he youthful metals bull is set to prevail vs. a stock-market run that’s closer to retirement. A bottoming VIX and escalating trade issues have pressured industrial metals into good support areas, backed by increasingly favorable bullish drivers. A gold rally is a matter of time.
Metals are rested for rally resumption
Essentially unchanged since late August, metals appear well rested to resume a rally. With the Fed’s March interest-rate hike past tense, the positive forward-looking drivers indicate the next stage of a stair-step recovery. The increasing fed funds target signals a recovery that coincides with increasing economic growth and inflation risks, which are positive for metals. The sector also tends to back up into rate hikes, then recover.
Since the March 2017 rate hike, the Bloomberg All Metals Total Return Index has gained about 10% vs. a 6% decline for the trade-weighted broad dollar. With a high annual negative dollar correlation (0.74) and beta (3.05) since 1996, metals have plenty of upside with a peak greenback.
Gold up vs. copper down an ominous indication
Gold atop the 1Q list of top-performing metals vs. copper and aluminum near the bottom is an ominous economic indicator. Precious metals outperforming industrials is typically coincident with a bottoming VIX and peaking bond yields — both clearly evident near the end of March. The Fed’s latest rate hike boosted gold to the top of the March and 2018 leader boards, up about 1%. Stock-market volatility, inflation and a declining dollar are a strong combination for higher gold prices.
The Bloomberg Industrial Metals Subindex Total Return, down 6.5% in 1Q, denotes mean reversion in the strong bull market since the start of 2016. It’s deja vu for base metals vs. a year ago, bottoming in June near the 52-week mean before resuming the rally.
High hedge-fund short-covering risks in bonds
Industrials underperforming precious metals, plus record net shorts, indicate declining Treasury prices are near an end. Among the most consistent bond-yield indicators, the ratio of the Bloomberg Industrial Metals Subindex vs. the precious-metals gauge bottomed in April. Five months later, 10-year yields reached the 2017 low of 2.03%. Despite a peak in industrials vs. precious in December, yields continued to climb. New short positions have been a driver, but cover risks are quite elevated.
Combined managed-money net positions of 30-, 10-, five-year and ultra bond futures are the shortest ever (since 1995). The annual correlation between the 10-year yield and industrial vs. precious ratio is 0.78 since 1991. By comparison, the 10- to 2-year correlation is 0.63.
This analysis is by Bloomberg Intelligence analyst Mike McGlone. It appeared first on the Bloomberg Terminal.