the monthly jobs numbers aren’t nearly as important as the weekly unemployment claims, which stand at 6 month highs and are trending in the wrong direction.

Don’t get distracted by shiny objects. There is a better chance of a Fed rate hike in March than what the market is currently pricing in. However, whether the Fed hikes in March is immaterial.

There are two more shoes to drop.

There won’t be multiple rate hikes this year. When markets realize this fact, investors of all types will being to re-allocate assets accordingly. The second shoe will drop later this year or the beginning of next year when the market figures out that the Fed hiked too soon and is going to be forced to go back to easing once again.

When that happens, even more funds are going to flow into our two favorite markets. By the time all of this happens, we will already be positioned to profit, long gold and US Treasuries.